Q&A with Jesse Hurley on Private Equity in Today's Innovation Economy

Silicon Valley Bank is well-known for its role in the venture ecosystem. Can you describe how SVB also works with private equity firms?

Across the bank, we are in the business of financing innovation. This approach extends to our investor partners, and 20 years ago we pioneered creative financing solutions for our venture firm clients. As a result of this experience, SVB has also developed unparalleled expertise in lending to and banking private equity firms. Today, our Global Fund Banking business works with more than 1900 venture and 700 PE firms globally.

SVB’s deep industry experience and nimble approach to fund lending helps firms address their financing needs. Our tailored liquidity and fund-level debt solutions include subscription/capital call facilities, fund-guaranteed loans to portfolio companies and NAV-based facilities. For example, our Fund Banking team may provide financing to a fund’s portfolio company that perhaps a more traditional bank would not be comfortable offering. The unsecured note is often lent to a holding company housing the fund’s investment in the portfolio company, and the note is guaranteed by the fund. This fund guarantee allows SVB more flexibility in underwriting. As the company scales, the firm could look to refinance the guaranteed debt, removing the guarantee from the fund.

We know there is a lot of dry powder with more firms chasing deals. How is this impacting private equity?

As of December 31, 2017, US PE dry powder was at $493.6 billion—that’s an incredible amount. Globally, firms continue to raise larger funds, enabled by the robust business environment and an unprecedented pace of deployed capital flowing to larger deals. Also, LPs are flush with distributions from older vintages, with 752 PE–backed exits through September 2018. With the bull stock market of the past decade, LPs need to increase the capital allocated to PE to simply maintain their internal PE target allocation. We have also seen strong returns in the asset class over the past five years, and GPs are not paid to try to time the market; so given the sheer amount of dry powder, there is a need to continue deploying capital, even if some think valuations are high to frothy. As a result, PE deal multiples are reaching historic highs.

We are also seeing PE firms deploy new strategies, including credit options to augment existing growth, buyout and real estate funds. Given these firms’ robust deal-sourcing methods, they often find opportunities that may not fit their equity strategy but would be a good match for a debt investment. In other cases, they may supply credit exclusively to their existing portfolio companies in need. In both scenarios, PE funds are seeking to capture the value internally instead of sending it to a third-party debt fund.

Some of the larger PE firms are carving off smaller pieces of their growth funds, for example, to focus on seed or Series A deals. This strategy helps deal sourcing and identifies potential investment opportunities down the road. As those younger companies mature, the PE fund may have a good vantage point from which to consider making a later investment from its larger growth fund. With such rich valuations in growth and midmarket companies, funds are chasing better returns and investing in earlier stages.

Looking ahead the next 12-18 months, how do you see private equity evolving?

Short term, I don’t see the supply/demand equation of capital vs. opportunities changing meaningfully anytime soon, so deal multiples will likely remain high. Even if we see an economic downturn or a material ramp in interest rates constraining borrowing capacity, there still will be historic amounts of dry powder (both direct and secondary) to fuel liquidity options.

Stating the obvious, it’s definitely time to be harvesting, and many firms have already done so. As discussed above, it’s also a historically great time to fundraise; and with fresh allocations from LPs on the horizon, I expect fundraising to continue unabated in the first half of 2019.

Another trend we are monitoring is what I would call the blending of capital sources in private equity and venture investing. PE and hedge funds continue to show more interest in venture and growth-type deals, as their deal flow remains limited and hyper-competitive. I’ve spoken with multiple Series A venture firms that say they now view private equity as a top potential liquidity option for their portfolio companies. In general, it is a phenomenal time to be an entrepreneur and a founder.

With such fierce competition for deals, what other nontraditional strategies are private equity firms considering?

We have seen platform models being deployed with more regularity, a strategy in which firms are aiming to buy small companies at low multiples, build in a fragmented market and then sell the larger company at higher multiples. Other interesting trends we’ve seen lately include hardware-as-a-service, alternative-financing/fintech companies and their warehouse needs and home-as-a-service. On the latter, we’ve seen PE firms targeting the fragmented home-service market, to roll up multiple companies and take on a market. As a dad of two young kids, this market particularly resonates with me: I go home at night and struggle to find time to cook or mow my lawn or clean the house or work on my HVAC system. So consumers may be willing to pay nearly whatever it takes to get these kinds of recurring services, which can carry attractive margins.