business Private Equity Industry Update January 07, 2020 Private equity firms must address several significant challenges in 2020, including high valuations, cyber risks and a talent shortage. Here are the details. Many private equity (PE) firms have thrived in recent years, fueled by large amounts of “dry powder” (cash reserves) and strong credit markets. Forecasters expect deal activity to remain healthy, but firms must address several significant challenges.Focus on ValuationsSkyrocketing valuations of portfolio companies have led to relatively low exit activity in 2019. Not surprisingly, high valuations are drawing increasing scrutiny from both investors and regulators. This scrutiny could intensify if the Securities and Exchange Commission follows through on loosening the requirements for PE investors.PE firms can expect increased pressure to be transparent about how they value their portfolios, including the specific methods they use. Although mandatory standards have been established for valuations of publicly traded companies, private company valuations aren’t subject to such constraints. PE firms can employ a variety of approaches, including:The guideline public company method,A discounted cash flow analysis,A comparable transactions evaluation, orA combination of these or other methods.Consistency in selecting and applying these methods is critical to building stakeholder confidence in the results. They’re also likely to have greater faith in valuations performed by third-party appraisers. Both factors boost the odds of passing muster when subjected to operational due diligence by potential limited partners and other interested parties.Cybersecurity RisksPE firms are confronting cybersecurity issues on two fronts — in their own firms and in their portfolio companies. Firms make ripe targets for cyberattacks, because they move large amounts of money, collect mountains of sensitive data about investors and others, and often allocate inadequate resources to protecting themselves from hackers and cybercriminals.For example, perpetrators might obtain access to wire transfers by sending phishing emails to PE firm employees who deal with outgoing payments. Then they could search messages for outbound wire instructions and execute or alter a wire transfer to send the money to their own accounts. Hackers also can dig through email accounts to learn about investors, impending deals and similar information that could be used for ill-gotten gain. PE firms must pay close attention to the cyber risks when evaluating target companies, too. Investors expect firms to take the necessary measures to ensure targets don’t come with poor security practices that require costly upgrades or undisclosed cyber incidents that could lead to hefty fines and reputational damage. Comprehensive cyber risk assessments are especially important for target companies with business models that are heavily reliant on technology and digital data. Search for TalentWith longer holding periods becoming more common, PE firms can no longer reap quick profits simply by slashing costs. Instead, success will come from growing portfolio companies to generate higher returns. That strategy requires hiring top-notch executives who can optimize investments. In today’s tight job market, though, landing such talent is easier said than done. And the retirement wave among Baby Boomers doesn’t help.The priorities when hiring include matching the candidates to a particular firm’s strategies. A candidate can have an impressive resume with years of experience in the relevant industry — but does that background align with the expected strategies for growth and value-creation? And does he or she have the discipline and accountability to work with equity sponsors and satisfy the performance demands of equity investors? Increasingly, PE firms are outsourcing talent acquisition to executive search consultants that use sophisticated assessment tools for assistance. Bringing in qualified recruiters allows firms to devote themselves to their core competencies. Contact UsThe future looks promising for PE firms that anticipate and prepare for the bumps in the road. Our venture capital and PE group can help your firm stay ahead of the curve on these and other issues and continue to prosper going forward.