Greater flexibility in capital structures means more opportunity, experts say

Private equity makes a comeback amid recovery
CEOs and CFOs can take advantage of shifting capital structures, say Bain and Co. executives.

Capital structures are getting more flexible, say three executives from Bain and Co.

Alternative investment models are emerging as activist investors have seen success with applying shorter-term pressure to the chief executive officer agenda at publicly traded companies, wrote James Allen, co-leader of Bain’s strategy practice; James Root, co-leader of the firm’s organization practice for Asia-Pacific; and Andrew Schwedel, head of the Macro Trends Group, in a CFO article Monday.

“Traditional equity and debt raising will continue to be vital to corporate growth, but capital structures are becoming more flexible,” they wrote. “That offers the potential to align investors more closely with a firm’s strategy, time horizons, and specific investment projects. That trend will bring its own set of pressures; the emer­gence of these new vehicles will offer new potential for activists to target specific pieces of firms, which will increase the sophistication required of a company’s investor relations strategy.”

The experiments are responding to stagnation at 12.5% of the average hurdle rate, or the minimum rate of return on a project or investment that a manager or investor requires, and declines in capital expenditures and research and development budgets alongside increases in share buybacks and dividends.

“Many CFOs abhor this dynamic,” the authors wrote. “They, their [chief executive officers], and their board members have voiced increasing dissatisfaction, and many institutional investors such as Vanguard, BlackRock, and Warren Buffett have urged greater long-term focus and reinvestment.”

Private equity firms, which aren’t subject to short-term pressure, have lengthened their investment horizon from four and a half years in 2006 to six years in 2016, and other firms such as Blackstone and the Carlyle Group have started funds with even longer periods, according to the article. Additionally, scale startups are staying private longer or going from venture to private equity ownership.

Investors are also looking at investing in specific aspects of a firm without owning a share of the whole, the article states. For instance, “Pfizer and other pharmaceutical companies have lined up one-off funding for the development of specific products, matching their capital needs with the risk prefer­ences and expertise of individual investors,” the article states.

Other examples include Unilever’s green bond, which offered clearly defined criteria on greenhouse gas emissions, water use and waste disposal related to funded projects, and peer-to-peer lending and crowdsourcing platforms such as Kickstarter and GoFundMe.

“Over the next 10 years, it’s likely that the line between public and private ownership will blur,” the three wrote. “Large public companies will pursue long-term anchor investors and adopt the governance practices of leading private inves­tors, while larger private companies will trade in sec­ondary markets that require enhanced investor protec­tions. The line between debt and equity will also blur, as off-balance-sheet project-based equity becomes a significant funding source.”

They also predict the emergence of an “ecosystem of financial intermediaries” that can help investors find and access projects. CFOs and CEOs should ask themselves what they would do if capital and investor requirements were not constraints and if they can come up with more good ideas than they can fund. Those who answer yes would be wise to divide the investor base along time horizon and risk appetite, the experts wrote. “There’s an abundance of capital out there searching for projects that will create corporate growth, and CFOs now have new avenues to tap it,” they added.

Suggested Articles

Veteran CEO John Schwarz says the times dictate a fresh approach to the chief executive position.

Very little attention has been paid to the flip side of the CEO salary debate: CEOs whose salaries are much less out of kilter with workers' salaries.

Hamid Hashemi, CEO of iPic Entertainment, wants to make moviegoing an elegant experience.