FIG Private Equity: How to Navigate the Undiscovered Country

FIG private equity might sound like a contradiction or an impossibility.

After all, “everyone” knows there isn’t much private equity activity in the financial services sector.

If a PE firm acquires a certain percentage stake in a commercial bank, it gets classified as a “bank holding company” in most countries… which translates into heaps of new regulations and restrictions on the firm’s activities.

Plus, most banks and insurance firms are already highly leveraged, and you can’t use standard metrics such as FCF or EBITDA to price deals involving them.

Despite these issues, though, quite a few private equity firms do specialize in financial services deals.

They’re not common compared with tech, healthcare, industrials, and consumer retail firms, but if you’re willing to search, you might just find a unicorn at the end of the rainbow:

What is FIG Private Equity, and How Does It Work?

FIG Private Equity Definition: A financials-focused private equity firm raises capital from outside investors (Limited Partners), invests in companies in the brokerage, asset management, fintech, commercial banking, insurance, and specialty finance verticals, and grows and sells these stakes within 3 – 7 years to realize a return on their investment.

Notice the order of the verticals and the “invests in” language (rather than the usual “acquires”).

The order is intentional because the brokerage, asset management, and fintech verticals have far more PE deal activity than the specialized or Balance Sheet-driven verticals (commercial banks, insurance, and specialty finance).

And even when private equity is active in commercial banking or insurance, many deals take the form of minority stakes, like growth equity or venture capital deals.

Financial services deals account for ~5% of total PE deal volume each year (the numbers below are from Patria and Baird and are for the European market, but the percentages are similar in other regions):

It’s a low percentage because there’s a disconnect between the size of the verticals within FIG and the deal activity in those verticals:

(Source: Capital IQ)

I could not find a breakout of PE deal types by vertical, but since most FIG deals are in the non-specialized sectors, I assume that most deals take the form of traditional leveraged buyouts.

After that, growth equity and growth buyout deals are likely #2 and #3 due to the high activity in payments and fintech.

Also, the sparse deal activity in banks and insurance is often put in these categories.

Why Has Private Equity Avoided Banks and Insurance Firms?

Traditionally, private equity firms have stayed away from commercial banks and insurance firms for the regulatory and financial reasons mentioned above.

PE firms do not want to get classified as “bank holding companies” or “insurers,” because this means they need to comply with regulatory capital requirements and follow stricter federal and state laws.

In the U.S., a 25% stake in a commercial bank makes the PE firm a “bank holding company” – but if it has enough control/influence over the bank’s operations, even a much smaller stake could trigger this classification.

Financially, the traditional leveraged buyout model does not quite “work” for these firms because they have a different relationship with Debt than normal companies.

As banks and insurance firms grow, they do not de-lever, but instead amass even more Debt because it is more of a “raw material” for them.

They use it to fund the “products” on the Assets side of their Balance Sheets (Loans and Investments).

Therefore, one of the key sources of returns in a traditional LBO – Debt Paydown and Cash Generation – does not exist in the same way.

PE firms can still invest in these firms and earn solid returns via Multiple Expansion, Dividends, and Book Value Growth, but these require different skills and market conditions (see below).

Does Private Equity Like Other Financial Institutions?

Outside of these verticals, other areas within FIG are more attractive to PE firms.

For example, many asset management firms are appealing because they earn fees based on their assets under management (AUM), which translates into recurring, “sticky” revenue.

The industry isn’t doing well due to the rise of passive/automated investing, but many PE firms see that as an opportunity to make bolt-on acquisitions and grow by acquiring cheaper firms.

Brokerages can be less attractive because the revenue may not be “recurring” in quite the same way, but there are opportunities even there.

For example, there has been significant PE activity in the insurance brokerage space because it’s highly fragmented, brokers are regulated differently from underwriters, and there is some recurring revenue because many insurance policies are renewable, and brokers earn a percentage of renewals as well.

In areas like payments and fintech, most PE firms use more of a “growth equity” strategy and use their capital to expand companies’ markets and geographies.

And in specialty finance, the appeal is that it’s like commercial banking but with lighter regulations and the opportunity for outsized returns.

For example, PE firms might back specialty lending firms that cater to underserved populations, such as small businesses or subprime borrowers.

Specialty lenders have a higher cost of capital than traditional banks, so they need the ability to earn an outsized ROA and ROE based on a niche market or some type of technology or customer acquisition advantage.

Some of the private equity mega-funds also like to acquire specialty lenders and then invest in their loans via the PE firm’s internal credit funds.

Effectively, it’s “double-dipping” and using one part of the business to boost the other.

The Top FIG Private Equity Firms

The largest dedicated FIG PE firm is Stone Point Capital, with $65 billion in AUM and investments in hundreds of companies.

Some of the other top dedicated firms include:

Many of these do more than financial services deals; for example, Pine Brook focuses on both energy and financials.

If you consider financial-focused VC firms, you could also add names such as CreditEase, Motive Partners, QED, and Ribbit Capital to this list.

Moving up-market, there are also quite a few middle-market private equity firms that do financial services deals.

Examples include Crestview, Genstar, HGGC, Kelso, and TH Lee.

In the “upper-middle-market-to-growth-equity” range are firms like Centerbridge, GTCR, New Mountain Capital, and TA Associates.

Finally, most of the mega-funds and other “large” funds have done financial services deals, but they’re usually in fintech or tech-adjacent spaces.

Examples include Advent, Apollo, Bain, Blackstone, Carlyle, Francisco Partners, Hellman & Friedman, KKR, Permira, Silver Lake, Thoma Bravo, Vista, and Warburg Pincus.

How FIG Private Equity Deals Work

To illustrate the math and deal mechanics, we’ll look at one deal for a non-Balance-Sheet-driven firm and one deal for a commercial bank.

The example here is Advent’s $6.3 billion Enterprise Value leveraged buyout of Nuvei, a Canadian payments company.

In the years before the deal, Nuvei was growing revenue at a ~48% CAGR, clearly putting it in the “high growth” category:

Since it was EBITDA-positive, Advent used debt to finance this deal, which was executed at ~14x LTM “Adjusted EBITDA” (the adjustments here are questionable, but we’ll go with them).

The capital structure looked like this:

The leverage ratio is high but not necessarily unreasonable (5 – 6x EBITDA).

This was a classic growth buyout deal in which the PE firm bet on high growth rates and an expansion of Nuvei’s market to make it “less niche.”

Even with 16% forecast annualized revenue growth, the deal math would probably not work without debt.

You can find TD’s entire valuation and deal presentation here if you want to learn more.

It’s nearly impossible to find a good example of a recent, non-distressed buyout of a commercial bank, so I will use this fictional example based on MidFirst Bank, taken from our Bank Modeling course.

The basic deal parameters are:

• Purchase P / TBV Multiple:5x (banks are typically priced based on Book Value or Tangible Book Value)
• Equity %: 100% (it’s some type of consortium deal)
• Assumed Multiple Expansion: 20%
• Assumed ROA Improvement: 2%
• Cost of Equity: 15% (higher than normal since it’s a smaller bank)
• Common Equity Tier 1 (CET 1) Target: 10% (this determines the bank’s Dividend levels and how much capital it must retain)

The key model driver is the growth in Gross Loans, but the 10% CET 1 target constrains it.

Deposits and Debt are both percentages of the Gross Loans, and the ROA falls over the holding period, but gets bumped up due to the 2% improvement.

The 5-year IRR sensitivity looks like this:

The key point is that with bank (and insurance) buyout deals, leverage is not required to earn a 20%+ IRR.

If the PE firm can improve the firm’s ROE, reduce its Cost of Equity, or boost its Net Income in other ways, it can achieve multiple expansion and get a higher price in the exit.

The cash flows and returns attribution also look quite different:

In a traditional LBO model, a Dividend Recap might boost the returns by a modest percentage, but ongoing Dividends would never explain 28% of the equity returns.

TBV Growth and P / TBV Multiple Expansion are the analogues of EBITDA Growth and EBITDA Multiple Expansion for standard companies.

There is no Debt Paydown or Cash Generation for the reasons mentioned above: Cash and Debt are more like raw materials for banks.

PE deals for banks could take other forms as well:

• The PE firm could invest in another part of the capital structure, such as the bank’s Subordinated Notes, Preferred Stock, or Convertible Bonds.
• The PE firm could acquire some of the bank’s loan portfolio or other assets (e.g., KKR acquiring Discover’s student loan portfolio).

On the Job in FIG Private Equity

Most career differences have far more to do with your firm’s size, strategy, and performance than with FIG vs. non-FIG.

However, there are a few industry-specific points worth noting:

1) Many of the FIG-focused PE firms listed above are small and may have inconsistent performance, so you are taking a risk in terms of deal experience and promotions.

A prime example is JC Flowers, which was recognized as a top FIG PE firm for many years.

But then the 2008 financial crisis struck, many of their deals went bust, and they earned a 0.36x investment multiple on their Fund II (i.e., they lost 64% of investors’ capital).

2) You will get pigeonholed if you stay in FIG for any length of time, even if you work on brokerage, fintech, or asset management deals.

Recruiting

If you want to target dedicated financial services PE firms, you almost certainly need to be in FIG investment banking to have a shot.

It’s quite specialized, and even if you target verticals where you have deal experience, headhunters are dense and will not understand the nuances.

I have collected several case studies from these firms over the years, and they are completely different from standard PE case studies and LBO modeling tests.

Even if the firm focuses on brokerage or fintech deals, they could still give you a bank or insurance case study, so you should be prepared for anything.

As usual, most of the UMM / MF firms use on-cycle recruiting, while the smaller ones are mostly off-cycle.

Should You Target FIG Private Equity Roles?

Since financial services private equity is even more specialized than the financial institutions group in investment banking, this is an extension of the “Should you go into FIG IB?” question.

Personally, I would not recommend it to most people.

*I* think it’s an interesting sector, and I like creating case studies for financial firms since they’re so different.

But I’m also not working in private equity, and if I get bored, I can always create new courses based on new sectors or deal types.

If you are working in PE and you focus on one sector consistently, you should be cautious about FIG.

If you’re 110% committed and have no desire to do anything else for the next 5 – 10 years, sure, maybe one of the dedicated firms makes sense.

But if not, you should aim for the generalist UMM/MF firms that do some financial services deals but also operate in many other areas.

Sometimes, it’s best to stick to the tried-and-true path rather than exploring the undiscovered country.