Gloomier long-term outlook for private equity should bring buy-out recruitment back down to earth

Early last year this column dubbed the latest round of high-profile, highly-expensive private equity recruitment as the high-water mark for the status of the common-or-garden buy-out lawyer. Like the house-price bubble, this trend had been building for a long time; David Cheyne first spoke publicly of the need for Linklaters to recruit private equity talent way back in 2001. By early 2006, the general desire to secure the services of a decent City buy-out partner had become near-obsessional at too many firms to mention. That the flow of transferring senior lawyers slowed over the past 12 months was thanks to the very limited supply of partners ready to swap sides rather than any lack of demand from firms ready to offer big money.

But the sustained turmoil in the credit markets over the summer has surely at last pricked this mini legal bubble. There are plenty of reasons to believe that the overall picture for M&A is one of only moderately painful correction, but private equity is facing a gloomier future as more expensive debt cuts back sponsors' buying power.

Data provided for Legal Week by Mergermarket shows the dramatic impact that the recent credit turmoil has already inflicted on the industry. While European M&A activity in August as a whole still ran at roughly half the level of the very busy August 2006, private equity virtually shut down at the upper end last month. In the UK, private equity deal value fell from E24.7bn (£16.7bn) last August to just E2.98bn (£2.01bn). Obviously, there is a limit to what you can draw from a genuinely exceptional month, but in a fundamental reassessment of risk – which this is – the odds are that it is going to be more sedate in private equity land than it has been for a long, long time.

Taking the credit

Even the less buoyant outlook cited above relies on there not being a credit crunch proper, rather than the inter-lender paranoia and malfunctioning black boxes fouling up short-term debt markets that occurred last month. Should banks start withdrawing credit from reliable industry borrowers, private equity and its advisers will have to shut up shop for months.

This environment should prove a wake-up call to partners who have become used to being feted, in some cases beyond their contribution. For those recruited on lavish packages, the pressure to deliver will be intense and often hard to manage given the notorious unpredictability of fees in the sector. This will be particularly pressing at US firms which will find it harder to diversify out the impact in Europe.

Another legal bubble that seems certain to face a bit of deflation is structured finance, where advisers in asset-backed securities are strapping in for a slower period. Many branches of securitisation should be reasonably resilient, but lawyers focused on slice 'n' dice products like collateralised debt obligations, where banks are already shedding staff, could soon find themselves 'refocusing' their practices. Such markets have also been on a long upward trend but at least in legal this has not been further inflated by the sustained lateral recruitment seen in private equity.

That's not to exaggerate. Private equity has established itself as a serious part of the City and the world's deal economy and it will remain so. But the current conditions are serious enough to recall that truism about markets: it is only when the tide goes out that you see who was swimming naked in the sea.