Leverage has returned full throttle for large private equity houses
Bill Nixon, managing partner at Maven Capital Partners UK, also says managers are partly remunerated on deploying funds, so there can be a temptation to overpay for good assets.
Is there too much cash in the private equity sector?
The UK private equity sector has now established a track record of delivering high returns to investors, which has in turn seen more entrants to the sector, and more capital looking for a home. Managers are partly remunerated on deploying funds, so there can be a temptation to overpay for good assets. The best vintage of returns for many managers are for transactions completed during the period following the financial crisis when less capital in the system meant less competition, and better entry pricing for the private equity sector.
Are corporates willing to spend more money on buyouts than private equity companies?
It depends on the nature of the corporate buyer. Smaller corporates without private equity backing are often reluctant to overpay for acquisitions and may need the support of their bank to finance an acquisition. Private equity backed ‘buy and build’ companies tend to be more willing to pay higher prices for acquisitions, especially if they are in a hurry to deliver an enlarged business or group which will be attractive to a buyer. Public companies can often pay much as their rationale and metrics in relation to a purchase can be different, or have a longer term strategic rationale. Critically, a public company trading on a healthy earnings multiple can often pay up for an acquisition at a level private equity buyers cannot match. A Private Equity buyer needs to acquire at a level that leaves some ‘arbitrage margin’ in for the next buyer, whereas a public company will be primarily focused on whether the purchase is EPS (earnings per share) enhancing and a strategic fit.
Is bank debt difficult to obtain for private equity houses? What impact does it have on investments and returns?
For larger private equity backed transactions, the amount of available leverage has returned to pre-crisis levels. At the lower mid-market or SME end of the market bank debt can remain challenging to obtain, or is available at modest levels, with challenging terms including covenants and repayment and pricing at a level that can make a private equity investor think, why bother? In some cases, private equity houses are funding an entire transaction without recourse to bank debt. Whilst this allows much greater control, returns can be depressed without the use of bank debt to leverage the equity capital.
The introduction of the new EU state aid rules has restricted the activities of venture capital trust managers. How does that affect the market?
The introduction of state aid rules into UK statute in 2015 to comply with EU legislation has restricted the activities of many VCT managers. Older companies unless there are new markets or geographies being tackled and transactions which involve ‘cash out’ such as an MBO or replacement capital investment, are strictly prohibited. The aim of the legislative change is to bring the UK into line with other member states and channel VCT money into younger companies. This is a laudable objective, but the legislation has been enacted in such a way which is overly restrictive and a consultation process is ongoing with HM Treasury to amend the type and stage of companies which can benefit from VCT support.
How will Brexit uncertainty affect sales of UK private equity backed businesses?
Short term UK domiciled smaller companies are likely to see a much enhanced competitive position if they export into the Eurozone. Sterling has depreciated more than 20% against the Euro since the Referendum and this has an immediate benefit for those UK companies selling into this market. Longer term the position is less clear, with a myriad of new trade agreements required or a deal to be agreed where the UK retains access to the single market in exchange for continuing to pay into the EU. With political change coming across Europe in 2017, we see a pragmatic solution along these lines as the most likely outcome.
While the buy-out funds have continued to expand, and new entrants emerge, recent years have seen more capital become available for younger companies and technology disruptive businesses. The continuing expansion of technology, and the emergence of the first £1bn+ value Unicorns in the UK has seen more investors take an interest in earlier stage businesses. The government sponsored Business Growth Fund has been established with 2.5bn of capital, and there is also continuing support for tax assisted equity finance, including SEIS, EIS and VCTS. Across the whole funding spectrum, the UK continues to be well placed to continue to offer funding solutions to deserving companies seeking funding to grow or acquire.