Every so often the average multiples paid by PE houses for businesses exceed the FTSE All Share index, and now is one of those times. Our own long term research shows that it has only happened on 11 occasions in the last 10 years. What does this mean and why is it happening now? Do PE funds believe they are immune to Brexit?
In theory, trade buyers should always be able to pay more than PE buyers. This is true because trade buyers often have synergies and long term strategic goals to consider. When they compete with PE they should win on price.
Well, of course, PE isn’t immune to Brexit but capital is an extraordinary thing: it’s restless, it seeks risk and it needs a home. Over the last 4 years, we have seen unprecedented levels of new capital coming into the UK market.
Given the fund cycles (generally funds have a 10 year life), this capital really needs to be deployed in 3-4 years so that it has enough time to generate attractive returns.
And other homes for global capital such as bond markets, emerging market capital markets, sovereign debt and stock markets have not been performing as well as PE. I have heard it said that the allocation to Alternative Assets, such as PE, is expected to increase from 5% to 6% of global capital which is a phenomenal amount of money. All this means that there is a lot of ‘dry powder’, capital sitting within PE funds that needs to be invested.
However, wait a minute I hear you say, why would so much of this be coming to the UK? After all, for over two years we have been wrestling with how we are going to leave the European Union. Well, global capital doesn’t seem to worry about that. When we carried out a straw poll of PE houses we came to the following conclusions:
- The amount of capital allocated to the UK middle market would stay strong through to 2025
- The number of PE houses would not change that much over the same timeframe
This is because good returns are still expected from the UK market – it’s a large, highly evolved market full of innovative smart financers and entrepreneurial people.
We also explored how PE strategies were having to evolve. Three main areas are:
- Multiple funds targeting different areas managed by single PE houses
- More sophisticated value enhancement strategies
- Genuine minority investing or ‘partnership capital’
Today’s PE houses are experts at buying and selling businesses and using debt to reduce the cost of capital. They are also seeking to emulate the trade buyers: operational expertise, international expansion expertise, digital expertise and even synergies. If you look at some of the PE portfolios you will see enough scale to drive better pricing for commonly procured goods and services such as telecoms, energy, insurance and professional services. They are also able to bring together portfolio companies. In many ways, today’s PE houses are like yesterday’s conglomerates.
At BDO, we believe in PE as a smart source of capital to help grow and/or transform businesses. We don’t think that it is right for every situation, every company or every entrepreneur, and we would always advocate taking good advice. Nonetheless, on average PE backed businesses do better: the pure application of capital invested by very smart and hard working professionals sees to that.
My personal belief is that PE funds cannot countenance a hard Brexit: it just doesn’t make sense to them. However, they don’t have a ‘head in the sand’ attitude, it’s just that they do their diligence, look for resilient business models and believe that good businesses with smart management and capital will prevail. A hard Brexit would, though, make life difficult for the PE houses but they’ll work it out.
The long and the short of it is that PE seeks risk and reward. There’s a wall of money there with its own momentum and the smart PE funds will invest commensurate potential through the cycle. This means that if you have a good business that needs to fuel growth or change, I would strongly encourage you to consider PE. You might find some smart funding, you might just be able to get a better price for your business than would be afforded by a trade or strategic buyer AND you will get another bite of the cherry if you decide to remain in the business.
After all, as a very good friend of mine, a colonel in the British Army would say: ‘All reconnaissance is good’.
Come and talk to us about PE, as the UK’s No.1 advisor, it’s something we know a lot about!
Read the latest Private Equity Price Index (PCPI) Q4 report