UK mid-market funds: Higher tiers risk overload

Click here to read  the first instalment of our series on fundraising the UK lower mid-market

With increased competition in the UK core mid-market, it follows that there is a risk of multiples creeping upwards. Yet, Catalyst Corporate Finance managing partner Andy Currie argues there is little room for multiples in the £100-250m value range to rise much beyond their current levels. He says uncertainty surrounding Brexit will dampen multiples – at least in the short term – due to perceptions surrounding future prospects of UK companies.

A far greater concern, Currie says, is that some firms may find themselves sitting on substantial quantities of dry powder in the coming years, with no immediately apparent opportunities to efficiently deploy their arsenal of capital.

However, Janet Brooks, a partner at placement agent Monument Group, argues opportunities are increasing within the core mid-market space, as companies become more familiar with the private equity model. "There are an increasing number of assets year-on-year as private equity becomes more of a mainstream financing mechanism," she says. "So there is overall growth in the market. But historically there has been a cap on the amount of capital a pure UK player can invest without going to other markets outside the UK."

Indeed, Brooks is surprised that more of the current crop of maturing lower-mid-cap GPs have not elected to follow in the footsteps of predecessors such as Bridgepoint, Equistone and Montagu Private Equity in setting up offices in other European markets. She says: "Some people think having an office in mainland Europe as well as Britain is the place to be post-Brexit, because you can win regardless of which side fares better [following Britain's EU exit negotiations]. I'm also surprised we hadn't seen this pre-Brexit; these mid-market players going into Europe. That's historically what people have done if they wanted to increase their fund size. That is how they would broaden their investment remit."

Fighting fatigue
Mid-market multiples aside, with so many GPs raising vehicles recently – and with the economic road ahead looking precarious – there is a risk that an element of LP fatigue will start creeping into the market in the short-to-medium term. However, as one industry insider tells unquote", the economic principles of supply and demand very much apply, with institutional investors increasingly committing capital to the asset class due to strong returns. Furthermore, given the long-term investment remit of most LPs, for whom liquidity is not an immediate concern, the 10-year lifespan of private equity funds is a good fit.

To a certain extent, argues Brooks, UK fundraising was particularly widespread prior to the Brexit vote, as many players looked to pre-emptively mitigate against any uncertainty that followed. As a result, she anticipates there might be a lull in activity until the next round of GPs go to market. "For people coming out, new into the market at this point, there may be an element of investor fatigue," she says. "There may also be more questions about the longer-term impact of Brexit, which we may not have seen yet. LPs, as a whole, may be a little more cautious given they have invested substantially in the asset class in the UK and may be feeling a little more concerned."

It continues to be the case that it's easier to find a private equity house looking to deploy £50m of equity rather than £15m. That lower end of the market is still relatively under-served, which surprises me because that's where there is the ability to make very good returns" – Andy Currie, Catalyst Corporate Finance

While an increasing number of lower mid-market players move up in weight class, it is unclear who will fulfill the demand for capital in the space they vacate. It is possible some venture capital trust fund managers – many of which have been forced to raise institutional funds after regulation changes hamstrung their ability to make buyouts – will eventually evolve into lower-mid-market players. In the short term, though, these firms remain committed to the small-cap space. Decreasing competition will likely mean there will be plenty of opportunity for firms to source attractive deals.

"It continues to be the case that it's easier to find a private equity house looking to deploy £50m of equity rather than £15m," says Catalyst's Currie. "That lower end of the market is still relatively under-served, which surprises me because that's where there is the ability to make very good returns." Not only will lower-mid-market players likely find themselves in an increasingly attractive position when it comes to making buyouts, but enhanced competition among GPs in the larger deal space should make for a healthy exit market. This, coupled with a potential dearth of secondary buyout opportunities, could well be a recipe for particularly favourable returns.

It is natural in any line of business for firms to evolve. Indeed, the capitalist economies in which private equity thrives are very much reliant on this phenomenon. Historically, in the field of private equity, this has often meant GPs being entrusted with larger pots of capital and consequently turning to bigger, often more complex deals. But, while many of the lower-mid-market firms making the jump will undoubtedly prove successful, those opting to remain focused on their existing remit could deliver increasingly profitable results for LPs.

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