UK private equity: small is beautiful

Alice Murray
23 September 2015

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Two reports published in September highlight the strength of the UK small-cap market, with one suggesting these companies have the most confident growth prospects, while the other finds buyouts in the space are becoming more common. Alice Murray reports

According to Lyceum Capital and Cass Business School's UK Growth Buyout Dashboard, deals with an enterprise value of between £10-100m recorded in the first half of 2015 were at consistent levels with the previous six months. However, those deals valued at less than £50m accounted for 80% of activity, representing a 16% uptick on 2014's H2 activity.

Indeed, checking these figures against unquote" data, UK deals valued at between £10-100m have been fairly consistent, with 76 recorded in H1 2014, 97 in H2 2014 and 78 in H1 2015. And in accordance with Lyceum and Cass's findings, those deals valued at less than £50m accounted for 79%, 80% and 83% of activity respectively.

Lyceum believes the findings underline the quality of UK SMEs and the opportunity to build scale and create value in a recovering economy.

Another encouraging theme that the findings point to is UK SMEs' resilience when compared with global corporates. According to Andrew Aylwin, a partner at Lyceum: "Our own experience has shown that companies at this scale are more insulated from macroeconomics and more able to change course if market conditions do become more challenging."

Growth ambitions
Lyceum and Cass's report comes as Albion Ventures' Growth Report, which surveyed 1,018 UK SMEs, found that 61% expect their business to grow over the next two years. Furthermore, 44% of SME surveyed want to raise investment to develop their business.

Even more encouraging for private equity firms hunting for deals in this market is SMEs' dwindling reliance on bank loans and credit cards. According to the report, this type of financing accounted for 76% of funding in 2013, but has now slipped to just 49% in 2015. In conjunction with this, equity or other sources of long-term financing have soared in popularity from just 6% in 2014 to 34% of companies surveyed considering raising external finance.

Furthermore, 10% of SMEs surveyed would consider giving up equity in their business in return for hands-on support, up from just 6% last year. What is most interesting is that younger business owners are far more inclined to use this form of finance, with 42% of under-35s showing an interest.

While these findings are undoubtedly encouraging for GPs looking to deploy cash in the UK lower-mid-market, private equity firms would do well to strengthen their position as hands-on and experienced growers of business.

Helping hand
With red tape cited as the number one barrier to growth for SMEs for the third year running, private equity can certainly position itself as a solution to these concerns, having supported portfolio companies in dealing with regulation and reporting.

The second most important concern revealed by the report is finding skilled staff. Again, this is an area where private equity can show off its strengths, particularly those firms with active networks and pools of talent from which they can recruit experienced and successful people.

Skills, management, R&D and familiarity with export markets also remain weak spots, according to the report – all areas in which private equity's expertise can help overcome obstacles.

With valuations continuing to soar thanks to liquid debt markets, and given the current optimism and confidence displayed by the UK SME market, we are likely to see a strengthening of the trend for larger private equity firms buying up smaller companies previously beneath their remit. Indeed, in July, BC Partners, which typically invests in companies with turnovers of more than €500m, picked up Côte Restaurants, which generates around £110m. GPs with a firm footing in the small-cap and mid-market can expect to increasingly come head-to-head with the bigger-bracket players.