UK sub-£100m buyout volume rebounds

UK deal volume for buyouts valued at up to £100m reached a post-crisis quarterly peak between July and September. There were 51 deals in the price range during the three-month period, according to Unquote Data, three more than the previous peak seen in the second quarter of 2017. In aggregate value terms, the Q3 2018 total of £1.73bn was the second highest post-Lehman figure since the £1.75bn witnessed in the first three months of 2017.

Johnny Colville, managing director at investment bank Houlihan Lokey, says one of the key drivers behind the trend is the vast amount of dry powder chasing scarcer opportunities around the £100m equity cheque range. "Many of the transactable deals where a sponsor can write an equity cheque of £100m have already happened during the long and profitable bull market, which may well be coming to an end," he says. "Nevertheless, there are multiple potential opportunities that coincide exactly with GPs’ investment theses – mega-trends around health and wellness, for example – but which fall below that core mid-market size range. So you are seeing established financial sponsors – such as Bridgepoint, Silverfleet and numerous others – raising dedicated funds to address this lower end of the mid-market."

Indeed, numerous larger-cap players have launched lower-mid-market and small-cap strategies since the beginning of 2017. Bridgepoint held a final close for Bridgepoint Growth in May 2017, NorthEdge Capital closed its SME fund in July 2018 and Silverfleet Capital held a first close for its European Development Fund in August 2018. Other GPs, such as Inflexion Private Equity and Livingbridge, are further along in the process of deploying vehicles raised to target smaller investments than their flagship funds can deploy.

Demonstrating the ability to find buried treasure by writing a smaller equity cheque and making five times money multiple plays well with LPs when it comes to raising your next fund" – Johnny Colville, Houlihan Lokey

"Demonstrating the ability to find buried treasure by writing a smaller equity cheque and making five times money multiple plays well with LPs when it comes to raising your next fund," says Colville. "It is much harder to find that type of opportunity if you are putting £500m equity cheques to work. Most fast-growing assets in that larger equity range have already been picked over by advisers and private equity houses. At the lower end of the mid-market, it is all about growth and there is significant growth on offer in the smaller value range. There remains ample opportunity to find businesses that are doubling or trebling in size in a short timeframe. Additionally there is the opportunity for some of the big players to dip down and make platform deals, which has proven successful in the past."

The growth opportunities in the UK’s small-cap and lower-mid-market ranges have certainly fuelled LP appetite to the extent that numerous new-entrant GPs are capitalising. There have been multiple recent first-time vehicles with mandates to target sub-£100m EV businesses, including those raised by Tenzing Private Equity, Limerston Capital Partners, FPE Capital and Inverleith. This has been further stoked by VCT managers such as Mobeus Equity Partners, YFM Equity Partners and NVM Private Equity, which have all had to raise institutionally backed vehicles in order to continue making buyouts following UK regulatory changes.

Bearing down
Inevitably, a build-up of capital requiring deployment in the sub-£100m EV range, coupled with highly competitive debt pricing and terms, has had an effect on entry multiples. This is likely to create significant challenges for fund managers, particularly if we are approaching a bear market as Colville anticipates.

"The reality is that returns will be compressed because we are at an all-time cyclical high," says Colville. "In this market, where people are paying huge multiples for businesses that are small but growing fast, you are backing a management team that can execute on an investment thesis. If you can average down your in-multiple by bolting on cheaper businesses than the initial platform deal, then you can out-compete. But even if you have bought at 15x and compressed that to around 13x through M&A, the through-cycle market has consistently traded at 10-11x. Deals have to be priced to perfection and the investment thesis has to be carried out flawlessly, otherwise that multiple compression on exit will damage your returns."

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