2021 Preview: UK activity on the up, but market braces for tax hit

Katharine Hidalgo
09 December 2020

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In a volatile year, which has seen buy-and-build and technology deals increase, GPs have adjusted working habits to achieve some semblance of normality in their operations, drawing investment volumes back towards pre-Covid-19 levels. Katharine Hidalgo reports

The coronavirus crisis made an impact on UK buyout volume almost immediately in March 2020. With just 21 deals recorded, the second quarter of 2020 saw the lowest number of deals since the first quarter of 2009. The global lockdowns and travel restrictions put in place in response to the pandemic meant deal activity and fundraising was effectively put on hold.

The exit market in the UK & Ireland was severely affected, with total realisations for both PE and venture reaching just 43 in Q2 of 2020, the lowest level since the second quarter of 1997. On the fundraising front, firms such as Charterhouse, Capdesia and Sovereign Capital each delayed their efforts beyond their initial expected timelines.

In the absence of strong primary dealflow at the height of the pandemic, buy-and-build proved a good way for GPs to deploy. Rupert Howard, a director in PE at 3i, says: "People prefer to put money to work in sectors they understand already and have invested in previously in these uncertain times."

John Harper, managing director and head of the London LBO team at HIG Capital, says the firm has also pursued buy-and-build strategies throughout the lockdown: "We bought Vernacare in February and our plan was always to make add-ons, as the company operates in a fragmented market. We did our first bolt-on, Frontier, in July and we hope, and expect, to do more."

Other acquisitive PE-backed companies include Searchlight Capital Partners' Global Risk Partners, which has bought eight insurance-related companies in 2020; and Babble, which made two acquisitions after the outbreak of Covid-19 and was sold by LDC in November 2020.

Another field that has seen an uplift in activity throughout 2020 has been technology. The share of total buyout volume occurring in the technology sector increased to 22% this year, up from 18% in 2019 and 16% in 2018.

That number increases dramatically in venture and growth capital deals, with more than 60% of all deals occurring in the technology sector.

"Technology and tech-enabled deals have made up around 75% of our deals this year, and most involve selling to PE," says Phil Adams, CEO of GCA Altium. "There is a huge amount of capital chasing a narrower field of assets."

While many sectors in the UK & Ireland, such as leisure, travel and fitness, may never see the same investment from PE again, sectors that are resilient to the impact of the coronavirus crisis have buoyed overall investment volume in the fourth quarter of 2020.

Potential tax changes are not driving multi-billion-pound transactions, but in the mid-market, people will be thinking about it. If you have not started a process by the end of November or the start of December, though, it is probably too late" – Phil Adams, GCA Altium

On the up
November 2020 saw deal volume in line with monthly figures prior to the crisis, with 29 deals, compared with just five deals in March 2020. Monthly exit figures have also risen from a low of 12 realisations in August to 19 in November.

GCA's Adams says: "In July and August, our pitching was up by 60% year-on-year. The two factors that have been at play are the Covid-19 hiatus, where nothing happened for a while, and the risk of tax changes."

In November, the Office for Tax Simplification released a report commissioned by Chancellor Rishi Sunak on capital gains tax. Among other conclusions, the organisation found the tax – levied at 10% for basic-rate taxpayers and 20% for higher-rate taxpayers – could be doubled if it were brought in line with income tax.

Adams says: "The general consensus is that tax rates will go up, and possibly materially, but no one is sure. These potential tax changes are not driving multi-billion-pound transactions, but in the mid-market, people will be thinking about it. If you have not started a process by the end of November or the start of December, though, it is probably too late."

The increase in activity could also be due to GPs successfully adapting to new ways of working. Harper says: "We are seeing lots of investment opportunities, we are getting our message across to management teams and we are doing due diligence in a slightly different, but no less effective way. Ultimately there is no substitute for face-to-face contact, but in the meantime, people do not stop doing things, even when you have a big shock to the system."

3i's Howard agrees: "There will be a long-term impact on working habits as a result of Covid-19, which has accelerated an understanding within organisations about how flexible they can be and, on an individual level, how productive one can be in different locations."

Some GPs may have even improved some functions as a result of the changes. Adams says: "In a process, PE buyers have become dramatically more efficient and faster. Some houses have become real execution machines because they have decided they are not going to bid for lots of assets, but rather focus on going more aggressively at a smaller number of assets, which are exactly what they are looking for. We have seen some processes complete in four months where it might have taken six months or more previously."