Small deals, big results

Not a day passes nowadays when the broadsheets don't feature at least one story on the perceived need to pump more money into British SMEs. Whether because of an equity gap or reluctance on the part of beleaguered banks to lend, that part of the market seems perennially afflicted by underfunding.

There have been increasing efforts by governments to do this. Back in 1995, the UK government's introduction of tax-efficient venture capital trusts (VCTs) tried to offer tax advantages to help plug this gap. But it wasn't enough and in 2011 the Business Growth Fund was launched with £2.5bn of firepower.

One firm has quietly put £24.8m to work across nine new deals, with a further eight follow-on investments so far this year. Founded 30 years ago in a time when the industry was dominated by 3i with now-household brands such as Apax and Cinven taking root, YFM Equity Partners is now among the UK's most prolific deal doers, investing in select small and medium-sized businesses.

As mid-market players struggle to woo investors, the last 18 months have seen some small buyout houses shine

It was set up as an enterprise agency and seeded by local authorities in 1982, and was intended to support businesses in three ways: with money, property and advice on how to sell more and increase efficiency. Though it was before the term private equity was commonplace, points one and three are spot on with today's asset class. Today, YFM manages both VCTs and a £40m institutional fund (Chandos), with plans underway to raise a £100m successor vehicle.

Small buyouts in the UK are faring well, with a 44% increase in year-on-year volume for £5-50m deals in H1 2012, according to the unquote" Regional Barometer, published in association with LDC.

Three decades of backing British businesses means YFM managing director David Hall (pictured) has witnessed the birth, coming of age, and current slowdown the industry has undergone.

"Equity is more understood now than when we started out, because lots of people have had experience or know someone who has. Often it's a positive experience, so there is more of an understanding of this type of business funding. The upshot of this is that capital has been shifted out of corporates and into private hands," Hall says, explaining how some management of private equity-backed corporate spinoffs have made it to The Times rich list. "These individuals go on to become serial entrepreneurs or even angel investors, often helping to perpetuate entrepreneurship."

The other major change he's noticed is that of external governance. "Most of the businesses we back nowadays have an effective NXD on board already, whereas years ago they sought advice from their Rotary Board. NXDs are no longer 'bidets in the boardroom' – something everyone has but no one knows what to do with. They've become a useful resource firms utilise."

This development may have helped pave the way for private equity to work with such businesses in a lucrative way: while most rhetoric is about backing SMEs and fostering innovation, YFM has shown there is money to be made while supporting small businesses.

And in addition to putting money out, they have been getting the money in, with five exits worth £66.5m so far this year, one of which generated 5.6x cost for the backer.

Most recently the firm sold Primal Pictures, a publisher of medical models, to Informa UK for 2x money. Last year YFM exited three businesses, including Sheffield-based Go Outdoors, which is a story of patience paying off: it sold a minority stake to 3i, retaining a residual minority shareholding itself worth roughly £10m. YFM had backed the business in 1998 with an entry value of £1.6m, pumping a total of £555,000 into the business during the 13-year holding period. It grew from 30 people to 700, while YFM generated 30x money.

It's not just YFM making money in this space. There are currently at least half a dozen VCTs with respectable track records. They are not just producing the odd homerun, but consistent returns for investors. In addition to YFM's own recent successes, Mobeus and Foresight reaped 32x money on its sale of AppDNA – one of six exits in 12 months for Mobeus, generating an average 4.2x money. Maven sold Walker Technical Resources last year to LDC to generate a 70% IRR in a two-year holding period. Baronsmead clocked up two strong exits last year in Quantix and Getting Personal – the latter after just a year's stewardship.

The small buyout space is attracting some big names in private equity. In April, YFM named industry veteran Andrew Marchant as non-executive chairman. He started his private equity career around the same time YFM was founded, initially with Prudential before founding Schroder Ventures (now Permira) and eventually joining Cinven.

Despite today's difficult economy, Hall remains confident about his sweetspot, suggesting the caution that characterises the post-crisis backdrop should foster more robust businesses. "People are acting in business as they do in their personal lives: they're paying down debt and taking on less risk. This is a welcome change from the boom years where people said, 'If you want to be old-fashioned and carry out due diligence, you won't get any deals away'. It's crucial to stick to your principles. Business planning has improved since the 2008-2009 period, when institutional investors worried their banks would shut the next day and 'long-term' business planning meant 24 hours. This confidence crisis persists today as caution, but this is positive. Businesses are looking ahead five to seven years, instead of two to three."

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• Topics
• UK / Ireland
• Buyouts
• Exits
• United Kingdom
• YFM Group
• BGF (Business Growth Fund)
• Mobeus Equity Partners