Over the last four decades, increasingly fewer UK companies have traded on the London stock exchange, while private equity has grown in prominence. Chris Papadopoullos looks at the UK private equity market's development over the last half-century, from state-backed initiatives to the growth of VCTs
At this year's BVCA Summit, Helen Steers, partner at Pantheon and chair of the BVCA, discussed the decline in the number of companies listed on public markets.
The flow of companies listing on exchanges has been disrupted by the fact more firms are spending longer in private markets, a phenomenon reflected in UK data. Over the last four decades the number of UK firms listed on the main London market has trended downwards – even the peak at the height of the 2008 boom failed to match the number of firms listed in 1975, when the economy was in a downturn. Now the figure is at its lowest level in at least 40 years, down to 1,858 from 2,820 in 1975, according to data from the World Bank.
The downward trend has continued despite a rise in the number of companies. There are now approximately 40,000 companies with more than 50 employees in the UK, according to the Office for National Statistics – a figure that has bounced around somewhat, but mostly moved upward since 2000 when there were 34,000 such companies.
While fewer companies are listing on the London stock exchange, the UK's private equity market is becoming more mature. Buyout numbers are lower than 20 years ago but values much higher, which suggests GPs have picked much of the UK's low hanging fruit. This is reflected in the average value of buyouts, which is currently £153m for 2017, up from £34m in 1997. Moreover, a growing proportion of buyouts have been SBOs; revealing a greater level of specialisation among GPs.
UK's head start
Private equity gained early momentum in the UK, boosted by its already large financial sector and state-backed initiatives. The Finance Corporation for Industry (FCI) and Industrial and Commercial Finance Corporation (ICFC) were set up to help rebuild industry in the post-war period. Both were backed by the Bank of England, with the ICFC receiving additional capital from the retail banks, while the FCI received its extra capital from insurance companies and investment trusts. They had a mandate to invest in small and medium-sized industrial and commercial businesses through both debt and equity, and dominated the venture capital and early-stage markets for decades.
The FCI and ICFC were merged into the organisation Finance for Industry (FFI) in 1973 and floated on the stock exchange as the more commonly known 3i in 1994, with the Bank of England offloading its entire stake.
Around the time FFI was formed, a flurry of GPs were founded, many of which are still around today; Montagu Private Equity and Cinven date back to 1968 and 1977, respectively. Charterhouse Capital, which claims to be the oldest buyout firm having been established in 1936, raised its first third-party capital fund in 1976.
Britain's monolithic retail banks got in on the act with their own private equity initiatives too, with Lloyds Bank setting up its own private equity arm – now LDC – in 1981, and Barclays with Barclays Private Equity in 1979, which was eventually spun out to create Equistone.
The state took a break from the industry after it listed 3i in 1994 – until two decades later, in 2014, when it established the British Business Bank (BBB). In contrast to 3i, BBB is an LP, with little direct activity other than a small SME lending operation. It currently has £1.2bn in assets.
The government also opened the door for venture capital trusts in the mid-90s; publicly traded vehicles that provide tax relief to investors in small and medium-sized businesses. Measures of relief are given on income tax from VCT dividends and capital gains tax. The policy proved successful, with a good population of VCTs now providing capital to higher-risk, early-stage businesses.
Search for yield
Growth in private equity has really taken off since the late 1980s, when there began a secular decline in returns on more traditional asset classes. Low interest rates are often attributed to relatively recent actions of central banks, but it is important to note they have been falling since the early 1980s.
In a trend mirrored across developed nations, the interest rate on a 10-year UK government bond fell from an average of 11.4% in 1984 to 1.3% in 2016. Meanwhile, one common gauge of public equity returns, the cyclically adjusted price-to-earnings ratio, is currently around 15 for the FTSE 100, which is historically low. For most of the 80s and 90s it was above 20 – sometimes substantially higher.
While returns have dipped, the amount of money searching for investments has continued to climb. In the UK, there has been huge growth in the assets of pension funds. Pension fund assets totalled £282bn in 1990, a figure that had climbed to £1,474bn by 2015 – which works out as a compound annual growth rate of 11.7%.
Not only have pension funds grown, but private equity is now a common feature in their asset allocations. It is now not uncommon to see pension funds allocate between five and 10% of their investment portfolio to private equity, which would have been rare 25 years ago.
The search for yield in a low-returns world has prompted the move of big institutional investors into the asset class, at a time when the amount they have available to invest has grown.