UK returns: Think small

Susannah Birkwood
08 July 2011

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The UKтs small buyout sector will continue its decoupling from the larger market, and should provide better returns than large-cap players in the coming years.

According to some, this trend will become most apparent in 2013, as the current subdued nature of the M&A landscape means that scores of firms are waiting until then to realise their existing investments.

This is not a new phenomena however, with unquote" data showing that the average money multiple for European buyouts valued at £100m generated returns of less than 2x in this period. Statistics from other data providers also support this pattern, such as the graph below by Preqin which shows that in the years to June 2010, the highest IRRs were reaped by funds in the small to mid-cap bracket.

The reduced degree of competition at the smaller end of the market is one of the reasons this pattern will continue, or so believes Tim Levett, chairman of NVM Private Equity, whose deals span £2-£10m equity. "There are less funds operating in the small to mid category right now and quite a large population of companies. Entry prices are thus staying low," he explains. "This area used to be popular with a lot of VCs, but many have been successful in raising bigger funds meaning they will be doing bigger deals."

Another important factor is the reduced availability of financing, which stands to impact larger players more than their smaller counterparts. Deals in the smaller space require little to no debt, after all, meaning they incur lower financial risk. "Also, with smaller businesses, you can quadruple them in size, so leverage becomes less relevant to your returns," points out Yann Souillard of LDC, who is responsible for transactions in the £2m-£100m range. "A much larger business is far more difficult to quadruple in size, so the magnitude of change you can generate is much lower."

Levett agrees that it's more straightforward for SMEs to expand dramatically than it is for larger companies. "It's easier to grow a business from a £20m to a £30m turnover than from £200m to £300m. Once businesses are seen to be past growth and provide an opportunity to enhance their bigger acquirer's earnings, then that is reflected in the multiples." NVM is hopeful that if small MBOs continue to provide superior returns, the ability of smaller funds to raise money will improve correspondingly. "People will become less enchanted with big deals and more interested in small transactions," predicts Levett.