We surveyed 41 UK private equity firms to understand their appetite to invest post the COVID-19 outbreak. Several common messages emerged from the respondents which are relevant to business owners and management teams who are considering raising private equity in the current climate.
Is private equity funding currently available?
The period post lock-down saw an unprecedented fall in private equity deal activity with a 62% reduction in Q2 whilst private equity firms initially focused on assessing the impact on their existing portfolios and then refinancing and reforming business models as required. Similarly, few new businesses came to market and many processes paused whilst management teams urgently dealt with the immediate impact of lock-down and assessed the longer-term implications for their business.
However, funding is available and 64% of the firms surveyed had made, or expected to make, an investment before the end of the summer with Mark Snaith of Connection Capital noting that “there is a lot of pent up demand from private equity funds in terms of money needing to be deployed.” Indeed, deploying capital appears to be demand rather than supply constrained for investors with Dan Walker of FPE commenting that “business as usual is the intent. Finding appropriate targets may be more difficult.”
What sectors are attracting private equity interest?
In recent years, private equity has focused its investment towards B2B businesses that are ideally both technology enabled and have a high proportion of recurring sales. The current crisis appears to have accelerated this trend as these businesses are typically resistant to macro-economic shocks such as the impact of COVID. The Technology, Media and Telecoms (“TMT”) sector accounted for 33% of the respondents most recent pre-lockdown investment with 5% in retail and consumer and 3% in travel, leisure and hospitality. TMT is now expected to make up 52% of investments during the remainder of 2020 with industrial and manufacturing remaining resilient at 20% but a substantial reduction predicted for business and professional services. None of the respondents had or expected to invest in retail and consumer or travel, leisure or hospitality.
Paul Brown of Capital Partners noted that “all new deals will be assessed through a new filter with COVID resilience being a key performance factor” explaining the accelerated shift in investment to B2B tech enabled businesses from the consumer facing sectors. Indeed, James Livingston of Foresight explains that “our leisure and non-e-commerce retail investments stopped and are now only cautiously being explored.”
Have Valuations Been Impacted?
Attracting private equity in the current climate is dependent both on sector and the ability to demonstrate resilience to the impact of COVID-19. For those businesses able to get over these hurdles, what does it mean to valuation?
Kevin Grassby of Bowmark “expects to have to pay a premium for the highest quality assets” and indeed 65% of respondents did not expect valuations to reduce as a consequence of COVID-19. Average EBITDA multiples were actually expected to increase with 23% of respondents quoting multiples in excess of 8x. Whilst there is no evidence to suggest that valuations will fall, an increase in EBITDA could be explained by a focus on investing in higher quality businesses. (None of the respondents specialised in investing in distressed businesses.)
Will Funding Structures Change?
Whilst valuations are broadly expected to hold, it is clear from a large number of respondents that funding structures will change. Fernando Chueca of The Carlyle Group is expecting to “see more use of deferred consideration in deal structures to allow sellers to achieve full pre-COVID value for their business once they return to pre-COVID profitability.”
The greater use of deferred consideration, and a desire for a more conservative funding structure in uncertain times, is reducing debt leverage with 71% of respondents not expecting to use any debt during 2020 (compared to 53% pre-COVID). Andrew Ferguson of Maven Capital “will look at all equity deal structures more actively”. For the respondents that are expecting to use debt, 67% are anticipating leverage less than 2x EBITDA which compares to 50% pre-COVID.
It would appear that there has been a polarisation of the effect of COVID-19 on the ability to attract private equity investment in the current climate. Many businesses will find it challenging to raise funding on any terms, whilst others will find themselves in greater demand from investors with no reduction in valuation, albeit with pressure to defer an element of the consideration.
Based upon our survey, there appears to be little logic in delaying a transaction if the timing is right for the business and its major stakeholders. Indeed, this is arguably more pertinent with the pending review of capital gains tax in the autumn budget and potential alignment of capital gains tax rates with income tax rates.
Our team would be delighted to have an exploratory conversation if you are considering raising capital or a business disposal. Contact us on 01491 579740.