Positive messages for SMEs seeking backing from private equity

By TBM Team

11 September 2019

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The Roundtable team

National audit, tax, advisory and risk firm Crowe hosted this roundtable at the Thames Lido in Reading looking at the current state of the private equity (PE) market in the Thames Valley. Tim Wickham reports.

State of the PE market

Bob Alsop from Crowe chaired the roundtable and began by summarising the health of the private-equity market. “We have seen near record levels of PE deals globally in recent years; however, in respect of the UK market, some commentators have noted a softening in the last quarter of 2018 and in the first quarter of 2019, both in terms of volume and value. But is this the same picture for our local market?” he said.

Enthusiasm for private equity appears to be relatively strong among SMEs. “Smaller and mid-market deals up to £30 million are happening,” said Alsop. “The South East is maintaining its momentum in terms of deal volumes and value, so the situation is perhaps not necessarily as bleak as you might read about.”

Crowe’s Mark Allen added that the PE industry is taking a more sophisticated approach to the way investments are both made and managed. “The PE market is probably on the cusp of quite a significant change in terms of operational efficiency and taking advantage of greater digitalisation in the deal process,” he said.

Mike Freer from law firm Osborne Clarke echoed the sentiment of a softening market. “However, we see a potential strengthening of the market from Q2 and Q3,” he said. “The view among many businesses thinking about PE who might have been holding off at the end of 2018 is ‘let’s just get on with it’.”

Miles Otway from private equity firm Connection Capital observed: “One of the reasons for resilience in the market, particularly with MBOs, is that they are driven as much by personal life moments, like retirement, as they are by underlying economic factors.”

HSBC’s Ed Hutton provided a banker’s view: “We are still seeing deals coming through. The PE market seems fairly resilient and if a business has a good management team, then a PE deal should succeed.”

Chris Baker of private equity investor LDC sounded a note of caution: “There is deal flow out there, although it would be interesting to see the metrics on successful deal conversions. My sense is that successful conversion percentage will have reduced during the past 18 months as we come off a busy, ‘frothy’ market. On the whole, compared to this time last year deals seem to be taking longer to complete.”

PE expertise strengthening

Are PE houses bringing useful expertise and support to company management teams? “A lot of customers are telling us finance houses are very supportive. Having a stakeholder and a bank that really understand the business is the sort of chemistry that underpins PE success,” observed Hutton.

Otway said Connection Capital’s success relies on both its track record of delivery and the nature of its PE model. “We have around 1,300 high-net-worth individuals looking to invest in SMEs. Many have run and sold their own businesses, so they know what it’s about. We offer companies time and flexibility – we’re not looking for quick returns.”

James Austin of investment partner BGF said his company spends more time than ever crunching numbers on the companies in which it invests. “Our forecasts aim to predict what the company might look like in five or seven years. We’re doing a lot more of this by working closely with management teams of companies looking for PE. Around 30% of our investment is now follow-on capital after the initial deal, which is a significant change in recent years.”

Company management teams are getting more demanding about what their PE partners and advisers should provide noted Otway, Hutton and Freer.

“Increasingly, management teams understand a lot more about PE and want to know where their business will sit in your funding cycle. That’s good because we need to treat each investment as a standalone business as well as demonstrate that our responsibility is to their company as well as our investors,” said Otway.

“Probing questions by company management teams ensure everyone is better aligned by understanding their objectives,” added Hutton.

“Ultimately, a PE house’s responsibility is to its investors, but they also concentrate on the growth of the business they invest in. We align ourselves with this by bringing skill sets that support businesses we advise in the PE process,” said Freer.

Views changing on PE

Alsop asked the panel if they thought PE was becoming a more acceptable, and valid, asset class for owner managers.

“Yes,” said Baker. “The emergence of dedicated management advisory firms, specialist lawyers and more sophisticated M&A advisers has helped the PE market mature over the past five to 10 years. However, there are still PE sceptics out there. But that is a good thing – owners need to retain a certain wariness about selling some or all of their business to a third party. The key is to allow enough time in processes to ‘get to know’ your PE investor to ensure cultural and business alignment”

Freer suggested more effort should be made explaining the potential costs and benefits of PE. “A lot of companies understand the stereotypical risks and the personal benefits for company owners, but more education is needed on the costs and benefits to the business itself. Business owners need to ask what can PE add to my company rather than just my back pocket.”

That comes down to treating each PE deal on an individual basis, thought Austin. “We do this by getting the right resources in the right place. We have the same senior experts who advise on a deal available to support companies post-deal. That enables us to take a personal rather than a cookie cutter approach.”

Management information challenge

While interest in PE may be holding steady in the SME market, are companies making it easy for investors to appreciate their potential? “Is the quality of management information there?” asked Alsop.

Baker thought some failed processes had suffered as a result of businesses being oversold. “One of the biggest issues we’ve seen are overly cumbersome auction processes which restrict potential investors ability to thoroughly understand the dynamics in management teams. Very short deal timetables with multiple parties running in tandem places massive strain on management bandwidth and can make it challenging for PE and management to properly carry out their due diligence on one another.”

For owner-managed businesses, management style is another important factor that PE specialists scrutinise closely. Otway highlighted the danger of the business owner stretching their talent too thinly. “Not all owner/founders have the personal bandwidth and wider experience to take their business a big step forward when they bring in private equity. Success or failure of the business often comes down to management bandwidth and whether they are able to take on the challenge of growth.”

Austin agreed: “Business owners can benefit by hiring people who can do the job of running their business better than they can. This frees owners up to focus on what they need to be doing in the future.”

Connection Capital aims to get businesses looking at issues like personnel assessments, succession, and how they are going to grow their business. “But it’s important that we don’t try to run their business for them – there are a lot of PE investors who think they can do this well, when in fact, probably they can’t,” said Otway.

Positive about the future

Wrapping up the roundtable, Alsop said: “I think there is a lot to be positive about for SMEs. Regional mid-market activity is still strong with a continued desire by PE investors to deploy capital and good assets out there for them to invest in. Transparency, trust and realism are growing on both sides.”

He concluded: “The PE community is getting better at what it offers post deal, particularly in supporting business owners and helping company management teams to grow.”