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Private equity boost for SMEs as amount of growth capital invested jumps 45% in three years

1 December 2016

  • Total neared £1billion mark last year

  • 72% rise in PE investment by private investors - and stockmarket volatility could further increase demand

UK SMEs are being boosted by a significant increase in growth capital investment provided by private equity firms, as investors increasingly see the value in backing this sector of the market, says Connection Capital, the specialist private client investment business.

Connection Capital says that new private equity industry figures from the BVCA* show that there has been a 45% jump in the amount of expansion capital invested in the past three years - meaning more small and medium-sized businesses will be able to pursue their growth plans. 

Private equity firms invested £995million of expansion capital in total in 2015 (latest data available), up from £685million in 2013, according to the British Venture Capital Association (BVCA) data.

Venture capital investment in start-ups and early stage companies has also risen, up 15% in the last three years to £344million in 2015 from £298million in 2013.

Claire Madden, Partner at Connection Capital says:

“This is a real shot in the arm for ambitious small and mid-sized companies who can now put their growth strategies into action.With private equity backing for business expansion just shy of the £1billion mark last year, many more SMEs have been given the chance to boost their capacity and extend their reach. Whether they want to develop new products, move into new markets, take on more staff, open new sites or invest in their infrastructure, they now have the financial firepower to do so.”

“Since there’s little sign of a reversal in cuts in bank lending to the SME sector, smaller businesses are increasingly seeing private equity as a viable alternative to fund growth. But while there’s a large gap to be filled, there are other motivations for choosing the private equity route.”

“There’s a desire not to over-burden the business with debt and to have longer-term certainty over the funding package, but SMEs can also take comfort from the knowledge that they are being supported by stakeholders who have a keen, direct interest in the  success of the business.”

“Bank lending may be the more traditional option, but it has its drawbacks in that it is often subject to stringent covenants and may only be offered on a short-term or impermanent basis.”

“For investors, this is a very exciting segment of the market, offering a range of opportunities to create value by backing sensibly-priced, driven businesses to achieve their goals.”

Sharp rise in PE investment by private investors – and stockmarket volatility could further boost demand

Connection Capital says that demand from private investors for private equity investment opportunities is also growing strongly, fuelled by robust returns potential.

The BVCA’s figures show a 72% increase in the amount of investment coming from UK private investors in the last three years to £315million in 2015 from £183million in 2013.

UK private equity returned 14.2% per annum over three years, compared to 7.3% for the FTSE All-Share and 8.5% for pension fund assets.

Claire Madden says:

“Private investors are showing growing interest in private equity as an asset class – a trend which looks likely to continue as they ensure they have sufficient diversification across their portfolios amid recent stock market volatility and the low-yield environment.They are more and more aware that having the right mix of long- as well as short-term investments can help balance risk and drive overall returns.”

“Growth capital investments in more established, already profitable companies with demonstrable track records and strong growth prospects are particularly attractive because they tend to be less risky than start-ups and very young businesses. Direct access to such opportunities has traditionally been the main sticking point. Crowdfunding may be a way into venture capital, but we are seeing sophisticated investors who want to back larger SMEs and who want a greater degree of comfort about due diligence levels and exit prospects looking for a more professional, private equity-style approach.”

Connection Capital offers a model whereby groups of private investors can pool funds to participate direct in private equity deals, as an alternative to a traditional fund structure. Investments are managed pre and post-deal by Connection Capital’s private equity investment professionals. In this way it acts as an institutional investor on clients’ behalf.

Could private investors fill funding gap for smaller MBOs?

Connection Capital says there is also significant demand from private investors for small management buy-out (MBO) opportunities – which are increasingly overlooked by institutional investors. However activity is hampered because private investor capital is particularly difficult to deploy in these deals.

Small MBOs are a segment of private equity SME investment that has seen a decline since three years ago as institutional capital focuses on larger deals – almost halving from £154million in 2013 to £83million in 2015 (according to the BVCA data).

Small MBOs are attractive due to their consistent performance, and because they tend to be sizeable businesses being taken over by highly experienced management teams with a clear focus on driving the business forward. They generated returns of 14.2% IRR p.a. over three years and 23.5% over ten.

However, MBOs require a more rigidly institutional-style investment process to be followed compared to early stage venture deals, and they often pose greater challenges requiring professional management, such as tighter deadlines and the co-ordination of multiple parties including banks, vendors management team and private equity provider all with their own advisors.

Connection Capital provides an entry route into smaller MBOs for private investors but says that this remains a highly under-served section of the market.

Claire Madden says:

“We are seeing real appetite from private investors for MBO opportunities. However, while private investor capital is starting to fill the space left by institutional money at the smaller end of the scale, with models like ours offering a way in, in general terms access is still a major hurdle.”

*Source of all data quoted: British Venture Capital Association. Figures relate to investment by BVCA members, including almost every major private equity and venture capital firm in the UK

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