Private equity has been hitting the headlines for all the wrong reasons again recently, with the industry being branded as the bad guy for snapping up pandemic-hit businesses, and causing controversy over its handling of the takeover of major household names, like Asda. But private equity’s role as pantomime villain is overdone. At this economic crunch time, it could actually turn out to be the hero – for UK SMEs at any rate.
While news reports tend to focus on the big leveraged buyouts, what’s often overlooked is the vital, constructive role that private equity plays in funding the growth of small and medium-sized enterprises (SMEs) which make up the vast majority (98%*) of UK plc. Latest figures from the British Venture Capital Association (BVCA)** show that in 2019, more than £10billion was invested by the private equity community in UK venture capital, growth capital and buyouts, with over 1,500 businesses benefitting.
In a prosperous economic climate, that investment enables entrepreneurial ambition to take flight, expansion plans to be put into action, new jobs to be created and tax receipts to swell. In tougher times like these, it can help sustain sound businesses through temporary challenges, underpin future growth potential, protect jobs, maintain the tax base and keep entrepreneurship alive, so that those businesses can both drive - and take advantage of – recovery when it comes. And private equity firms currently have significant “dry powder” ready to deploy.
That matters because bank lending may not be the funding solution to save the day for much longer. Once banks’ commitments to fund government loan schemes are over, will they be willing or able to lend more or restructure existing debt on favourable terms? Many small businesses were dismayed to find that bank lending was in short supply in the years after the financial crisis, and they will be understandably concerned that this time round, the answer could again be: no.
Availability of finance is not the only issue, however. The way in which it is provided is also important. Bank lending is often constrained by rigid rules dictating who can borrow and on what terms. Loans are invariably amortising, so that companies are focussed on paying down debt, leaving limited headroom to use the cash to drive growth. Moreover, banking covenants can be very restrictive and obtaining further funding, if the need arises, is often challenging. By contrast, private equity has the flexibility to structure transactions on their own merits, in whatever way best suits the business’ needs and promotes value creation.
Another positive feature of private equity is that it is focussed on long-term gain rather than short-term targets. As a result, privately-owned businesses often are in a better position than publicly-owned ones to implement investment and growth strategies with longer time horizons or to pivot into new markets. This is not about making a quick buck. In fact, private equity investors are often prepared to take a short term hit to profitability to help create sustainable business models that perform better over time.
Put bluntly, without private equity investment, many previously successful businesses may not make it in a post-Covid world. Private equity players are stepping in to save viable SMEs that are otherwise at risk of going bust or becoming ‘zombies’, providing them with capital that is structured in a way that gives them room to breathe, re-position and come back fighting. Yes, private equity is having to take an opportunistic approach, but at a time when agility is widely seen as a sensible – even essential – business strategy, surely that’s a good thing?
What’s needed now is not a debt-fuelled recovery, but an equity-supported one. SMEs played a central role in powering the rebound from the last recession and they will do so again this time, but they will require permanent equity capital as a solid, sustainable way to fund growth. From some of the recent news articles, business owners and entrepreneurs - and the public at large (who are often beneficiaries of private equity through their pensions) - could be forgiven for viewing private equity with some suspicion. They shouldn’t. It could turn out to be the lifeline SMEs need.
* Source: https://www.gov.uk/government/publications/small-and-medium-enterprise-action-plan#:~:text=Small%20businesses%20make%20up%2098,the%20supply%20chain%2C%20by%202022.&text=As%20SMEs%20make%20up%20a,ensuring%20the%20economy%20grows%20sustainably