The View from the Direct Investments team – Q2 2022

News: Insight & Opinion | 12 May 2022

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"Clearly, it has been a turbulent time for the economy recently, however, our portfolio of direct SME investments is in excellent shape and the outlook for deal flow looks extremely positive", says Bernard Dale, Managing Partner at Connection Capital.

For most businesses, trading has effectively returned to normal post-Covid, although Brexit is still posing some issues for those that trade in the EU, with regulation creating extra costs. Historically, high inflation has yet to bite, and there will inevitably be an impact across the whole economy over the next few months.

So, there are challenges, yes, but for Connection Capital, the flexibility of our model allows us to structure deals to suit the circumstances, for the benefit of SMEs and investors, since we don’t have the same constraints as a fund. Added to which, our growing, high-quality roster of non-executive directors, built from both our general network and from within our client base, gives assurance that another layer of expert, specialist skills is being brought to bear on the appraisal and management of our investments.

Recent exits have clearly demonstrated our ability to deliver maximum growth, helping SMEs ramp up their profitability, so that prospective buyers are prepared to pay more. We have a consistent track record of taking investee companies from the £10-20m value entry range to three times money invested upon exit, and sometimes far more, for example, the £110m Virgin Wines IPO. When it comes to MBOs, recent deals we have led have achieved an average 4x overall return, with a 1.5x increase in revenue and a 1.8x rise in EBITDA across all buyouts. With the way the portfolio is trading, we expect to achieve several good exits in the months ahead.

Opportunities ahead

We’re currently seeing a record volume of high quality new private equity and private debt opportunities in our prospective investment pipeline, across a range of sectors such as technology and business services. This includes a good mix of growth capital deals, MBOs, and what we call “cash-out” deals (where business owners are seeking to release a portion of the value of their business without selling up entirely). Another advantage for us is that competition at the lower-mid-market end of the spectrum where we operate is still far less intense compared to the mid-market level.

Deal prices are now capping out and as a result, the inexorable rise in EBITDA multiples that we’ve seen in recent years appears to be flattening. Though this means that the differential between entry and exit multiples will narrow, we believe the best scope for multiple arbitrages still exist in our part of the market and in the type of deals we are doing.

The Connection Capital model is now well-established in the corporate finance community where we source most of our deals, we therefore, expect the number and calibre of opportunities we offer to clients to improve. As a result, we continue to invest in our team, with three new talented recruits to our Direct SME Investment team already this year and more to come. It’s shaping up to be a busy and exciting time ahead.