Time To Invest
According to data recently released from CMBOR, the third quarter of 2009 reached an all-time low in private equity deal completions for over 25 years. If you add to this the low deal volumes in the first half of 2009, then most market statistics make depressing reading. So is now a good time to invest into businesses, or better to avoid them? The private equity community seems to be polarised in its opinion, with a few completing most of the deals and some investing little or nothing. In my opinion, now is the time to invest.
It’s now more difficult to make the returns work as super profits have been achieved in the past by using financial engineering, on the back of high debt multiples. This doesn’t work in the current environment. So, a business strategy based around cost cutting in order to achieve profit improvement alone will not attract the investment. In order to deliver a healthier bottom line we need to focus once again, on how to improve profitability in a flat or declining market. So it’s back to good old fashioned business principles and growth strategies that win market share. The better management teams can create these and should still attract investment.
So why are so few deals being done? Is there a lack of quality businesses? The good businesses are still out there and they become even more noticeable in the current economic environment. However, multiples and business valuations are at a low point, and there is a lack of availability of debt at high multiples, but there are still many sources of funding out there and some new ones. There just doesn’t seem to be many businesses coming to market. If profits are down and valuations are impacted then why would you sell in the current climate? Well some people need to sell. It’s often either a “life event” or some form of distress that will change the circumstances of business owners and drive them towards a sale. But distressed parents, distressed companies or distressed shareholders do not sit comfortably with the private equity model and the more traditional investors will not do these deals. There are many businesses out there that have the wrong funding structure, that are over geared for their current level of profitability, but are still profitable. These are exactly the businesses that we should be investing in.
Some deals are getting done. To get them away we need to be more creative, utilising the Vendors, private investors and investing ourselves to bridge the funding gap to ensure that businesses can attract other external funds. This is easier to do in the lower mid-market, but as deals get larger there are few private investors out there that have £10m to invest per deal.
There are some specialist turnaround funds, or funds that focus on stressed deals, but they are few and far between and still need the positive business dynamics and growth plans to work. The banks will lend more over the next few years and there are some newer entrants to the market that are trying to win market share. However, they will do this by lending to more businesses not by gearing up and lending more to each business.
Valuations will remain low, in part restricted with the lower availability of debt, but will no doubt creep back up as confidence returns. We are likely to see many of the private equity funds under pressure to conclude deals and start investing their cash, but I doubt whether this alone will drive an increase in prices, it will certainly help. So the landscape will remain pretty benign for deal-doing for some years with few positive drivers.
An unknown at present is how the effects of a general election, win or lose, will impact on tax policies, and where capital gains tax is set to go. In my opinion, capital gains tax will increase markedly, meaning that those wishing to exit in the medium term had better get on with it. Changes in tax legislation alone will not be the impetus to get the deals market moving unless there are some very significant changes ahead, but it will help.
So, the market is likely to continue in its current state for some time. Creativity will remain key. We need to continue to focus on ensuring that deals are done with businesses with robust strategies that are targeting top line growth and can achieve it. If we put in place financing structures that suit their needs, with plenty of margin for error, then the deals we do now will be the most successful ones in years to come. These are vintage investment years.