Private Equity following Brexit – Doom and Gloom or Land of Opportunity?
2016 has seen a significant slowdown in private equity activity in the UK, largely as a result of PE houses holding off on investment decisions pending the outcome of the EU referendum. According to the Centre for Management Buy-Out Research, Q1 of 2016 was the slowest since Q4 of 2009, and financial sponsor backed investments dropped by 92% in the first half of 2016 compared with the same period in 2015.
The British Private Equity and Venture Capital Association (BVCA) have stated that they expect the slowdown in activity to continue in the short term for so long as the UK has not triggered Article 50 and until the Brexit roadmap starts to take shape. Investors will be wary of investing in UK businesses for so long as access to the single European market post-Brexit remains uncertain. As a long-term asset class, the PE industry has proven in the past that it is able to withstand periods of economic uncertainty; the BVCA believes that the longer-term impact on the industry in the UK may be limited if single market access is secured.
We are seeing some cautious optimism about what the future may hold when it comes to sourcing new investments, both in terms of new deals and bolt-on investments for existing portfolio companies. For a good number of the UK mid-market PE houses, an environment where there is real or perceived “disruption” is viewed as a source for new investment opportunities. Those PE houses who do not share this view see themselves spending the foreseeable future focusing on their portfolio and growing their existing investments organically and through strategic bolt-ons. Others have struggled to find sufficient dealflow for their dry powder, losing out in increasingly competitive auction processes. With non-UK institutional investors thinking twice about investing in the UK (at least in the short term) and trade buyers potentially struggling to raise acquisition funds in stagnant capital markets, UK PE houses with available cash might find themselves able to secure prize assets at attractive valuations.
Securing a good exit is never far from PE investors’ minds. Investors may choose to play a longer game, and put exits on hold until Q1 or Q2 2017, hoping for some clarity on the UK-EU deal by then. Apart from a slight renaissance in 2013-2014, IPOs have been out of fashion as a PE exit route and Brexit is only likely to exacerbate that trend. Trade sales may be more difficult as buyers will likely struggle to raise funds in the capital markets. This could yield opportunities for secondary (or indeed tertiary) UK PE investors with a properly calibrated risk profile and available capital.
The industry’s cautious optimism regarding new deal and bolt-on investment opportunities is also tempered by concern over Brexit’s potential impact on fundraising. Market participants sense a weak fundraising outlook in the short term, driven by the lack of clarity on the UK’s access to the single market and the continuation of passporting for the UK financial services industry.
Over the last several years, among our European-based mid-market PE clients and contacts we have noted an increased focus on opportunities in the North American market – particularly the US. Existing portfolio companies with global businesses are seeing growth potential in the US market in contrast to other geographies. While the current currency fluctuations in the immediate aftermath of Brexit may temper this trend in the short term, we expect this trend to continue and, perhaps, to be amplified.
From a purely legal perspective, the impact of Brexit on transactional documentation for PE deals is likely to be limited. Some legislative references may need to change depending on what EU legislation may or may not still apply to the UK following the outcome of the Brexit negotiations. Furthermore, PE houses may be well-advised to review Brexit specific provisions in equity documents around reporting obligations and business plan warranties. We will keep a close eye on trends and provide updates accordingly. The impact from a banking/finance perspective is discussed here by Paul Denham who heads up the Finance team at Dorsey in London.