UK Private equity: building momentum during Brexit uncertainty
The UK private equity industry has just emerged from a remarkably successful year. But these triumphs are being put at risk by the UK’s current Brexit uncertainties. Up until now, the UK private equity (PE) sector – like much of the economy – has been in a state of ‘phoney war’ since the referendum; much of this due to the seemingly endless political trials and tribulations unleashed since June 2016.
Rather than panic or exodus, the general reaction of managers and investors both domestic and abroad over the past two years has been to circle in a holding pattern, awaiting a more concrete prognosis on the future of UK-EU relations before making any major strategic decisions.
The shared assumption has been that whatever ultimately emerges from the smoke, the UK and the EU will strike some sort of reasonable deal, and that the Brexit deal will more or less protect crucial cross-border trade in financial services, the engine of the UK economy.
In the meantime, you could be forgiven for thinking it was business-as-usual, or better. The UK remains a very attractive market, and US investors in particular have continued to back UK managers. Wider macroeconomic circumstances haven’t hurt either, with UK managers as much as anyone else reaping the benefits of the global boom in fundraising. Brexit has even delivered some good news for the sector; with dry powder mounting and deals dwindling amid high share prices, the UK bucked the trend over the summer with 65 deals being completed during Q3 - the joint-highest for any quarter since 2013, and surpassing Europe, which by contrast saw a decline.
However, underneath the positive headlines there could be trouble brewing. In business, uncertainty of the benign ‘wait and see’ variety can quickly turn sour. March 29th is fast approaching, and Parliament remains at an impasse. Theresa May suffered the largest government defeat in Parliamentary history but survived a vote of no confidence. Britain’s path to any sort of withdrawal deal – merely the first step on the road to a future relationship – is becoming less clear by the day. -With no guarantee that the industry will be able to keep its head above the rising waters of political volatility, firms must begin to prepare for all possible eventualities.
Despite a drop-in fundraising of 68% in Q3 compared with the previous year, fundraising and deals have held up. What could be a sign of times to come is the significant number of firms and managers who are themselves voting to leave, and domiciling in jurisdictions such as Luxembourg where future access to critical European markets is guaranteed. Luxembourg’s fund industry has grown by 10% this year as the number of authorised entities rose to 306. It still remains to be seen what percentage of the UK private equity industry will actually decide to uproot after the dust has settled on any UK-EU deal. For stability’s sake we must hope that the figure doesn’t climb too high, and reassuringly we haven’t seen an exodus yet.
However, the timings are particularly bad for the private equity industry in that almost all firms in the UK sector have the calendar year as their accounting year. This means that, in December, firms were in the unenviable position of having to value unquoted assets that could easily be impacted by a bad or no deal scenario such as an importer of goods, and to agree these valuations with the auditor. This level of uncertainty is simply not something that firms are used to having to navigate at the year end.
If firms are about to enter into a tricky phase, a firm grip on investor relations will be crucial to making it through. Many of the current PERE investors are unaccustomed to bad news, a by-product of the success of the private equity industry in attracting capital from investors who would not normally allocate funds to private investments. However, should Brexit uncertainty cause a systemic devaluation in portfolios early this year, fundraising will become that much harder. It will be more crucial than ever that managers are able to clearly, regularly and efficiently provide information on portfolios, explaining the situation and their strategy. Managers will need to communicate, reassure and prioritise key relationships in order to avoid casualties and stay on the front foot.
In fact, boom times or not, investors have been agitating for greater transparency into their investments for a number of years. The industry has done some good collaborative work to respond to this. However, there is still a way to go, and the worry here is that a lot of the industry is still not geared up, technologically speaking, for this sort of close management of investor sentiment. Despite a recent wave of investment in technology, some parts of the industry remain relatively low-tech relative to their peers in finance, with much of this visible in the area of investor communications. Too many firms still rely on outmoded, simplistic updates delivered via PDF or email.
While this may have sufficed in the PE industry of old, in the current environment it means one of two things: damaging relationships, or creating obscene amounts of unnecessary cost and work in the process of responding to ever-more complex and idiosyncratic investor demands or worse, both. But what might have damaged investor relationships previously could now be fatal should Brexit uncertainty start to hit home.
However, by embracing new technology and communication methods, private equity firms can improve investor relationships, putting themselves on good footing to weather any storms ahead, and gain that crucial edge in an increasingly competitive and unpredictable environment. There are choppy waters out there, but there is no reason to doubt that, with the correct steps taken, the UK’s private equity sector can go from strength to strength.
First published in IFLR.
By J.P. Harrop
Group Head of Sales.