Agile lower mid-market businesses key to driving deal flow

Ian Sale, managing director in the Acquisition Finance team at Lloyds Bank Commercial Banking, analyses how the performance of the lower mid-market could lead to its own investment focus. 

The lower mid-market has been the foundation of UK private equity deal flow since the downturn began – regularly outperforming the wider European buy-out arena in terms of volume.

This has not gone unnoticed by LPs and could spark the formation of new lower mid-market funds, and further encourage managers in the larger deals space to broaden their investment focus.

A recent survey by Preqin found that 39 per cent of investors believed that small to mid-market buy-outs presented the best opportunities in 2013, compared to 19 per cent who favoured large to mega buy-out funds.

The attractiveness of companies in the lower mid-market is their agility, and the ability of investors to drive transformational change and focus squarely on growth.

Making the same type of impact at a large corporate business, in which governance and decision making processes are commonly more convoluted, is naturally more difficult – although the larger buy-out firms are adept at doing this.

The acquisitive growth opportunities in the lower mid-market are also greater than in more consolidated sectors in which larger, established companies operate. The UK’s economic focus on a host of high growth industries, such as digital, and the changing regulatory environments of others, including legal services, creates a positive backdrop for expansion.

Buy-and-build has emerged as a key tactic to create value in the challenging economic environment and we are seeing an increase in the number of lower mid-market buy-out houses asking us to fund add-ons for their UK-based portfolio businesses.

Entrepreneurial businesses

The owner-managed company segment also continues to provide a steady flow of new investment opportunities for private equity houses, whether these businesses are known to the market or self-originated by investors over a longer period. Their rapid growth is being encouraged in the UK via government tax breaks, funding initiatives and support organisations.

Debt financing remains available to support private equity-backed deals for companies in the lower mid-market which can demonstrate robust long term growth potential, high levels of repeat income and conversion of EBITDA to cash.

Businesses’ private equity suitors are putting greater emphasis on building track records in specific sectors, improving origination capabilities and refining investment criteria to differentiate themselves. The latter will become increasingly important as competition in the lower mid-market grows.

Lessons learnt in recent years have naturally formed sponsors and financiers’ approaches to investment in 2013, with deals arguably being better quality and more carefully considered – albeit they are taking longer to get over the line.

Against this backdrop, the lower mid-market’s resilience will continue to prove vital to the UK deals market as a whole, and provide a strong flow of capital to support ambitious management teams, and the expansion of traditional and emerging industries.