UK mid market: cautiously optimistic

Buyout investment, and to a lesser extent exit, activity in the UK mid market has remained relatively resilient during the recent economic downturn. Lisa Bushrod finds out why.

One result of the resilience of the UK mid market is that everyone wants to be there, institutional investor and VCs alike. For VCs their fund size predetermines which end of the mid market they can realistically operate in. With the ongoing debate about what constitutes mid market, this article defers to Venture Economics’, which computes private equity performance data on behalf of the European Venture Capital & Private Equity Association (EVCA), definition of small and mid market buyouts.

Small buyouts emerge from funds raised up to €250m and mid market buyouts from funds raised up to €500m. (Anything emerging from a fund of between €500m and €1bn is technically a large buyout and mega buyouts emerge from funds raised in excess of €1bn.) It is an important distinction because the returns in each of these segments of the buyout market differ remarkably; something institutional investors ought to be acutely aware of given the number of fund raisings coming into the market with a mid market tag attached. (See tables.)

One of the ways that institutional investors are gaining access to some of the more attractive mid market deals is through co-investment schemes. With a more conservative economic climate this activity seems to have be more welcomed by VCs than it was during the boom period when the race was on to put as much money to work as possible and co-investment by LPs was in large part denigrated as a cheap, or fee-less, way for institutions to put more money to work.

One thing is sure; the mid market (deal size sub £100m) is a busy place. “Given the number of PE houses in the mid market, I’ve been saying for some time now that there will be some form of rationalisation or consolidation, but we haven’t seen it yet,” says Stephen Cole, partner private equity group KPMG. But as Michael Proudlock, chairman of Granville Baird Capital Partners, notes it’s also a fluid space. “Those that we would have considered to be competitors at the start of the 1990s would have included the CVCs, Apax and Cinven’s of this world. The landscape has changed and other people have some into the lower end of the mid market. It’s still a healthily competitive end of the market, but there do seem to be enough deals around to keep us all happily occupied.”

Sourcing deals

Good quality deal flow equals good quality deals equals good returns for investors, which equals a successful future fund raising and business continuity for a private equity firm. While this is tremendously simplistic, not factoring in things like the value add or unique angles a private equity investor can exploit in any given investment situation, it goes someway to explaining the need to maintain deal flow quality. A lot has changed on the deal sourcing front in the UK mid market, which was once content to sit and wait for the phone to ring.

“Years ago the PE community at the mid market end was highly dependent on intermediary introductions and a lot of [these introductions] came from accountancy firms. Through successful deals the PE firms built their confidence to develop their own sources and ways of doing deals. Any PE houses only waiting for intermediaries to bring them the deals now will not have enough deal flow to justify their existence,” says Cole of KPMG.

Private equity firms have worked hard on the deal sourcing issue and one obvious incarnation is the sector focus approach. Taking the sector approach not only allows intermediaries, for they are still a vital source of deal flow, to easily identify which types of transactions will interest different firms. It also enables the private equity firms to set up a good internal methodology for researching opportunities in their chosen sectors. But no matter how good the intentions having chosen sectors will only work if a private equity firm has both an intrinsic understanding of the strengths, weaknesses, opportunities and threats in a given sector or sub sector but all the firm simply must have an internal champion of that sector, someone truly interested.

Proudlock says; “One of the reasons we went down the sector route is that it enabled us to be masters of our own destiny by developing proprietary deal flow.” Another firm that has developed a workable focus in the way it approaches developing its deal flow is Sand Aire Private Equity. It looks not for particular sectors but for family-owned businesses and believes the experience it has gained of this genre of company through transacting and investing is a compelling value-add to other family businesses. John Hudson, director Sand Aire Private Equity, says: “We spend quite a lot of time with the big four [accountancy firms], more in the regions than in London. Our deal flow is 25% big four, 25% second tier accountancy firms, 25% boutiques and other and 25% own sourced transactions, which we have done through conferences and developing a database of family-owned businesses.”

Although private equity firms have made some real inroads into generating a proprietary deal flow they cannot afford to ignore the advisory community, as Simon Turner, co-founder of Inflexion, points out. “The accountants have a pretty good lock on the transactions that are advised. Followed by the second tier accountants and a long trail of boutiques that will occasionally yield some interesting deals,” he says. Given the fragmented nature of the intermediary market it is therefore very relationship driven.

That’s not to say that the accountancy firms do not weigh up the market with an analytical eye, however. In the same way that private equity firms are becoming increasingly aware of the need to monitor their deal flow and pay attention to the relationships that reward them with deals, the accountants keep a tally of how much each firm is worth, not just in terms of straight forward transaction support work but also tax, structuring and audit.


Although those that have gone the sector route have already chosen which ones it is, as Wol Kolade, head of ISIS Equity Partners, points out, the niches and sub niches that will offer the best returns in the future, but they are unfortunately quite difficult to identify. One way to spot these niches and sub niches might be to pick industries in turmoil. “There is merit in industries going through tough times because out of those tough times comes some interesting opportunities,” says Proudlock of Granville Baird Capital Partners.

“Manufacturing is a difficult place to be investing at the moment. We are still quite keen on investing in focused manufacturing businesses but finding them is quite difficult,” says Simon Wildig, partner Close Brother Private Equity.

Sand Aire Private Equity has found the family business sector, which tends to give equal priority to matters such as succession and tax as it does to price, a stable place to be of late. “We are delighted at how resilient the middle market has been over the last 24 months in terms of deal volumes, in particular family businesses have continued to create a large number of interesting opportunities and we cannot see that changing in 2004,” says Hudson.

One thing that has characterised the mid market in the UK in the last couple of years is the distinct lack of corporate buyers. Cole of KPMG believes this is, albeit selectively, beginning to change. “We have seen a number of corporations come back into the market place looking at making some acquisitions. They tend to be in traditional industries,” he says. But Richard Grainger, chief executive Close Brothers Corporate Finance, lays down the gauntlet: “I think this is the time for the corporates to start getting brave. If you believe we have reached the bottom of the market this is the time to buy: fortune favours the brave.”

Interestingly Grainger reports that restructuring work and M&A at Close Brothers Corporate Finance are pretty much matched. The firm has also recently added two new sectors to its coverage, which it thinks will yield interesting deal flow both for private equity and corporate buyers. They are consumer products and media. “Consumer products are a consolidation play, anything from good manufacturing to cosmetics. And there is a lot going on with television and radio, which is being deregulated, and we think there will be moving around of pieces in the magazine and publishing sector,” says Grainger.

Wherever the opportunities arise private equity investors will have to work hard to bring about returns. Kolade of ISIS Equity Partners says: “The market has professionalised enormously in the last ten years. People are much more engaged in their investments [in the mid market]. These days a fundamental part is to influence and change boards.”

Part of this engagement has resulted in private equity investors in the mid market, where exits have been as hard to achieve as elsewhere in the market, becoming far more creative in the way they approach the funding of their investments. This has meant that a lot of restructuring work has been applied to balance sheet with a view to showing returns to investors; an all important activity if a follow-on fund raising is in the offing. “The IRR clock is running against you. Simplistically the fact you can get money back into the hands of investors a), the better they like you, and b) the better the ultimate return you will achieve in your funds. Great IRRs are not the be all and end all. You want a great IRR and at least two times investors input in the fund,” says Proudlock of Granville Baird Capital Partners.

He is careful to caveat such comments though. He points to the fact that such interim returns to investors should not jeopardise the long term growth prospects of a business. This is important simply because corporates are prepared to pay more for a business with real long term growth plans and prospects. He also notes that during the bubble period there were corporates with money to spend which paid less attention to the issue of long term growth than they should have done but that private equity investors are unlikely to get good prices on such businesses in today’s more cautious business environment.


Pricing is always a tricky subject to get people to agree on; with some believing it is favourable and others not. “Pricing is very good at the moment and has been coming down since the end of the 1990s. I don’t think it has necessarily troughed yet,” says Turner of Inflexion. The fact that corporate buyers are back in limited numbers does not necessarily suggest that things are beginning to move upwards; instead they may be driven by strategic need.

Corporate vendors are certainly more willing sellers in today’s market. Cole of KPMG explains why: “Corporate vendors have adjusted their prices down. Compared with PE houses corporate vendors are slower to react to price change whether the price is going up or down.”