UK VCs bearish on economy, bullish on deal flow

The latest poll of UK VCs has a quarter expecting a deteriorating economy and the majority see restructuring PLCs delivering most buying opportunities.

UK consulting firm Deloitte & Touche has just released the results of its latest quarterly survey of venture capitalists that reveals many have a pessimistic outlook for the UK economy but also see opportunities for increased deal flow for themselves.

Each quarter Deloitte & Touche Corporate Finance surveys its network of 770 individual venture capitalists to gauge their expectations for the UK private equity market for the subsequent six months.

A quarter of the contacts predicted the economic climate will deteriorate further (this was only 4 per cent of respondents last quarter) and only 17 per cent anticipated an improvement (37 per cent felt this way last quarter). 

This pessimistic view of the economy is one reason why 52 per cent of respondents are predicting that restructuring public companies are going to be the most significant source of transactions. Another 20 per cent saw family and private companies providing the most deals as the impact of April's capital gains tax changes take effect whilst 15 per cent cited the increasingly popular secondary purchase (where one financial buyer sells a portfolio company to another fund) as, in their estimation, to be the best source of deals.

Mark Pacitti, Deloitte & Touche private equity partner said, 'there’s more pressure on vendors now. They put their non-core businesses up for sale six to eight months ago and are now coming back with revised prices to get a deal done.” 

But there has not been the predicted wave of distressed sales as public companies struggle to divest as their bankers exert increased pressure on them: “By and large the banks have been supportive of vendors and it’s more the private equity houses who have been waiting it out,” said Pacitti. “The interesting thing now is that there’s a greater sense of the UK market having bottomed out and that buyers need to get moving before valuations climb upwards again,” he continued.

Pacitti was also keen to dispel the view that secondary sales are a last resort for embattled funds. “Secondary buy-outs are now a viable exit channel and have accounted for some of the largest deals this year as depressed M&A and IPO markets keep alternative exit routes shut', he said. “They let a [selling] fund redeploy capital and can provide an interesting dovetailing of deal size preferences between two funds: one which invests in the £20m to £50m range may have bought at £30m, grown the portfolio company to a £60m valuation and can then sell to another fund that invests in the £50m to £200m range.”

That said, given the lack of exit alternatives, most VCs (75 per cent) surveyed expect to be net buyers over the next six months with only 13 per cent expecting to be net sellers (these figures were 70 per cent and 15 per cent respectively last quarter).

There was a small increase amongst respondents expecting their own portfolio companies to be affected by tougher market conditions, with 7 per cent expecting a decline in performance (0 per cent felt this last quarter). And only 18 per cent anticipated underlying business growth to bring returns. Most respondents instead predicted that improved performance would come from hands-on input to a portfolio company: 42 per cent expected buy and build strategies to bring opportunities and 33 per cent saw the greatest potential for portfolio company improvement to come from restructuring.