There are both threats and opportunities for private equity firms and their portfolio companies, write Mike Wright, Kevin Amess, Nick Bacon, John Gilligan and Nick Wilso

Amess, Kevin

Bacon, Nick

Gilligan, John

Wilson, Nick

Wright, Mike

LSE Research Online

1/10/2017Brexit is changing the scenario for private equity in the UKblogs.lse.ac.uk /businessreview/2017/01/10/brexit-is-changing-the-scenario-for-private-equity-in-the-uk/Private equity (PE) firms typically raise capital to establish limited life funds of 10-14 years duration. They use thesefunds to acquire a portfolio of existing firms. Each portfolio firm is acquired in a transaction which combines capitalfrom the fund with third party debt finance. The debt is secured against portfolio firms’ assets and/or future cashflows. PE firms aim to increase the value of the businesses acquired, before selling it to realise a capital gain.Impact on private equity activityThe UK has the largest private equity market in Europe (Figure 1). Over the period 2005-2015 the UK accounted forabout one third of all deals and one fourth of all deal value in Europe[1]. Although the market had been recoveringsince the financial crash, during 2016 it fell sharply.Figure 1: The UK’s private equity-backed buyout market1/4Source: CMBOR/Equistone/InvestecA number of Brexit related factors could negatively impact on private equity firms’ abilities to conduct deals. First,many debt funds are foreign-owned and may exit the UK in the light of Brexit. Reduced debt availability makes itmore difficult to put the finances together to fund acquisitions. Indeed, in the six months since the referendum,average leverage in buyouts has fallen[2]. Second, the UK will no longer have access to European Investment Fund(EIF) funds. The EIF has been a prolific investor in private equity funds and its leadership role also attracts privatecapital into funds. Third, the UK will not be able to influence any new Alternative Investment Funds ManagementDirective (AIFMD), which might inhibit the ability of UK PE firms to access the EU institutional and retail investmentmarkets.On the positive side, however, Brexit will allow the UK to develop its own policies on private equity operations withinthe UK. For instance, the UK government would be able to re-introduce more flexibility concerning state aid tostimulate PE investment in growth finance and the buyout sector.The macroeconomic impact of Brexit is yet to be felt as the UK has not yet exited the EU and at the time of writing itis not clear what form this will take. To the extent that there may be an economic slowdown this is expected to createan increase in the number of firms bought from insolvency. In addition, private equity firms are looking to buycorporate assets that are undervalued due to economic uncertainty. However, if asset prices are reduced,corporations and family owners of private businesses may be reluctant to sell. Although the overall market value fellin the first six months since the referendum, buyouts of family businesses have held up[3], which may signal adesire on the part of owners to sell now before prices fall.Impact on portfolio firmsAny restrictions on labour mobility may have important implications for portfolio firms operating in sectors that rely onEU labour e.g. healthcare. Difficulties in recruiting employees could lead to wage inflation due to firms competing forworkers in a smaller labour market.2/4Several areas of employment legislation most relevant for portfolio firms pre-dated the UK’s entry into Europe,including redundancy law and protection against dismissal. Nevertheless, Brexit offers the opportunity to reduce theregulatory burden on firms, making it easier for portfolio firms to cut costs. This would add to controversysurrounding private equity and buyouts that have previously been criticised for transferring wealth from employeesto PE investors. If the UK were to maintain access to the European Economic Area (EEA), it is likely it would berequired to maintain these labour laws.While PE firms take a long term perspective and sometimes conduct acquisitions in order to exploit entrepreneurialopportunities and increase employment, Brexit may contribute to economic uncertainty, deterring these deal types.However, those private equity-backed acquisitions that focus on improving efficiency and creating sustainablebusinesses might preserve jobs that would otherwise be lost in an uncertain macroeconomic environment. There isevidence that PE-backed buyouts are more resilient during recessions.Reconfiguring of global trading relationships following Brexit could provide access to new export marketopportunities; however, uncertainty regarding the terms of trade with the EU and elsewhere could deter PEinvestment in export-oriented businesses in the short to medium term, worsening the UK’s balance of paymentscurrent account deficit.Government policy to tackle regional and sectoral imbalances could draw on PE experience to play a significantrole, taking advantage of the potential removal of EU ‘state aid’ rules in tailoring incentives for investors to supportspecific sectors, regions and export markets.SummaryBrexit creates threats and opportunities for both private equity firms and their portfolio companies. It will be sometime before the dust settles regarding the future relationship of the UK with the EU. It is therefore important todistinguish between short-term effects arising from political uncertainty from the longer-term implications of a certainnegotiated Brexit outcome. The forecast economic downturn creates a challenging environment; however, UK PEfunds have been more adaptable than other types of UK funds and portfolio firms have shown performanceresilience. Throughout the cycles of the PE market over the last three decades, changing economic conditions havealways generated opportunities to create new types of deals and new ways to generate returns. It is going to beinteresting to see how the market evolves in the presence of these new challenges.[1] CMBOR (2016) European Management Buyouts, Centre for Management Buyout Research,Autumn.[2] CMBOR (2016) UK Management Buyouts, Centre for Management BuyoutResearch, Winter.[3] CMBOR (2016), European Management Buyouts, Centre for ManagementBuyout Research, Winter.♣♣♣Notes:This blog post is based on the authors’ paper Brexit, Private Equity and Management, in British Journal ofManagement, Volume 27, Issue 4, October 2016, Pages 682–686The post gives the views of its author, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: Canary Wharf – One Canada Square, by Bob Bob, under a CC-BY-2.0 licenceBefore commenting, please read our Comment Policy.3/4Mike Wright is Professor of Entrepreneurship at Imperial College Business School and Director ofthe Centre for Management Buyout Research (CMBOR) which is sponsored by EquistonePartners Europe and Investec Bank. Email: mike.wright@imperial.ac.uk  Kevin Amess  is Associate Professor at Nottingham University Business School and a fellow ofCMBOR; Email: kevin.amess@nottingham.ac.uk   Nick Bacon is Professor of HRM at Cass Business School and a fellow of CMBOR; Email:Nick.Bacon.1@city.ac.uk  John Gilligan is visiting professor at Imperial College Business School and a fellow of CMBOR;Email: rjmghome@hotmail.com   Nick Wilson is Professor of Credit Management, Director of the Credit Management ResearchCentre at Leeds University Business School and a fellow of CMBOR; Email: nw@lubs.leeds.ac.uk    Copyright © 2015 London School of Economics4/4

Brexit is changing the scenario for private equity in the UK

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