Trends, recent deals, and move towards cashing out

We have been encouraged by the level of private equity deals being completed in recent months in Scotland, particularly in the Central Belt, in comparison to historic levels. We have seen investment across a wide range of levels, from very early stage up to Aggreko being taken private following its £2.3 billion takeover by TDR Capital and I Squared Capital in the spring of this year. Overall, there has been very promising activity from private equity houses in Scotland than has been seen in some time.

A trend we have begun to see more and more is private equity houses offering “cash out” to business owners as part of their investment structure. This is where cash is paid directly to shareholders who take a level of cash off the table, rather than all of the investment going to fund growth in the company. Historically, private equity investment into small and mid-cap businesses has focused predominantly on supporting the future growth of the business rather than towards shareholders de-risking with a level of cash off the table. Recently, we have seen many private equity houses move to offer prospective investees the opportunity of cash out as part of their investment offering.

It is evident that allowing an element of cash out is in the shareholder’s interest, however, the key reason why private equity are moving towards this has been driven by business owners seeking to de-risk after weathering the COVID storm over the last 22 months, and allowing some cash out from the value tied up in the business.

Another reason for the move toward cash out has been uncertainty around what the UK government will do to capital gains tax (CGT) in the coming years. Before the last few UK Budgets, there has been much talk about CGT reform and increasing rates, as well as the abolition or further restrictions on business asset disposal relief, which has led to many owners to seek a disposal or partial sale to lock in lower tax rates. While tax rate hikes have yet to happen, the spectre of it taking place is very real and will inevitably happen in the coming years, which will lead to a flurry of pre-Budget activity. While CGT rates are still currently advantageous, there is not currently any visibility on when that may change.

Cashing out can be attractive to vendors for many reasons. It lets them realise some of their capital without actually exiting the business. Private equity houses have generally been receptive to that opportunity as long as they are confident that they can manage the risk that owners aren’t taking out so much money that they will lose the incentive to grow the business. If the cash out is a life-changing amount of money, then the owner or management team may not be entirely invested to continue growing the business following private equity investment.

There has been a significant increase in transactions in a number of key sectors, including technology businesses, covering IT managed service providers and software businesses, as well as healthcare investments, across the dental care and medical device spaces.

In the past year, we have seen BGF invest in a number of businesses in the TMT sector, recently investing £8.7 million into Kick ICT, a Scottish IT platform business, to support its ambitious growth plans across the UK. BGF has also put more than £5m into Odro, a provider of video software to the recruitment sector. Maven has also invested in The Snappy Group, a tech solution for convenience stores. In the dental space, private equity-backed Clyde Munro has been buying up dental practices across Scotland and the UK.

The private equity market looks set to remain buoyant as we move away from the peak of the pandemic, when it was difficult for potential investors to fully understand the underlying profitability of the businesses, they were looking to invest in. Last year, private equity houses held off investing in businesses due to a reduction in performance as well as a gap in the valuation expectations between the private equity houses and the vendors. Deals therefore slowed for a period, however, now actively returned to Scotland.

While COVID-19 is still causing great uncertainty, confidence does seem to have returned among private equity houses and we expect to see many deals completed over the next 12 months.

If you would like further information or require assistance regarding private equity, please contact Corporate Finance Partner Iain Walker or your usual AAB advisor.