But what makes capital 'smart'? It's growth capital offered by investors that can offer more than financial gains. These investors bring knowledge, contacts, valued networks, or purpose-driven thinking to a company.
In the current post-election, pre-Brexit climate, the need for this kind of smarter investment looks critical to re-kick-starting our economy, as financing opportunities begin to re-open.
Uncertainty. The word has irritated British SMEs and UK Plc for nearly four years. It was all but presumed we could do away with it once the election was done and Brexit more or less guaranteed. Yet, a degree of uncertainty remains. Despite markets looking to be on the up again, a more measured, smarter approach to the investor/investee relationship will ensure the cream of our companies rises to the top.
Following the election result, the markets look like they’ve been rallying. But now is not the time for a gold rush. Rather, selective, smart investment is needed to grow our most ambitious and promising companies in ways that suit their needs exactly.
Reflecting on the result, there’s a lot that is still unresolved; the hasty amongst us may be expecting too much too soon. The Conservatives may have come to power with a strong majority however this has not upgraded people’s economic expectancy for this year. Commentators’ consensus predicts low growth for the next 12 months as markets recover from the weighty economic environment of recent years.
Furthermore, while we may look set to leave the EU, the final trading relationship with our biggest trading partner is far from decided. Leaving at the end of January with no trading deal whatsoever is still a possibility.
And while the election triggered somewhat of a relief rally in the markets in the final quarter of 2019, we’ve seen a lot of downgrades. Earnings expectations have also decreased. As markets went up in the last quarter, with sterling also up against other currencies, for the European or US buyer of UK companies, the UK market now looks about 15% more expensive.
What does appear certain is that we shouldn’t expect any radical policy changes that will impact entrepreneurs and business leaders. As uncertainty remains over the EU trading relationship, there is a reticence to disturb the status quo. For example, going into the election there was some expectation that the Tories would reduce corporation tax. This now looks unlikely as the cost is prohibitively high.
Additionally, the Conservatives pledged to ‘review and reform’ Entrepreneurs Relief, a tax break that currently allows business owners to pay a lower rate of 10% capital gains tax when they sell a business, compared to the normal 20% rate. How this pledge will manifest remains to be seen. The rules around Entrepreneurs Relief look likely to be tightened or potentially abolished. This would not happen until at least following the ‘post-Brexit Budget’. As such, for entrepreneurs keen to sell their business, there is roughly a two-month window right now before that gets more expensive.
Finally, the new government also seems enthusiastic to provide additional funding for R&D bodies in science and technology, but at the moment this is more to ensure continuity, plugging the EU R&D funding hole.
All in all, for businesses, little has changed. While there has indeed been a rally, the smart investor would be wise to view this cautiously and be quite selective about where to put their money. Perhaps look for that undiscovered value in companies that the market might not have yet identified.
Smarter about small cap growth
The onus for 2020 is on smart capital. Smart capital is the growth capital you need that exactly suits your business goals and takes many forms. It might be growth capital where the investor can offer much more value than a big cheque, where the investor and investee’s needs and goals are aligned. It might be the fund manager that buys public companies with a proactive approach and outlook to their growth. Or the private equity firm with specific sector expertise that buys an SME to run it themselves.
The smaller end of the market has suffered disproportionately of late. As well as the pressure of Brexit and the election uncertainty, factors like the Woodford fund’s failing have had an impact. Investors are more wary of buying smaller, sub-£100 million market cap companies as a result of the Woodford case. These smaller companies are less attractive to fund managers as they are harder to liquidate quickly, a complication that compounded the fund’s downfall. The episode shone the spotlight on funds that may contain a lot of small, illiquid public companies, giving fund managers pause.
As a result, smaller cap companies like these could see more acquisitive activity from private equity which is less concerned by liquidity.
Indeed, for private equity one could argue that the outlook is now very positive. Smart private equity investors looking for small UK companies have probably never had it so good. Private equity firms are often debt funded and debt is particularly cheap currently. For the scaling entrepreneur or business leader, deciding whether such an acquisition amounts to a smart investment depends on individual ambitions.
Meanwhile, what has also changed is that we’ve reopened opportunities in the IPO market, which was more or less dead last year.
Following the general election, we are beginning to see inflows into the UK capital markets and confidence return to management teams. This makes it an ideal time to think again about how the public markets can help fuel growth for a business and what a public listing might do for a business’s prospects.
For those businesses that rely on friction-free access to the single market, the uncertainty over the future EU trading relationship still requires clarity. But for ambitious domestic businesses – such as wealth managers, UK consumer businesses or support services businesses involved in UK infrastructure or house-building contracts – both the fundraising and IPO windows have reopened.
So, for a business that is large enough to consider private equity or the public markets, the age-old question is which do you go with that offers the smart capital? Acquisition by PE can be advantageous but can install management that may take things in a new direction to what the founder envisaged. PE will affect very much how you run the business, whereas with listing it you can carry on as you did before.
2019 was a year of political turmoil in the UK with continued debate over when and if the UK would leave the EU, a change of Prime Minister, a minority government, the Supreme Court overruling prorogation and finally a general election.
Most agree that whatever your political views this environment was not helpful to investment decisions for either management teams or fund managers. Not only was decision making difficult but as capital continued to be withdrawn from UK equity focused funds, the UK domestic equity market substantially underperformed its global peers. This led to a dearth of public market fundraisings and a terrible year for IPOs.
It would be hasty to assume all is on the up again following a decisive election result and more certainty on Brexit. But there is still much that is unresolved; the market rally is more a case of relief and recovery and little economic growth is expected for the next 12 months.
However, the fundraising and IPO windows are open again. With a degree of cautious optimism and a smarter look at the growth capital options on offer, assessing what is the investment and, importantly, the investor that best suits your growth ambitions, companies will reap long term rewards. The smaller cap end of the market may have suffered of late, but the opportunities now are opening up. Private equity is in a good position to provide new direction, and the IPO market looks set to reinvigorate, with public listings able to offer fuel for growth for the right businesses.
At finnCap, we are experts in growth capital and would be delighted to discuss where the smartest investment for your business lies.
By Raymond Greaves, Head of Research, finnCap