As the number of acquisitions and management buy-outs appears to be on the rise in the UK, Evette Orams, Managing Director of Hilton-Baird Financial Solutions, explores the reasons behind an interesting shift in the financial composition of those deals.
News that the UK boasted the fastest growing economy of all the G7 countries in both 2013 and 2014 has served to confirm the strides that the nation has taken since the depths of the global downturn.
Even if an element of caution does still remain, confidence continues to creep back into the markets as businesses increasingly realign their goals from survival to growth. While the approach of different businesses to secure this expansion might vary according to their size, it is becoming evident that many are opting for an aggressive growth strategy.
One thing I’ve noticed of late is a growing number of acquisitions, management buy-outs (MBOs) and buy-ins (MBIs) taking place. This is to be expected in a recovery to a degree, as the healthiest companies make the most of the opportunities that present themselves. Yet the interesting part is the make-up of those deals, or rather the methods of funding that are being used to facilitate the transactions.
Where the MBO/MBI space was once dominated by equity-backed investments, it would appear that asset based lenders are now having an even bigger involvement as businesses look to make the most of their assets.
So what are the reasons behind this shift, and will it continue?
Equity finance clearly carries a number of benefits to businesses seeking growth capital. There’s much more to it than simply the funding element; the expertise and support of the investor, together with their ‘contact book’, can make a huge difference to the business’s growth potential. The sticking point has always been the need to cede equity.
Arguably, however, there just hasn’t been a viable alternative available to businesses when it comes to raising the finance to complete an acquisition, MBO or MBI.
Due to the sums of money required, it is rare for growing companies to be able to rely on their existing cash flow to fund the transaction without jeopardising their immediate financial health. Traditional debt finance, meanwhile, can be a costly and risky option, though the banks’ adoption of a more cautious stance in the wake of the financial crisis has made the likes of loans and overdrafts difficult to secure anyway.
What many have realised is that the strength of their existing business is in fact their biggest asset when it comes to raising finance.
The UK’s mid-market businesses are performing very strongly. Together they employ nearly 10 million members of staff and turn over a collective £1.5 trillion every year. This means that they are typically asset-rich with a great amount of cash therefore tied up in a wide range of assets, cash that’s becoming far simpler to access as the asset based finance sector continues to evolve.
Asset based finance has undergone a significant transformation in the UK in recent years. Although it too contracted sharply as the global downturn struck, it has come back fighting and played a key role in fuelling the economic recovery.
According to the Asset Based Finance Association (ABFA), advances made to British businesses between April and June 2015 against the value of assets including debtors, stock, property, plant and machinery reached £19.3 billion. This is 32 per cent higher than the £14.6 billion that was advanced during the corresponding quarter five years earlier, in 2010.
There are a number of well-documented reasons for this dramatic increase. The decline in bank lending is of course one, which has also led to the alternative finance market expanding at breakneck speed (peer-to-peer lending and crowdfunding reportedly grew by 160 per cent in 2014 alone to provide £1.2 billion of funding).
Similarly, the introduction of the ABFA’s Code of Conduct has arguably helped to enhance the sector’s image, giving clients fresh confidence in the lenders and reassurances that any discrepancies or disputes can be resolved with the help of the trade association.
Yet a more overlooked reason is the sheer suitability of asset based finance in the current climate. Whether a business is struggling to maintain a steady cash flow or requires additional funding to capitalise on expansion opportunities, the features of this form of funding make it an extremely useful solution – particularly in times of economic recovery.
Crucially, this is what has appealed to so many larger companies who are looking to finance their growth plans.
A viable alternative
The statistics back this up. In Q2 2010, only 14.9 per cent of the asset based finance industry’s clients had an annual turnover of more than £5 million, according to the ABFA’s quarterly statistics. Fast forward five years, however, and this figure has risen steadily to 19.2 per cent as the profile of the sector has shifted.
Further still, comparing the data over the past five years reveals a notable change in the assets being funded. While advances against stock has risen by 160 per cent, for instance, funding against plant and machinery has increased by 327 per cent. Those assets alone now account for 6.1 per cent of overall asset based lending, up from 2.8 per cent in 2010.
While equity finance of course still has a place in acquisition and MBO/MBI transactions, it would appear as though, for the first time in a long time, businesses are being presented with a real alternative to ceding equity when looking to expand.
The challenge now is for the market to sustain its evolution, thriving on the success stories that are coming out of it. If it can, the MBO/MBI landscape will be just as different in another five years from now.