Private Equity in the UK

Content Industry Snapshot Industry Performance Products & Services Major Markets Globalisation & Trade Business Locations

Industry Snapshot

Key Statistics Snapshot

Revenue

Annual Growth 09-14

Annual Growth 14-19

£1.8bn 4.7% 4.3% £468.6m £875.2m 249 Profit

Wages

Businesses

Ftse100

Revenue vs. employment growth 40

9000

20

8000

Index

% change

7000 0 −20

5000

−40

4000

−60

Year 06 Revenue

6000

3000 08

10

12

14

16

Employment

18

20

Year 06

08

10

12

14

16

18

20

Industry Performance

Private equity investments were kind to both investors and the firms managing them in the five years through 200708. Stable economic conditions, steadily rising stock markets and cheap, abundant debt financing fuelled a global boom in large private equity buyouts. This all changed in 2008-09, when the financial crisis put an end to cheap credit conditions and consistently rising asset prices. Private equity firms earned lower returns and fee revenue, but the lower asset prices and reduced competition from other investors provided them with the chance to pick up stakes in companies at bargain prices. As equity markets improved in subsequent years, the value of private equity investments also increased. The industry is estimated to record strong revenue growth of 7.8% in 2013- 14 as equity markets continue to improve. This follows moderate growth the previous year as weak economic conditions and the ongoing European debt saga weighed on valuations and deals. Regulation introduced in response to the financial crisis is expected to make life more difficult for private equity firms. Over the five years through2013-14, industry revenue, in the form of the management fees, is expected to increase at a compound annual rate of 4.7% to £1.8 billion. Conditions in the Private Equity industry are forecast to improve further over the five years through 2018-19 as debt markets improve, buyers return to the market and private equity firms exploit large cash balances and cheap valuations to add assets to their portfolios. However, regulation poses a threat to the industry because banking reforms and changes to takeover laws are anticipated to raise borrowing costs and make it harder for private equity firms to engage in leveraged buyouts. IBISWorld forecasts that industry revenue will increase at a compound annual rate of 4.3% over the next five years, reaching £2.2 billion in 2018-19.

Products & Services

Products and services segmentation (2013-14)

10% Venturecapital

15% Replacement capital

20% Expansion capital

Total £1.8bn

55% Buyouts

Products & Services

The types of investments made by private equity funds can be broken down into two broad segments: buyouts and growth capital. Growth capital can be further broken down into three categories: venture capital, early expansion capital and late expansion capital. Buyouts Buyouts account for 55.0% of private equity investment. Management buyouts, where a company’s management purchases the company with support from a private equity firm, are particularly common. Management buy-ins, when an outside management team with financial backing from a private equity fund buys a company and replaces its management, are more unusual. The other major form of buyout is that in which private equity managers buy a controlling interest in a company directly. Often, some or all of the company’s management team is replaced and its strategy is overhauled. This type of buyout is often used to take a public company private. When it is financed with a high level of debt, it can be referred to as a leveraged buyout . The buyout market slowed dramatically when the financial crisis took hold. Expansion capital The other side of the Private Equity industry is based around providing capital to companies that are thought to have strong growth potential. Capital given to established companies with growth potential is referred to as early expansion capital. This can be used to fund further research and development or expansion into new markets. As established companies tend to carry slightly lower risk, providers of expansion capital tend to require a lower ownership stake and less control than venture capital investors.

Products & Services Replacement capital Private equity investment in more mature companies often replaces existing capital rather than expanding the company’s capital base, and is referred to as late expansion capital. It can include private equity investment in, or purchases of, companies already under the control of private equity. It can also represent the use of private equity funding to replace (i.e. pay back) the initial sources of capital, such as bank loans. Companies facing difficulty obtaining new capital from their original sources often turn to private equity firms for replacement capital. A private equity fund might then provide mezzanine capital or purchase distressed securities. Venture capital Capital provided to companies in their very early stages is referred to as venture capital. This type of funding often allows a company with an idea or invention to develop it into a product and bring it to market. Due to the high risk associated with investing in start-up companies, providers of venture capital tend to require a strong equity stake in the company and want to be actively involved in managing it.

Major Markets

Major Market Segmentation

Major market segmentation (2013-14)

8% Privateindividual investors

28%

9% Other

Pensionfunds

9% Insurancecompanies

13% Other corporateinvestors

18%

Total £1.8bn

15% Banks

Funds of funds

Major Markets Pension funds Pension funds are the largest market, investing retirement savings on behalf of workers. Private equity investments tend to make up only a small proportion of pension funds’ overall portfolios, representing a small allocation of investment in slightly riskier assets with higher potential returns. Funds of funds The second-largest market is funds of funds, which are collective investment schemes that invest in other funds, rather than directly in securities, to achieve diversification. A fund of funds may invest in a range of private equity funds as well as various other managed funds such as trusts. Corporate investors The remainder of the institutional side of the market largely consists of corporations, such as insurance companies, banks and other companies, investing excess cash reserves or money that is being held for later use. Similarly, other institutional investors that park money in private equity funds include academic institutions, government agencies and sovereign wealth funds. Private individual investors Private individuals make up a relatively small proportion of the market for private equity investment. Investment in private equity funds is generally limited to high-net-worth individuals due to most funds’ minimum investment requirements being in the hundreds-of-thousands or millions of pounds.

Globalisation & Trade

The Private Equity industry is highly globalised and many of the largest funds operate in locations around the world. Many private equity funds, particularly those managed by the larger players, raise money from investors across multiple countries, and similarly invest in companies on a continental or global basis. The larger private equity firms have offices in major financial centres across the globe, which manage investments and clients in their region. For example, Kohlberg Kravis Roberts & Co. (KKR) is a US-based private equity firm whose London office manages and advises on investments in Europe. The firm has a number of private equity funds that focus in investing in Europe. As emerging economies grow and outperform mature economies, globalisation is increasing, with private equity investments being made in companies in a wider range of locations throughout the globe.

Business Locations

The geographic spread of the Private Equity industry has been calculated based on the location of the companies in which private equity funds invest. The South East is the region with the greatest number of companies that tend to attract private equity investment. The region is particularly notable for the many tech start-up companies that attract venture capital and expansion capital, such as those emerging from the research hubs around Cambridge and Oxford Universities. Approximately 30.0% of companies that attract private equity are in the technology sector. The London region is the next strongest in terms of private equity investment, with its share largely reflecting its proportion of overall economic activity. Private equity investments in the remaining regions also largely follow the dispersion of economic activity.

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