How could private equity investment affect Scottish businesses in the short to medium term?

Iain Young (Partner, Morton Fraser)

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by Iain Young, Corporate Partner, Morton Fraser

THE NEXT few years present a strong opportunity for the private equity (PE) industry to make a significant impression on the global economy.  Political and economic circumstances brought on by long periods of lockdowns are converging in a manner which means that we are likely to see mid-sized and larger companies in need of external investment to survive, develop and thrive.

At the start of the pandemic, the instinct of the private equity community was largely to sit tight and wait and see how the situation developed.  As it became clear that we were in for a more prolonged period of economic recession, private equity funds reacted in three distinct ways.  

Firstly, PE firms took stock of their existing investments and placed them into three categories: businesses which were worth supporting as they had decent recovery prospects; businesses which were likely to be badly hit by the recession and had little prospect of future survival; and those for which the pandemic provided good opportunities for substantial growth. Following categorisation, the PE funds then deployed their firepower accordingly.

Secondly, PE firms identified non-portfolio companies which were likely to grow despite the pandemic and invested in them.

Lastly, PE firms went out into the market and raised new funds. During the first half of 2021, investment levels into European PE funds reached a new high, in excess of €50 Billion. This means that funds have considerable liquidity that is ready to be deployed post-pandemic.

This is what will enable mid-size and larger businesses to gain PE funding in the short to medium term. It’s worth businesses noting, however, that the best investment opportunities for these funds will fall into three categories: geographical, sectoral and special situations.

When it comes to geography, the general consensus is that investment should take place in the UK (for funds based outside the EU), emerging EU countries (although the extent to which this may be affected by the current war in Ukraine remains to be seen), the Middle East and North Africa, as well as South Africa.

Investors are also more likely to target sectors that have flourished during the pandemic, including technology and communications, life sciences (particularly on the back of the development of anti-Covid vaccines), digital and cyber-security and fintech. Indeed, this plays to some of Scotland’s burgeoning strengths, with a growing technology industry and recent wins in the life sciences sector. 

PE firms are also likely to look towards special situations (providing debt and equity investments to companies undergoing significant challenges) when looking to invest, including restructuring with a view to sell on once profitability has increased. Moreover, PE firms will also look to fund businesses that can be pivoted to a different model of working, for example by taking advantage of flexible working and greater digitalisation.

Traditional management buy outs are also attractive when it comes to PE investments, where there is a solid business performing well but the existing owner-directors wish to exit.  They can then either pass the business on to the second tier of management or a PE firm can bring in a new management team with a proven track record of success.

There is still, however, some threats which businesses should be aware of that could have an impact on securing PE investment. These include supply chain pressures, energy costs and continuity of supply, geopolitical factors, inflation, and in particular, wage inflation combined with a shortage of qualified and skilled workers and increased interest rates.

It’s clear that post-pandemic, the private equity industry is beginning to look at investing in new opportunities and with specific areas being of interest, mid-sized and larger companies should begin to look at how they can position more attractively to investors. 

Iain Young, Corporate Partner at Morton Fraser

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