2021: a bumper year for UK deal flow?

The start of another national lockdown may seem a strange time to be bullish about the prospects for the year ahead. But there are a number of reasons why 2021 is shaping up to be a bumper year for deal flow at the lower end of the UK mid-market (in our definition, companies making £2m to £10m of EBITDA). Whether that means growth capital to fund expansion plans or replacement capital to finance changes of ownership, Prefequity’s flexible capital solutions should find plenty of takers.

First, and most importantly, a Brexit deal has been concluded a mere four and a half years after the referendum (subject to ratification at the EU end). While this leaves many loose ends to be tidied up, it should unlock many of the transactions and investment plans that were put on hold pending the outcome of the negotiations. Even if you believe the concerns about the short-term impact of a no-deal Brexit were exaggerated, it is undoubtedly true that the uncertainty acted as a deterrent to business investment. This uncertainty would largely seem to have now dissipated. From this point of view, it is reassuring how quickly Brexit as a media topic has almost disappeared from view as the focus has moved on to other concerns.

Second, the prospects of a vaccine-led exit from the pandemic later this year should act as another catalyst for increased deal flow. While public markets have tended to look through the disruption and have gone on to trade at record levels, the pandemic has acted as a major brake on transactions in the private sector as buyers and sellers have struggled to find common ground. Though the end of the pandemic is still some way off, it already looks close enough that we should soon see this situation start to correct itself.

Third, the response to the pandemic itself has had, and continues to have, profound effects on the shape of the economy. While sectors such as hospitality, travel and leisure have suffered enormously, areas such as technology and e-commerce have correspondingly flourished (the so-called K-shaped recovery). Though it remains to be seen how permanent these changes will be, they are undoubtedly creating opportunities for nimble-footed companies to take advantage of new openings. Many of these will require external funding for their growth capital requirements.

Fourth, it is an open secret the government is considering changes to the UK’s generous capital gains tax (CGT) regime. Currently a high-earning business owner would pay CGT on a share sale at 20%. This compares to a top rate of income tax of 45%. If the rate of CGT were increased in line with income tax, the potential loss to a business owner considering a sale could be up to a thumping 25% of proceeds. This may well encourage business owners to sell (or at least partially sell) before it is too late.

Fifth, and finally, the first half of this year will see the end of government initiatives such as the CBILS loan scheme and tax payment holidays that have been a lifeline to many smaller companies. This may well throw up refinancing opportunities as companies look to repair balance sheets. It is worth noting that QE has not benefited small companies to anything like the same extent as large corporates – while the BBB corporate bond index yields barely 2%, this is little comfort to the kind of small businesses that Prefequity invests in. For companies unable to access the public capital markets simply because of their size, the cost of private capital remains stubbornly high – not that we are complaining.

All in all, then, 2021 promises to be an active and attractive period of deal-making after several years of delay and uncertainty. Against this optimistic backdrop, we expect to build on an already full pipeline, enabling us to be highly selective, not only in the companies we back, but also in the underlying terms and protections we commit to on behalf of our investors.