For the UK midmarket, very little feels stable or secure right now. But with all this change, consistency, simple messaging and an unwavering focus on the industry’s strengths, including nimbleness and resurrecting the expertise of deal craft, are vital to prosper in these uncertain times.

At the table

• Hazem Abolrous, CEO, RingStone
• David Barbour, managing partner, 
FPE Capital
• Chris Cormack, partner, Endless
• Wol Kolade, managing partner, Livingbridge 
• Malcolm MacDougall, partner, Stephenson Harwood
• Kirsty McDonald, partner, 
Growth Capital Partners
• James Tetherton, senior partner, GRAPH Strategy

Moderated by Alice Murray, 
editorial director, Real Deals

Given the macro and political environment, do you agree there is a sense of fear and pessimism in the UK midmarket? 

David Barbour: We were always going to have to unwind from low interest rates. It's happened in a very specific way because of Covid, which drove a massive peak of valuations in certain sectors and what now feels like an enormous fall. But we see it as all part of a continuum which, if you go back over the last 12 or 15 years, is relatively normal if you take out the peaks of 2020-2021. Interest rates are obviously having and are going to continue to have an impact on deal doing. But I think now it's more an air pocket of difficulty – an adjustment, which will quite quickly become normalised. And average valuations will come down to more reasonable levels, with some of the frothy outlier valuations we have seen some people pay curtailed. 

Kirsty McDonald: I think it's questionable that a changing government will have much impact on private equity at all. I don’t think the UK as a whole is as bad as the bleak headlines sometimes suggest. It looks like we might escape recession altogether. And there are some positive economic metrics coming through too. So I think there needs to be a bit of balance about the economy as a whole, and the private equity midmarket within that, which is performing very well.

Wol Kolade: I think we're going to see a bit more choppiness. There is a focus on how much private equity is taxed, and that it should be taxed more. That will have an impact on the location of private equity here. Let's be clear, our industry as a whole has benefited from the large funds being in the ecosystem, which we all profit from, which was driven by the fact they raised billions and billions and billions. If they move away, it won’t be so attractive anymore. 

Chris Cormack: Are we not just adjusting to what the new norm is? We had a period of low interest rates, low inflation, a strong and stable economy which supported transactions; leveraged buyouts had access to cheap debt and so the market was very buoyant. We've had a number of macroeconomic shocks with Brexit, Covid, political instability in the UK and the US, and the war in Ukraine. Now, we're trying to find where we're going to resettle. But I'd argue that 0.25% interest rates and 2% inflation, that was an exceptional time to do deals. The markets need time to adjust, we're not there yet, we don't know where it's going to land, but we've all got to adjust to the new environment and it should recalibrate. 

McDonald: There is choppiness in the UK economy but we mustn't allow people to confuse the health of the UK economy as a whole with the health of the UK midmarket private equity industry. Growth Capital Partners invests alongside founders in high-growth market segments and we have close to zero leverage on average across our current fund. So in places, it can actually be a buoyant market; we still see brilliant opportunities.

Kolade: On a macro level there are some major things happening. US investors, like it or not, can afford to ignore Europe; 80-90% of their capital is deployed in the US, and that remaining 10% is for the rest of the world. If we want our fair share, we've got to make our case. 

Inflation is also a big factor here and it is important to consider the impact that has on the economy. Inflation is persistent and takes years to drive out. We are back in a cycle. Inflation is tough for all of us in operating circumstances because it affects your cost structure. You've got to have brave people, a very good product, and a very good company that’s able to increase its prices every year. We are facing a very real challenge next year, with inflation highly unlikely to come down dramatically.

James Tetherton: I think there are divergent views in the midmarket at the moment. For investment committees and those doing deals, there are certainly big macro risks associated with some of the opportunities they’re looking at. And for some teams, that can lead people to just sit tight and not make any investments, and certainly we’ve seen some firms do that over the past 12 months. 

But there are also huge upside opportunities for the people who can find the right strategy and keep making investments. If you can dig into the nuances and the niches, then you can still find lots of really amazing businesses that are proving very resilient. Obviously, the market for bolt-ons continues to be very buoyant as well. For GRAPH, we've grown a lot this year but we’ve seen a huge spread in the kind of work that we're doing, which I think is reflective of this conversation; there are lots of opportunities but there are also risks. You've got to be very nimble in what you do. If you are nimble, you can succeed!

What about valuations in the current market? How can GPs best respond? 

Barbour: The debates around valuations have been pretty robust in the last 12 months, but what is the right price for something in a market where things are correcting? And just because it's 10% cheaper than last year doesn't mean it's the right price. You need a specialist sector focus and a strong view of value creation to have conviction on valuation. That sounds obvious but at this point of inflection, that can be a difficult call sometimes. A lot of firms have stood back from investing in recent months but we have made five new investments in the last 15 months and we see these conditions as positive for our strategy. 

Kolade: There's also what I call deal craft. So the cookie cutter MBO, here's the model, it needs this much money, this is the management’s sweet equity and so on. Actually, in environments like this where there is uncertainty and you can't match expectations on valuations, you have to develop a different structure. Maybe there’s some mezzanine or a vendor bridging loan – all the tools that are so often overlooked become key to structuring good deals.

Does the UK midmarket have an attitude problem? Does it need to be more optimistic about current opportunities and its ability to generate returns? 

Cormack: We need to highlight how value is created, job creation, innovation and growth. If you look at how we communicate through media and PR, we could do better. We're all relatively small firms, likely without dedicated marketing and PR functions, and we need to be much better at telling our story. We need to be producing case studies that demonstrate the impact of our investments and sharing insights, research and best practices with industry bodies, attending conferences and events, including an open and transparent dialogue with government and media. We need to be better.

Kolade: A different point here is our involvement with our LPs and the way we approach them, and the confidence we have when we talk about the UK really needs to change. And that is about having a ‘can do’ attitude, which you see in the US. The danger is that the perception that ‘nothing works in the UK’ takes hold. So it’s possible that an LP can meet with a great manager, producing knock-out returns, but perceive that the country is broken, which doesn’t make their IC judgement any easier. 

Does the UK government understand private equity? 

Malcolm MacDougall: The NSIA legislation is interesting here. It is so broad and catches so much that is completely unintended, which means needing government approval for a whole load of deals that shouldn’t need it at all, which can seriously impact timings. If you make it such that a smaller midmarket deal needs to be conditional and have a split signing and completion, it makes the whole deal massively more complicated. 

What about talent, management teams and the current labour market? 

Kolade: Management teams represent both my greatest fear and biggest hope. The fear is that they're simply just getting tired. They went through Covid, which was awful, and the good ones did a great job. Then they raised themselves above the parapet, and then they’ve been slammed straight into Ukraine, interest rate hikes and inflation. We're seeing burnout happen at a rate of knots, which I haven't seen before, and that’s when the need for new talent can arise. Now, the issue is sourcing that talent. But we're bringing in younger, more diverse talent and being more creative in how we think about hiring people. It's forcing us to do things we didn't do before; to change the dynamics to hopefully bring differentiated talent into the portfolio and, hopefully, achieve good returns. 

Barbour: Our biggest single focus is how we bring great talent into previously bootstrapped businesses. As a software investor, our market has been tight for a while so we have had to be creative in recruitment. As for burnout – we have seen more of that in the finance functions actually because there's been a lot of juggling around as businesses install systems and processes – and we spend a lot of time supporting all the teams.  But we're experienced in how to bring in new senior management so it feels like an extension of that process.

Tetherton: We work with midmarket companies and I love meeting management teams and hearing about the journey that people have been on. We see entrepreneurial spirit in every business – it's amazing and inspiring. For those management teams, the value of private equity is about what you bring beyond just capital. It’s about the knowledge sharing across all of the portfolio businesses and the understanding of what's going on in the world. It’s access to advisers and support, and knowing experts in particular specialisms. It's the access to talent – having the backing of a great investor enables you to get better talent into the business than you could do if you were just privately held. Demonstrating the engine that private equity can be for growth is always important. And when times are hard, as they are at the moment, it's even more important.

Hazem Abolrous: I think the elephant in the room is artificial intelligence. It scares a lot of us but also it potentially gives us a tremendous opportunity, especially for traditional businesses – the level of efficiencies that it can bring. Speaking of management teams, burnout, we've seen a lot, especially around CTOs. They can’t find the staff locally so they have to go at arm's length to find appropriate talent. I’ve had a lot of conversations with different private equity firms, where they want to help their CEOs comprehend what's happening with AI – to understand how to leverage AI for roadmaps, initiatives via efficiency, and improvements they can introduce into the business. There's a lot of change, which will require a lot of adaptations on both the private equity model, but also for management teams at large.

Barbour: But I think that's a huge advantage for private equity; you're part of a family when you're in a portfolio of similar businesses and where knowledge is shared, there's a central pooling of resources and sector knowledge. And that's so much more supportive than being a sole trader, or being a listed company where you don’t have that support, unless you pay a consultant.

Does the wider public have an appreciation, or even a basic understanding of the unique support private equity provides to its portfolio companies? 

MacDougall: There is this perception in the world at large that PE firms are sharks and have sharp elbows. We have a lot of deal volume and we do sometimes see it. It is a small minority but when that happens it completely tarnishes the reputation of our industry. And it doesn't get called out because of confidentiality. I think we need to be very careful in the industry about that small minority of incidents. I recently worked on a deal, which came down to two bidders at the end – a trade buyer and a PE buyer. The seller’s view was that the PE buyer was going to chip the price at the last minute, so they went with the trade buyer. If that's people's perception of the whole industry, that's a huge problem.

McDonald: I think part of our problem when it comes to the perception of PE is we start with the financial metrics and then perhaps we talk about value-add and we get into a load of jargon. But actually, for me, it's a personal thing. It's a personal thing for us investing, it’s a personal thing for the leaders and founders you're working with, with the teams in their business. We invest in the knowledge economy, so in people, culture and talent development. Let's talk about personal stories that might resonate in a way that Ebitda growth might not. 

Cormack: I still maintain we don't tell that story well enough – the benefit private equity brings to regional development. As an example, we have an apprenticeship and education business in the portfolio that converted an abandoned community centre in Bradford into a skills hub, in an area with high unemployment and a high percentage of residents with no qualifications. It was proposed as part of winning an adult education tender in Yorkshire to make learning more accessible to people who haven’t got basic English, maths or digital skills. That is a great story, so why aren’t the papers talking about this?

What about the broader domestic ecosystem in the UK, especially pension funds? Did the recent Mansion House reforms go far enough in convincing UK pension funds that there is real value in investing in private capital funds? 

MacDougall: There is a structural problem with our whole pensions industry; it is made up of very small and regional pots. When you talk about Canadian and Australian pension funds, they're massive. But here it's completely diverse. If there was some level of aggregation, that would go a long way in justifying the fee models in asset classes such as private equity.

Kolade: This is a multi-decade problem. The Canadian pension funds didn’t just get big, they compelled everybody to put money in and because of the power of compounding after a while, it became really big. If you are really going to attack the problem, you've got to have consistency. The Mansion House reforms are a good but small step and we’ll see what the impact will be. But there's always negative press that pops up, you've got to just ignore all that and say: this is about the long-term health of the country. Look at Canada, look at Australia, where they funded it properly. We've got to win that debate.

Does the industry need to look at itself more carefully? And if so, what does it need to think about? 

Kolade: Let's be clear, private equity is still a minuscule part of the entire investment landscape. Thinking we are really important is dangerous. And that’s partly because if someone wanted to invest a billion dollars with us, and get that investment working immediately, we can’t do it. That’s because we are a craft business. What we do is slow; it would take time for a lower midmarket fund to build out and be able to handle that kind of investment. And that mismatch is still there. 

Tetherton: Wol’s reference to the craft story, I think it's exactly right. And that's really important to the success of the industry right now – in today's environment, that's where PE should really be excelling. Those who have developed the craft of dealmaking and who can deal with complexity are the ones who generate great returns. 
It’s about structuring things in the appropriate way, hiring the right set of advisers, working with management teams, taking a longer-term view and being responsive.

Cormack: We need to demonstrate our ability to build better businesses, overcome obstacles and achieve growth. There is arguably a misplaced perception that private capital loads companies with debt, leaves management on their own, benefits from multiple arbitrage, sells in five years’ time and makes a great return. But we all know that it isn’t that at all – it’s incredibly complex and it’s incredibly challenging. 

Barbour: Talking to entrepreneurs and founders, for us that’s the most important point of the whole transaction; that very early stage where we explain what we do and how private equity can be the best and most flexible solution for them. We encourage them to talk to other founders we've worked with. That’s an important part of how we get our story across to the value creators and founders, who often misunderstand the potential of a private equity journey. 

McDonald: People talk about the midmarket as if it's one homogenous thing – and that couldn’t be further from the truth. And it’s in understanding those differences that the magic and the opportunities in the industry lie.

Kolade: When we do what we do well, we're amazing; I think the investment story for private equity or private markets, in particular for the midmarket, is very strong, particularly now.

Abolrous: I agree that when you step right back, private equity is only a small part of the whole economy. But with the same token, I think it has grown enough and grabbed a lot of visibility that there is a certain level of responsibility for private equity to, actually, I don't want to say change the narrative because that's a difficult thing to do, but rather tell the story.

I remember a quote from Mark Twain where he wrote a letter to his friend and he said: “I'm sorry, I had to write you a long letter because I didn't have time to write a short one.” There is an essence in that. Private equity has a responsibility to come up with that short narrative that will be well suited for all the audiences it needs to speak to today.