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The Brexit factor

Talya Misiri 25 March 2021

A panel of experts discussed how Brexit has and will affect the private equity industry, with a focus on deals, portfolio company management, investor queries and more.

Speakers:

David Barbour managing partner, FPE Capital

Ken Terry CEO, Elysian Capital

Malcolm MacDougall partner, Stephenson Harwood

Tom King head of PDD, Global Counsel

Listen to the summary of the discussion here

 

Businesses offering services, such as banking, architecture, and accounting, will lose their automatic right of access to EU markets and will face some restrictions. How does the Brexit agreement as of 1 January impact private equity and its operations overall?

Malcolm MacDougall: In terms of deal volume, it doesn’t seem to have been impacted by Brexit at all. Deal volume still seems to be very high. It is more likely that the impact will differ from deal to deal. I’m currently working on a transaction where some Austrian investors are investing in a UK company and fund flows and moving money is proving difficult.

One area that I think will be impacted to a greater level is fundraising because we won’t have automatic passporting rights around Europe and we will have to comply with national rules, which are easier in some countries than others. One of the ways round the potential impact will be working under an umbrella of a Luxembourg manager or another administrator based in the EU. We may see more of this. 

Ken Terry: We finished fundraising for our latest fund in September and we’ve always been small fund AIFMD registered, so we didn’t have to go through the large AIFMD process. We also have pan European investors and none of them really brought up Brexit as a significant issue in the process. So, I’m a bit more relaxed about the situation overall.

On the deal front, the fact that navigating different currencies and cross-border deals in a post-Brexit environment has gone back to being slightly more complex is manageable and makes it slightly more interesting!

David Barbour: As soon as the vote happened in 2016, we saw quite a significant shift in behaviour that came out of surprise and uncertainty. We were fundraising at the time, between a first and second close and we saw most of the continental investors, I think, really out of shock, taking a step back and that was unhelpful to us. Over time, it’s like everything in life, other factors come along such as Trump, Covid, etc. and then you start to price in the shock of that.

Looking specifically at our market segment however, the tech market has grown hugely and so we’re seeing enthusiasm from all investors, including European, for UK software. I’m not too sure how different that is in different market sectors.

Moreover, some of our biggest challenges have been around talent. We’ve spent most of the last five years with a focus on this. We’ve conducted a number of surveys on the issue with Cambridge Judge Business School, we think about it constantly and probably one of the biggest drivers of this has been Covid in terms of driving people to remote working and opening up new pockets of talent which don’t have to live five miles away from the company’s office.

Overall, disentangling Brexit from the Covid effect, it’s not been something that has caused our businesses an enormous amount of concern. One thing that I am quite keen to see continue is that the US continues to see the UK as its landing point for European investment. We’ve sold a number of our tech businesses to US strategic buyers and it’s very important to us that Europe remains their premier destination as it really helps with our exit pipeline.

Tom King: Since the referendum results came in, we’ve been working with private equity and portfolio firms since that day on how to mitigate the potential effects of a deal or no deal. Therefore our trade team has been very busy with figuring out supply chains, diversifying how you distribute, making sure you have the right warehousing, all of those issues that are very practical and should have been done by now. Some firms haven’t done that yet and there is an issue of relative disruption within sectors where some firms are still disrupted but because they took some mitigating actions, are still winning compared to others.

We’re now looking more to the future where we have an agreement that gives us some level of macro stability but within that there is potential for micro instability and that will arise from either the UK or the EU seeking to drive home an advantage through diverging from the agreement. We don’t yet know whether that will be politically driven or how much that will be a consequence of sectors having advantages that are just there.

With tighter restrictions on travel, how will Brexit impact deal-making for European firms trying to invest in businesses in the UK and vice versa? Is virtual deal making a long-term option?

MacDougall: Covid has certainly taught us how to work from home and do things remotely. Deals are happening as much as ever before, probably in some ways it has been easier because you can do virtual calls like this and you don’t have to spend time travelling around. Other areas of deal doing have been impacted, of course, when it comes to meeting management teams in the flesh, but certainly the whole pandemic has made people realise that you can do a lot of things remotely, so if travel is curtailed [by Brexit], that shouldn’t be a problem for us in PE.

Barbour: We’re a UK and Ireland only investor, so travel restrictions haven’t been a big problem. One place I would like to be visting is Dublin and I’d like to be doing some face to face there, and hopefully that will resume soon. So, it’s difficult for me to see that being massively disruptive. For pan-European firms, most of them have people on the ground in select locations, so that may also not be a problem.

Doing things remotely is fine when everyone is remote, but as soon as we all break out and get back to normality, it feels as though being in person will be a differentiator again and I’m certain that if I was fundraising, I would rather be physically in front of investors. I don’t think that’s going to change and how difficult that’s going to be, I’m not sure, but probably the queues at Heathrow are going to be the biggest issue!

But otherwise, I don’t see it being an issue. I don’t think you’ll find a pan-European fund saying that they’ll do all of their European deals remotely. Once you’re doing a deal remotely with someone from a different country and culture, it gets a little bit harder again. We’ll see a return to travel for sure, probably less day trips that were just to have lunch and perhaps to flesh out more of the specifics.

King: It’s an interesting question from a wider than Europe perspective in that what Brexit supposedly offers to the UK is an ability to look outside of Europe, and the government will be very emphatic about that.

We’ve seen a couple of deals where the restrictions on travel have been a barrier, and that has been primarily in Asian settings where it’s now impossible to go to see sites, or businesses that are site-based, so it will depend on sector and also geographic spread.

It could also mean that [for deals to take place], firms will need a wider network of people on the ground and that could be the PE firm itself or the advisers. And I say this as an adviser who represents a global firm that has people in Singapore and Malaysia for example.

One of the things we’ve most encountered is reconfiguring supply chains where products are coming from China, etc. If you don’t have people who are in those countries and are able to see for themselves how things are produced and what the conditions are, you’re going to struggle with, not necessarily the due diligence on the deal, but certainly ESG considerations and coming to exit, that’s going to be an issue.

Living or staying in an EU country for an extended period will no longer be permitted for UK citizens. How will this impact geographic expansion for portfolio companies and setting up businesses/new sites abroad? Will internationalisation become more challenging for UK businesses? And how will restrictions on trade between the UK and Europe impact portfolio companies and their day to day operations?

Terry: It seems to me that we’re just going to become more efficient. If I’m doing an add on in Belgium or Germany, for example, I don’t need to go to every meeting and most of the work can be done on Zoom, but we will go to the key meetings.

Similarly, throughout my career I’ve done several deals in the US, flew in, completed them and flew out. The travel visas used by the US is something I presume the Europeans will copy and so I can’t see it being a major factor.

We’ve also looked at several businesses recently where site visits have been done via video calls and that’s great for a sense of the place and then one visit will tick the box. So, all in all, I think we will become more efficient in our processes.

Barbour: Working with our portfolio, we’ve noticed how the world has switched from lead generation to the ability to sell remotely. In terms of tech businesses, this has helped to level the playing field between smaller companies who don’t have the resources to have foreign offices, lots of sales people etc, and they can do a sale from their home to a huge corporate in the States, for example. It has kind of levelled the playing field.

For internationalisation in the portfolio, it [Brexit and Covid-accelerated digitalisation] will be really interesting too. We’re starting to see quite a lot of momentum in our businesses already of which are penetrating into markets that we thought would take longer to get into.

In terms of deals, where you normally have to spend more time wining and dining, showing your face and having multiple calls with a sales director, now we’re getting exposure straight away. We’ve had to train our sales teams to be ready and bear in mind that the first call might be the only call as you might find that all the sales people are on the call, because they all can!

Moreover, talent has been an issue we’ve been worried about. We did see a tightening up of talent after the vote, and I think a lot of that was due to the massive expansion of tech recruitment in the UK anyway, with the big tech firms hoovering up talent. And I think wherever we end up on salary caps for European hires, that’s going to be a clunky process, the idea of interviewing someone and bringing them over to the UK as opposed to them being here already is quite tricky. That remains my concern, but technology improvements are making it easier to hire people who are based further afield.

Malcolm, how has this pace of deals impacted your work as a lawyer?

MacDougall: I totally agree with David that virtual working has sped everything up. As we had the Budget today (3 March), we had a slew of deals completing last night; I completed three deals, which before, wouldn’t have been possible. You would have been in one completion meeting, you couldn’t have been in three! Whereas now, you can effectively do it all remotely online.

Will supply chains be impacted? For example, how will firms cope with the extra paperwork arising as a result of Brexit – and how will this impact portfolio companies?

Terry: I think the biggest issue is around the whole dislocation due to Covid. Brexit is being masked at the moment by what is going on globally. One of our biggest problems for one of our portfolio companies has been the lack of containers coming in from the far east. They’ve all been stuck at docks and to get actual products for supply chains is really tricky at the moment. This is more so the knock on effect of Covid in different parts of the world and it will take a while to settle down.

We have two operating staff members who have spent their careers in logistics, and they have been allocated directly onto the portfolio companies to work with them to help as much as possible with issues in the supply chain. 

King: This is something that we’ve been working on for some time and many firms have got to a point where they’ve done as much as they can on the mitigation front. I think there will continue to be stories drip fed into the press about particular sectors that have been heavily affected by this and you’ll get a tonne more stories in June when the UK enforces full controls.

Longer term, a lot of companies have moved to do more local sourcing, but against that I think there will be a lot more frictional costs for a lot of sectors and that is permanent. It’s the first free trade agreement we’ve seen where new barriers have been put up instead of barriers being taken down; that’s the reality and it won’t change. So, some innovative thinking may occur around where materials are being sourced, how products are stored and warehoused and where etc.

Malcolm, have any deals not gone ahead or been delayed because of Brexit? Or are any sectors getting less attention from PE because of Brexit?

MacDougall: I haven’t seen any deals fall over because of Brexit. I think that actually Covid has had a much bigger impact than Brexit and the whole sector view is being driven a lot by Covid. There has been a shift to digital in every sphere, software business and tech is booming as people move their life online and I think that will continue post-pandemic. So, I think Covid has led to a huge sectoral shift, but not Brexit.

One of the deals we’ve completed recently was an investment in an online retail business and they have had a bit of difficulty shipping goods, but that didn’t stop the deal from happening.

David and Ken, how has the Brexit impact been considered when dealmaking? Is it an area of concern for you?

Barbour: Since the vote in 2016, we’ve been screening every investment for a “Brexit risk” and for us that tends to be around: is it completely UK focused, does it touch regulation that is EU driven, etc. In the main we’re lucky that we don’t touch the physical shipping of goods or supply chains in any way.

I think there is an inflation element to this also. We don’t do any B2C ecommerce, but I’ve heard from someone in that sector that recently a lot of Europeans are not supplying the UK at the moment because they can’t be bothered with the administrative challenges.

One thing we did [to mitigate Brexit risk] is increasing our international business exposure. Our first fund had a non-UK customer revenue of about 20 per cent and in this fund, it is 60 per cent on the day of investment, so we’ve deliberately gone for more internationalised businesses that we feel are more broadly spread and have more downside protection, partly as that’s a badge of a great business but also because we didn’t know what would happen with Brexit.

Terry: It’s exactly the same as it was before for us. In each conversation we look at how businesses are affected by Brexit and how can we make it more resilient; is it the right way to go, etc.

One of the things that Tom mentioned, which I agree with is I don’t think many UK consumers know where their goods come from. They are now finding out that their goods are not from the UK when they are hit with a bill when it comes to returns. Going forward, I think people will think more about where their products come from to avoid hidden fees and costs.

King: To follow on from Ken’s point, I think that’s going to be really interesting to watch. Whether it's food, clothing or other, you will get a lot more niche providers that are sustainability oriented, fast fashion perhaps; those more niche players that are based in the UK and that will help larger retailers to deal with the requirements around ESG reporting and sustainability. One of the key questions on our clients minds is that alongside the frictional costs of Brexit, there is a whole load of government regulation on ESG, impact, where goods are produced and this will encourage firms to change their supply chains and sourcing approaches.

What are the potential benefits of Brexit?

Terry: Having spoken to a law firm [on the benefits of Brexit for PE] recently, one of the big things they mentioned was the possibility of avoiding DAC6, which is a new EU regulatory regime that is causing lawyers a lot of trouble and the UK will go under the OECD route which will be much less onerous.

Overall, I’m positive that there will be benefits from Brexit. There is going to be friction, but I am positive about the future. It was 40 years of marriage, so it will take more than three or four years of divorce to settle that down.

MacDougall: There are some benefits in terms of regulatory aspects. Of course we are still quite tied in in terms of regulation, but other aspects such as state aid rules relaxing could mean that companies can receive greater support from the Government. As the UK has often been entrepreneurial and forward thinking, I’m sure we can use our independence to steal a march on our continental friends in some areas.

What questions are LPs asking regarding the Brexit settlement and has there been a resistance to UK funds? And what are your final thoughts on Brexit considerations going forward?

Barbour: It’s certainly been a major topic of discussion over the last four years. We target a completely international group of investors in Europe and the US and they all come with their own mix of quite understandable concerns. They are the ones making quite macro bets on a ten year fund and they have to make a decision about the macro future of that region.

As a single country fund, our investors have been very focused on it [Brexit] and even up until before Christmas, we received concerns about Brexit from our target international LPs. Some haven’t committed to a UK fund in four years, some of that is emotional and some of that is pragmatic with the view that the future of the UK is too uncertain at present. But it definitely seems to be less of an issue now that Brexit has happened and it seems to be just another issue which has sector impacts in some areas but is pretty irrelevant to the software space we invest in.

Terry: During our fundraising, we found that there were a couple of countries that took Brexit more personally than other countries and that led to a bit of hesitancy for a while. We did have a couple of questions initially regarding what the market will look like when Elysian III will be investing, what types of companies will we look at in the new world order.

We did a lot of work on this and were able to reassure our investors that we are mostly investing in UK companies and because the size of the fund and the types of businesses we look at, we have limited pan-European businesses in the portfolio. So, we were able to convince them that there are a massive number of businesses in the UK that present opportunities for us.

Then when it comes to investing in a UK fund, if you have strong prior performance, investors still come flocking, but if you have medium performance and perhaps staff turnover for example, Brexit becomes one of their reasons not to invest.

There’s always a rule whereby you can fail on one thing, but you can’t fail on two out of three or four. For example, if you haven’t got team stability and track record and if you add Brexit to it as well you’re dead in the water, but if you’ve got team stability and track record, Brexit becomes a non-issue.

King: From our perspective, Brexit will continue to be relevant as when Brexit goes out of the headlines, that’s generally when we have more work to do. When it’s off people’s minds and out of their thinking, that is when the real policy and regulatory shift begins and far from Brexit being done, we are very much at the start of it and it will be incremental and complex and it will be sector by sector and that’s something the PE should keep an eye on. But, hopefully, they’ll use people like us to monitor it so they don’t have to spend much time on it themselves anymore.

Categories: Roundtables

TAGS: Brexit Elysian Capital Fpe Capital Global Counsel Gps Lps Private Equity Roundtable

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