The UK’s private-equity sector has been buffeted by the significant economic, political and geopolitical events of the past few years.
A global pandemic; Brexit; war in Ukraine and the Middle East; political changes in the leadership of the previous government; the exact economic trajectory of the new government; and a prolonged period of rising interest rates and inflation have all created uncertainty.
Grant Thornton’s report on private equity in the first half of the year observes that “the last 12 to 18 months have been volatile”. The firm continues to note that “the market is still cautious, and transactions are taking a long time to close”.
Other research shows that fewer deals are being done.
A KPMG UK mergers and acquisitions study published in July, revealed that the volume of private-equity deals during the first half of the year totalled 656 – down 20% in comparison with the same period of last year, when 822 were recorded.
But an improvement is anticipated: “There are signs that market conditions are settling down, with a new government in place providing much-needed stability,” says Humza Khan, director and head of private-equity coverage at Grant Thornton.
“Inflation is falling and, although still high, rates have peaked, which means valuations are stabilising,” he adds. “Deals are picking up and overall volume looks set to increase in late Q3 and Q4.”
Pete Terry, partner and head of private equity at the firm, takes a similar view. “Now that we’ve passed through the general election, we’re going to have more deals, although the effect will probably be delayed. Some that would have closed in Q3 were paused by the political uncertainty, and we are likely to see them close in Q4. ”
“Markets are upbeat and there are signs that interest rates will be cut,” he adds. “Political stability looks set for the next few years and Labour has repeatedly committed to prioritising growth.”
KPMG also foresees better times. Alex Hartley, head of private equity and London M&A, says: “Looking ahead to the remainder of 2024, after a prolonged period of uncertainty, investors will now be looking at the UK as a more stable environment for investing into new businesses and realising portfolio assets.
“The focus on deploying capital is here to stay, as many private- equity firms are sitting on significant amounts of dry powder,” he adds.
“Ultimately, the foundations needed for dealmaking have improved over the last few months, and we expect activity levels will continue to rise in the second half of 2024.”
A more positive mood is reflected by tax advisers, which is evident in RSM’s private-equity outlook for the second half of the year. “The corporate-transactions landscape is showing promising signs of revival, supported by a growing confidence among sellers and buyers,” the report states.
It also states improvements in, and more certainty around key economic influences, for example falling inflation, the definitive election outcome, the drop in interest rates and the prospect of improved GDP growth in 2025 is helping provide much more confidence in the financial projections of companies.
“While we may not revisit the frenetic pace of the period immediately post the pandemic where ultra-low interest rates, exuberance and historically high economic growth buoyed activity, 2024 Q4 and 2025 are poised for a marked improvement from the first half of the year,” notes the report.
The bull is back
Also pointing to buoyant levels of confidence within the sector is Ilja Hauerhof, director of quantamental research and solutions for private markets at S&P Global Ratings. “Our research shows that stable public markets are the secret to private-equity optimism,” he says.
“Our natural language processing analysis of statements made by executives of 28 publicly traded private-equity firms during first-quarter 2024 earnings calls revealed a significant rebound in private-equity confidence.
“Despite a challenging M&A landscape and slower fundraising environment, private-equity executives’ sentiment surged to its second-highest level in more than 13 years – or 57 earnings sea- sons,” Hauerhof adds.
Institutional investors’ interest in private equity remains solid too, according to Preqin’s investor outlook for the second half of the year.
Its survey of institutional investors revealed that alternative assets are still viewed as a key element in portfolios, mainly for diversification and return enhancement, as well as for lowering volatility. Furthermore, the research found that institutions are planning to invest even more in private equity, private debt and infrastructure.
The survey also demonstrated respondents’ satisfaction with private equity: 68% reported that it had met their expectations during the past year – representing a four percentage-point increase.
Furthermore, Preqin’s survey identified that investors continue to be upbeat about the short-term outlook. The percentage of respondents expecting a drop in performance over the next 12 months has halved for the second year in a row to 12%.
On the other hand, the percentage of investors anticipating an improvement in private-equity performance in the year ahead has shot up to 45%, from 26% in June 2023.
The survey also indicated that almost half (46%) of respondents plan to maintain their allocation to private equity. Slightly fewer (42%) said they intend to increase it in the longer term.
Shakeups on the horizon?
But there may be more headwinds on the way. While it is early days for assessing the impact of the new government on the sector, chancellor Rachel Reeves unveils her first Budget on 30 October − and there are rumblings of potential shakeups that could affect private-equity and institutional investors.
These were referenced in a speech that Reeves delivered in 2021 at Labour’s annual conference, when she was shadow chancellor. She signalled her intent, should the Labour Party come to power, to hone in on carried interest, specifically with regard to the tax ‘loophole’ which allows private-equity fund managers to pay a reduced amount of tax on their performance-related share of profits.
Carried interest attracts capital-gains tax (CGT) rates (28% for higher-rate taxpayers), which are a considerably lower amount than income-tax rates (up to 45% in England, Wales and Northern Ireland, and up to 48% in Scotland).
A paper published in July, The trillion dollar bonus of private capital fund managers by Ludovic Phalippou, a professor of financial economics at the University of Oxford – Said Business School, found that carry has exceeded more than $1tn (£749bn) during the past 25 years.
In her 2021 speech, Reeves stated: “Private-equity bosses who strip the assets of British businesses pay a lower rate of tax on their bonuses than workers do on their wages. That is indefensible so we will abolish it.”
The new government has not forgotten this vow. At least, in principle. In the Labour Party manifesto, it stated that £565m could be saved from closing the loophole. Then, at the end of July, only a few weeks after Labour formed a government, Reeves announced its commitment to take action.
The first stage took the form of a “call for evidence” on the tax treatment of carried interest. Meetings with stakeholders were offered as part of the consultation, which closed on 30 August. The next announcement is due to be made in the Budget.
Taking this course of action could have ramifications: firing financial shots over the bows of the City could result in returned re, such as proposing to take their business elsewhere.
Commenting on the potential impact of the new government on private equity, Jeremy Over, partner at law firm Moore Barlow, says: “In its manifesto, the Labour Party stated it would be hardening rules around private equity providers in relation to being able to claim capital-gains tax on carried interest payments. If this comes into effect, it could certainly impact the private-equity market, and whether some private equity houses decide to continue investing in the UK or look to invest in more tax-friendly jurisdictions.”
Reflecting on the potential shake ups that might emerge in the Budget, which could affect private equity and institutional investors, Over says: “The Labour government is widely expected to review CGT because the party ruled out changes to income tax, VAT and national insurance in its manifesto.
“This could affect private equity by obstructing deal flow and impacting the willingness of people to sell their companies and go through an exit event, which would potentially reduce the number of investment opportunities for private-equity providers.”
Alignment with growth?
The Labour Party’s plan for financial services, published in January, stated that a Labour government’s “defining economic mission” would be “to revive strong economic growth”, but this may not be compatible with their other aims.
Over says: “It’s important to note that Labour has consistently said that growth is a core part of its political agenda; if that is the case, it’s di cult to see how that can be reconciled with aligning CGT rates with income-tax rates because that could negatively impact growth in a number of ways. It could discourage entrepreneurs from starting new businesses, leading to less wealth creation and fewer jobs from which the government can generate income tax and national insurance.
“To make their growth plan work, any changes to CGT must be aligned with their growth agenda. For example, they could con- sider making business asset disposal relief more generous, while at the same time raising the headline rates of CGT, encouraging entrepreneurs to create and grow businesses.”
Lacking confidence
Although, looking at how the Labour government has approached other issues that it took a strong line in opposition, like the status of non-doms, which have been watered down in government, could well mean private equity firms and investors should not be too concerned about what the government will do.
Considering other factors affecting the private-equity sector, Over points to one area that has held investment back is the interest-rate environment. As many private-equity deals are based around leveraged finance, and if the cost of debt is higher, it makes it more challenging for private-equity providers to successfully structure a deal compared to when the cost of debt is cheaper.
“The high interest-rate environment has affected confidence in the market and the willingness of private-equity houses to invest, and that’s why the Budget will be a critical milestone,” Over adds.
Returning to the politics, Over says: “Labour has a huge majority with a huge amount of power, so it will be interesting to see what measures are announced, not least because Reeves is an economist by trade, so she should know better than anyone what levers to pull to generate the growth agenda that Labour has put a lot of political capital behind.”
In the meantime, Over sees encouraging signs in the market. “While we wait for the Budget, there’s a lot of anticipation, but there remains a considerable amount of capital to deploy within the marketplace, and private-equity providers will al- ways be under pressure from their investors to deploy that capital.”
This, Over says, “can only be a positive, and the market should be heartened by the fact that there’s a lot of money out there just waiting to invest. “It will be absolutely critical to ensure that the Budget lands well,” he adds. “This is a new Labour government and the markets are watching it very carefully.”
In conclusion, Over says: “The opportunity is that if the Budget can land well with well-thought-out measures, it will send out the message that Britain is open for business and that the government is truly committed to growing the economy. But for this to happen, they can’t be too punitive on wealth creators.”
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