Wednesday 15 September 2021 6:00 am

Stop blaming private equity, without it small businesses would be strapped for cash

Claire Madden is managing partner at Connection Capital.

Private equity has been branded the bad guy for snapping up pandemic-hit business. After household names such as Asda were bought up, there was an immediate flood of warnings about price hikes. But private equity’s role as a pantomime villain is worn out. 

Big leveraged buyouts are attention grabbing, but private equity plays a vital, constructive role in funding small and medium-sized businesses (SMEs). In 2019, more than £10bn was invested by the private equity community in the UK venture capital, growth capital and buyouts, according to the British Venture Capital Association. Around 1,500 businesses benefited from this influx of funding. 

In a prosperous economic climate, that investment enables entrepreneurial ambition to take flight, expansion plans to be put into action, new jobs created and tax receipts to swell. In tougher times, it can help sustain sound businesses through temporary challenges, underpin future growth potential, protect jobs, maintain the tax base and keep entrepreneurship alive.  Private equity firms are more comfortable with risk and have enough dry power to deploy. 

The other side of this picture is banks’ hesitance to provide funding once government loan schemes wind down. Will they be willing or able to lend more or restructure existing debt on favourable terms? In the years after the financial crisis, bank lending was in short supply. Small businesses will be understandably concerned that this time round, the answer could again be a resounding no. 

Availability of finance is not the only issue. The way funding is provided is also important. Bank lending is often constrained by rigid rules dictating who can borrow and on what terms. Loans are invariably amortising, so that companies are focussed on paying down debt, leaving limited headroom to use the cash to drive growth. Banking covenants can be restrictive and obtaining further funding, if the need arises, is often challenging. Private equity, in contrast, has the flexibility to structure transactions on their own merits. 

Private equity looks at long-term gain rather than short-term targets. Privately-owned businesses often are in a better position than publicly-owned ones to implement investment and growth strategies with longer time horizons or to pivot into new markets. This is not about making a quick buck. Private equity investors are often prepared to take a short term hit to profitability to help create sustainable business models that perform better over time.

Put bluntly, without private equity investment, many previously successful businesses may not make it in a post-Covid world. Private equity players are stepping in to save viable SMEs that are otherwise at risk of going bust or becoming “zombies”, providing them with capital that is structured in a way that gives them room to breathe, re-position and come back fighting. Yes, private equity is opportunistic, but at a time when agility is widely seen as a sensible – even essential – business strategy, surely that’s a good thing?

A debt-fuelled recovery helps no one. SMEs played a central role in powering the rebound from the last recession and they will do so again this time, but they will require permanent equity capital as a solid, sustainable way to fund growth. Business owners and entrepreneurs could be forgiven for viewing private equity with some suspicion. They shouldn’t. It could turn out to be the lifeline SMEs need.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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