How would you describe the UK mid-market private equity space today?
Kartik Shah: The UK market has experienced a slight decline in investor confidence impacted by wider economic and geopolitical uncertainty. We have seen a shift away from larger deals, with mid-market staying more resilient and specific sectors such as business services, energy and TMT remaining attractive. Consumer and retail remain vulnerable to inflation, supply chain issues, and the cost-of-living crisis. The slowdown in debt markets and uncertainty over valuations also means more focus on buy and build.
Ben Cotton: One massive driver for the midmarket has been a fundamental change in the debt market. Interest rates have increased costs for managers and their investees, also bank lending policies have changed. This is an opportunity for debt funds to pick up business with private equity firms at very attractive pricings.
How are private equity firms managing the current fundraising difficulties?
Cotton: There is dry powder out there but capital is not coming into funds. This is partly due to the fact that deals are taking longer, but I think investors are also hoping they can snap up the odd interesting market opportunity while keeping most of their capital for next year.
A number of investors have come back from the summer with their heads around the new global situation and are taking calls. Good managers who can differentiate themselves, especially those with proven track records, are not going to find it as hard as everybody else.
Is it possible to successfully fundraise as a first-time manager in the UK private equity mid-market at the moment?
Cotton: At the moment, investors prefer to look at the second or third fund from a team they have already completed due diligence on. But I am absolutely certain that either at the end this year or early next year we will find that investors are interested in specific first-time funds again. They will need ways of differentiating themselves and operational efficiency is one key way to achieve this.
What new investment strategies are being pursued by firms?
Cotton: Democratising access to private equity through retail investments started with some very expensive experiments. But now, thanks to improved technology, we have many calls from managers asking us to manage, say, 1000 new investors through a common LP to a fund. We are creating a product to assist with this.
Shah: We have seen a significant increase in hybrid funds as managers seek to differentiate themselves by adding diversification and flexible liquidity terms to attract investors. These types of structures will create operating challenges for managers as they try to manage the liquidity mismatch. Increased cost and availability of debt financing has slowed deal activity in the short term, paving the way for more co-investments. Whilst liquidity remains at the top of the agenda, and, with exits slowing, GP-led secondaries and continuation vehicles will remain a popular option to realise liquidity and hold onto quality assets.
How can fund administrators help firms with the issues they are currently facing?
Shah: Increase in regulation and sophistication of investors has meant a greater emphasis on transparency and data sharing. Administrators are being asked to support managers with their own data journey, with access to the underlying data becoming a key component. As client strategies and structures become more complex, this becomes more challenging as it may involve taking data from a number of different accounting systems. As much as we would like to have one solution, every client has their own requirements.
The growth of hybrids also means managers are increasingly placing more reliance on their administrator to understand and support the operational challenges of these types of structures.
Cotton: There are other complex processes around data. Regulators are always asking for information, plus the significant Environmental, Social, and Governance (“ESG”) trend also adds new data requirements. It is a really interesting time for the market and the challenges will raise the quality of managers substantially.
Shah: Digitalisation and continuous technology investment improves efficiency and gives a better client experience. Service providers can support firms with digital solutions such as onboarding for investors which will automate repetitive tasks, improving quality and consistency of data.
