Private equity firms the key for growth funding with merger and acquisition market still weak

SMEs should consider private equity for growth as larger firms and banks still remain wary of mergers and acquisitions due to excessive capital requirements, a new Ernst & Young report reveals.

The firm’s new Capital Business Barometer also shows Australian businesses are keen to grow and that banks are starting to ease up, with 51% saying that credit/capital conditions are better than 12 months ago.

However, Ernst & Young transactions advisory services leader for Oceania, Graeme Browning, says SMEs are better off looking for private equity rather than attracting larger corporates for an acquisition.

“Private equity funds are well capitalised, they have plenty of money to be investing and while cautious, they are willing to back the right deals,” he says.

“There are many ways to access capital for growth, but private equity can be very effective. It’s certainly not for everyone, and people need to understand when the circumstances are appropriate, but it is an avenue to explore.”

Browning also says while banks are still cautious about lending to SMEs, they will be more likely to assist in private equity deals involving established firms with solid track records of growth and profitability, particularly for firms with under $500 million in revenue.

“Banks will see a private equity party as a group that understands how to support growth agendas, and have a track record in doing so. Of course if you are a corporate and can demonstrate a compelling case, then that’s great, but private equity groups specialise in that.”

“And in an environment where banks are still quite cautious, small to mid-tier companies need to present themselves as attractive. They need to be transparent and need to be able to reduce their risk as much as possible.”

The survey also shows that private equity may be a better option for smaller companies, especially as larger corporates remain unconvinced that the M&A market remains healthy. About 10% of companies are focused on survival, rather than growth, and 34% of companies say they will need to look at re-financing in the next 12 months.

Browning says he is seeing more activity at the larger end of town, but smaller companies won’t be seen as targets for some time. “With larger corporates seemingly focused on larger deals, PE are enjoying free reign in the mid-section of the market,” he says.

About 46% of companies say they are likely to execute M&A deals in the 12 months, down from 61% in April, while 27% are actively seeking acquisition opportunities in the next six months, down from 46% in April.

Browning says mid-size companies looking for private equity need to be as transparent as possible – this includes preparing financial statements, business plans and any other materials that will make private equity firms confident about investing.

“If you don’t feel that you have a growth agenda, then there’s no point. They are prepared to allocate the right deals, but they need to be confident about their targets.”

“I think over the next six months we will see the level of transactional activity in private equity increase. The bulk of it happens in the mid-size sector and the banks will start to support growth there.”

The barometer also found that Australian companies are more confident about the global economic recovery, with 29% expecting a recovery to happen in the 12 months, up from 3% in April, while 27% believe the economy will occur in two years, up from 15%.

About 52% are pursuing organic growth over the next six months, up from 42% in April and 28% from November 2009.