Private equity’s SME trail

Private equity, famous for snapping up underperforming or under-pressure businesses, turning them around and flogging them off after several years, is still experiencing a major post-GFC hangover.

But players say the sector’s appetite for acquisitions is returning, and this is good news for quality small and medium enterprises looking to bring in new investors or exit altogether.

Tim Wilson, managing director of SME-focused Blue Sky Private Equity, says despite uncertainty over the economy’s outlook, it’s a good time to be buying.

“While the economy is not as strong as I thought it would be by now, it’s still time to be investing money,” Wilson says.

“And if you have a three-to-five year timeframe, you’d be anticipating that things would be better by then.”

CHAMP Ventures director Paul Readdy is also enthused by the longer-term outlook, and says the sector is doing quite well despite the doom and gloom stories over the past few years.

“People are suggesting that private equity isn’t performing and has issues,” Readdy says.

“And there’s obviously been some high-profile businesses that haven’t gone well, such as [book chain] Borders. The good stories have probably been lost a little in the noise.”

CHAMP has been busy of late, flogging Retail Apparel Group (formerly Tarocash) to Malaysian private equity firm Navis Capital, and TS Marine to an international trade buyer. It’s also believed to be in the process of selling its private hospital business Healthe Care, possibly to another PE firm.

According to Readdy, PE-backed businesses have worked very hard over the last couple of years, and are now starting to come on to the market in pretty good shape.

Still cautious

But it’s not all smooth sailing.

Deborah Chew, partner at mid-market law firm Hall & Wilcox, says PE firms are not yet operating at full strength after being hit “enormously hard” by the GFC. And she labels the Australian venture capital sector – which traditionally concentrates on smaller and younger businesses than private equity – as “anaemic”.

“VC in Australia has been defunct, even before the GFC,” Chew says. Venture capital success stories, such as LinkedIn and Facebook, are simply not seen here.

She adds post-GFC nerves have led to deals taking longer to be signed, and being more vulnerable to collapse.

CHAMP’s Paul Readdy says consumers are saving more than they used to and being more discerning about where they spend their money.

And he expects the next couple of years to be “reasonably tough”. “I’m no economist, but I would think that deleveraging will continue for at least a couple of years.”

But hot sectors remain

But in amongst this caution, select sectors will still attract attention.

The good news is that the strong local dollar is not crushing interest from overseas, because Australia’s growth outlook is still seen as attractive. Blue Sky Private Equity’s Tim Wilson has described the strong Aussie dollar as a double-edged sword, with happy days for importers at the moment, but exporters feeling the pinch.

There’s also still corporate interest in bolt-on acquisitions, and cashed-up buyers, as demonstrated by the recent $35 million investment in local crowdsourcing pioneer 99designs from US venture capital firm Accel Partners and a group of prominent angel investors, including Flickr co-founder Stewart Butterfield, Survey Monkey CEO Dave Goldberg and former eBay executive Michael Dearing.

And an $80 million investment in online retail giant Catch of the Day and its group buying subsidiary Scoopon has also raised hopes for Australia’s tech and online retailing scenes. The investment by James Packer’s Consolidated Press Holdings, Seek co-founder Andrew Bassat and American hedge fund Tiger Global valued the group at $200 million.

Investors also seem willing to look beyond Australia’s “patchwork” economy. Chew believes buyers will be swayed more by company-specific issues than others, so businesses with good financials and growth potential would keep on the radar.

Filer also reports continued interest from PE in well-run SMEs valued at between $10 and $100 million.

In terms of the sectors that PE is targeting, Chew says while retail has been terribly hard hit – look no further than private equity’s investments in Colorado, and the collapse of REDgroup Retail – there is still a fair bit of activity in resources, underpinned by Asian demand.

Agribusiness is also attracting interest, she says.

Wilson says he has cast his eye over IT, health and hire businesses in recent times.

And while he describes himself as “healthily sceptical” about the IT sector, Wilson says ageing baby boomers are expected to underpin activity in the health sector.

On whether retail might offer some attractive discounts at the moment, Wilson stresses that growth rather than discount drives decisions. Food retailing, on the other hand, is a more attractive proposition.

CHAMP’s Readdy adds that while he doesn’t discount current trends, he’s really focused on finding a point of difference, what makes a business unique and whether their business model is both sustainable and scalable.

“It’s not about buying a business with no growth; it’s about achieving growth, improving the business and taking it to the next levels. If we see something special, we hope the next owner will also see that.”

Be prepared to wait

Pitcher Partners director Rohan Filer says one potential buyer, rather than two or three, is the norm these days.

And he says reduced competition and the banks’ demand for more due diligence gives potential buyers less incentive to push through a sale.

Another potential reason for the slowdown might be the sector’s unwillingness to pay the generous multiples they were offering pre-GFC.

But Wilson, whose fund usually does deals of between $5 and $10 million, says the lack of urgency might be to do with how the economy is tracking.

“My sense is it’s being driven by short-term things, such as the slowdown in Japan production, and fear in Europe,” Wilson says.

Hall & Wilcox partner Deborah Chew describes private equity these days as “pretty risk-averse and picky”. “They’re once bitten and twice shy, so they’re looking at the highest-quality acquisitions.”

Having said that, Austin Scott, a mid-market corporate finance specialist at Deloitte, says activity in the PE space is higher this year than last, albeit coming off a low base and with a longer negotiation period.

Scott, who mostly works on deals between $8 million and $40 million, says the pendulum has shifted: nowadays, buyers need to be convinced a deal is in their best interest, rather than needing a reason not to go ahead.

Be prepared

According to Scott, many SMEs don’t prepare for a sale until an offer emerges, but failing to do so can knock some serious cash off the valuations they attract. “Many businesses don’t think about it until a deal is on the table,” he says.

He says SMEs can do plenty of things to prepare for a sale: ensure they have qualified leadership in place to reduce key-man risk, and present measured financial performance and actionable strategic plans that map out company growth.

He adds that SMEs looking to sell should formalise their business relationships, and reduce their dependency on key clients and suppliers, and consider appointing an experienced financer adviser.

For business owners mulling an approach by PE, Scott advises business owners to consider the firm’s experience in the relevant industry, the strategic guidance it would deliver, and whether they could work with the personalities involved.

Pent-up demand

It’s well-known that the GFC prompted many baby boomers to defer their sale or retirement funds. So with many private equity firms feeling more upbeat, SMEs are advised to get their plans in orders, and put an ear to the ground for potential PE interest.

“Deal flow is returning; people with good businesses are dipping their toe in the water,” Wilson says.

“We’re seeing some early signs that people are putting their heads up,” he adds.

“We’re not going to come back to 2007 economic conditions any time soon, so are you going wait five to seven years, until you’re 70, or look at options in the short-term?”