Private equity is top finance route as middle market feel optimistic about economic outlook

Recent research suggests almost half of middle market businesses in the UK will seek private equity finance in the next 12 months. According to the latest ‘The Real Economy Report’ from RSM UK, 47% of businesses expect to use private equity finance in 2023, rising from just over a third (36%) in October 2022, meaning it remains the most popular finance avenue to raise capital and ensure growth.

The survey also revealed that over a quarter of businesses (28%) planned to take out bank loans, and a further quarter (26%) intended to use public markets to raise funds. Nearly half of businesses surveyed (44%) said that making capital investments was the main reason for accessing finance in the next 12 months, to improve efficiency and productivity, grow the business, and cut costs.

After months of disruptions, it’s perhaps not surprising that nearly a third (28%) of businesses said restructuring their supply chain was the most important investment priority in the next 12 months, followed by entering new markets (22%) and expanding internationally (19%).

The middle market also seems more confident in its ability to navigate economic headwinds. When asked about the single biggest risk to their business, higher energy costs remained the top response at 14%, but this fell from 21% in October 2022.

In addition, results showed that almost half of businesses are still consistently accessing finance to make capital investments (44%), up from 43% in October 2022. Over three quarters (76%) of middle market executives said their business was prepared for recession, and although not over the worst yet, there are some reasons for positivity following the Chancellor’s Spring Budget announcement.

Inflation is expected to fall to 2.9% by the end of 2023, meaning the UK may narrowly avoid a recession, and the OBR has also revised the GDP growth outlook for 2023 upwards to a contraction of just 0.2%. More encouragingly, businesses’ inability to pass on increased operating costs to customers fell from 10% to 6%, indicating that the middle market is in a better position to protect margins in the next 12 months.

Jasper van Heesch, director and private equity senior analyst at RSM UK, said: ‘Private equity is a highly sought-after method of raising capital in the middle market, as it remains an available source of capital at a time when other investors have either delayed decision-making or pulled out altogether due to economic uncertainty. There is currently a significant amount of capital available ($1.2tn globally) for private equity investors to deploy, so looking further into 2023 we expect private equity to continue to be active.

‘There will be some pressure on the sector regarding further capital raising by funds and an increase in the cost of debt which is often used in buyouts, which will negatively impact transaction volumes, and companies seeking capital backing will experience competition for funding in an ever-increasing buyers’ market. However, private equity is an attractive option for many companies seeking capital to grow, enter new markets and make acquisitions, and seeking strategic partners who can help navigate the current climate.

‘Businesses that have a compelling and robust strategy and growth plan in place that they are already delivering on and have an eye on downside risks will be in a stronger position to attract private equity investors.’

Similar to RSM’s report in December 2022, this latest data shows middle market businesses are continuing to demonstrate resilience and manage inflation by implementing a number of measures to stay afloat within the next six months. These include improving energy efficiency (42%), enhancing operational efficiency (40%), and seeking access to additional funding (34%).

Thomas Pugh, economist at RSM UK, said: ‘The UK economy has shown remarkable resilience in the face of the largest rise in interest rates in a generation and a record-breaking fall in real incomes. The middle market is no exception to this resilience. Indeed, the RSM UK Middle Market Business Index jumped sharply in Q1.

‘Admittedly, we are not out of the woods just yet and there are a couple of significant risks in the road ahead. The economy may still fall into recession in the first half of 2023. After all, we have yet to see most of the impact from the roughly four percentage points rise in interest rates over the last year. And, although inflation has now peaked, it will remain high for the first half of this year, keeping up the squeeze on real incomes. Another area of concern is the large build-up in stocks over the last few months, which firms may find difficult to shift given an expected further downturn in demand over the next six months.’

He added: ‘However, the overall fall in GDP will probably be around 1%, making it one of the smallest and shortest recessions on record. In fact, the next year or so will feel more like a ‘slowcession’ than a typical recession.

‘So, even considering the remarkable resilience demonstrated, the next year will probably prove tricky for the middle market. Business leaders should plan for another step down in economic growth in the first half of the year, and inventory management is likely to prove key here. But leaders should also keep their eyes on the recovery in the second half of the year, meaning the businesses that continue to invest in their people and productive capacity will be best placed to take advantage of the upswing when it arrives. That is why it is encouraging to see almost half of businesses planning to make significant capital investments this year.’