While the value and volume of mergers and acquisitions fell in Scotland in the first half of the year, deals are clearly still being done and finance is coming from a variety of sources.
Where funding arrangements were disclosed, according to Experian analysis, private equity was the largest provider of finance for deals in the first six months of 2019. Just under 9 per cent of deals were funded by private equity (PE), with three of the top 10 deals recorded securing investment from overseas PE firms.
Although just over 4 per cent of acquisitions were funded by bank debt, Experian says traditional high street lenders are continuing to support Scottish companies keen to expand their business operations.
Brian McMurray, partner and head of equity funding at Anderson Anderson & Brown (AAB), says that while the banks are still lending and there is an element of debt funding available, they are being very cautious and are seeking security. He explains that most deals he sees are either PE or trade. In his experience, the PE is coming from a range of areas in the UK and overseas.
“While there are PE firms in Scotland, a lot is London-based. For certain deals – larger or sector specific ones – we’ll see interest from overseas because they regard Scotland as an attractive place to invest,” he explains.
In terms of what PE investors are looking for, a strong team comes top of the wish list, according to McMurray.
“Without a doubt there needs to be a strong team in place to attract investors, a strong business and a good track record,” he explains. “The business needs to be able to clearly demonstrate where the growth is coming from, and be able to evidence it. I think the alternative is a niche market, a business where investors see a unique opportunity.”
McMurray adds: “For PE, it’s all about the growth potential – funders need to see a return on their investment.”
For start-ups in particular, funding can obviously be a challenge because of the absence of a track record and the many unknowns about how the business will develop.
“I work with a lot of start-ups and it can be extremely difficult for them to find funding,” says McMurray. “For start-ups it’s too early for most, if not all, PE investment. Typically, such early-stage businesses will be looking for funding from private investors, such as high net worth individuals, or angel syndicates.
“For a small number, there will be early-stage venture capitalists that will invest. But most of them are based down in London. For Scottish start-ups it can be a real challenge trying to tap into that market and knowing where to go.”
He adds that it is always difficult for early-stage businesses because the perceived risk is higher for them, but they can attract individual investors who can benefit from some of the known tax benefits.
“My advice is to have a strong business case and focus on management and a strong team,” says McMurray. “This might mean bringing in outside support if needed, such as non-executives or mentors who will give the business credibility. Where possible the business should demonstrate market demand for their product or service.”
He adds that early-stagers should use experienced and well connected advisers who can get them in front of the right investors. “That’s what we do,” he says. “We use our network of contacts and investors, and share opportunities with them.”
Michael Stoneham, banking partner at Brodies law firm, describes a different set of circumstances for larger deals compared to smaller ones when it comes to finance
“The funding position for big deals is generally quite good,” he says. “For big deals there is the availability of London-based finance. There are a lot of specialist funds, such as ones in the oil and gas sector, to support acquisitions. This can be contrasted with the SME and middle market position in Scotland, where things are a bit more difficult.”
Stoneham believes it is particularly tough for businesses looking for second-stage funding to scale up. While he concedes that the Scottish Investment Bank is playing its role in supporting this part of the Scottish economy, he is concerned it is not in a position to meet all the demand that exists in the market-place.
“This has been a problem for a number of years,” Stoneham insists. “But I think it’s getting more difficult in this particular area at the moment.”
This concern over a lack of funding for SMEs and generally low confidence is reflected in a report published earlier this month that found the number of new start-ups in Scotland fell sharply last year.
The Enterprise Research Centre’s UK Local Growth Dashboard report found that in 2018 the number of new start-ups in Scotland dropped by almost 2,000 in 2018 to 16,001 from the previous year’s 17,959. The report said its findings partly reflected uncertainty around Brexit.
Looking at other sources of funding for Scottish businesses, Stoneham believes that the attitude of angel investors is also changing.
“My sense is that angel investors are shifting to less risky deals with shorter terms, say of five rather than ten years,” he explains. “They want to get their capital back more quickly. There were about 160 deals looked at by angels last year, and only about 20 went through.”
While crowdfunding is vibrant at the moment, Stoneham says that as it is a relativity new phenomenon it has not yet experienced the lending cycle, so he has concerns there may be some pressures in future.
He believes both the Scottish and UK governments could do more to help firms access finance and welcomes moves by the British Business Bank, a state-owned UK economic development bank, to get more involved in Scotland.
He says: “The British Business Bank is trying to get involved in the Scottish market through partners and is putting money into funds that are then investing in the SME sector.
“They have some funding to put out on the market over the next year or so, so that’s a potential increase in availability of finance.”
While commentators agree that Brexit undoubtedly poses a big challenge for business, investors and the entire economy, the figures show that it has not stopped deals from happening.
According to McMurray at AAB, while investment has not halted, Brexit is causing hesitation among financiers.
“Deals will continue unless it’s one that relies heavily on the European market, for example,” McMurray explains.
“I’ve seen one or two deals where potential investors have talked about waiting to see the outcome of Brexit. People are still pushing ahead deals, but the uncertainty isn’t helping.”
Start-up funding a real challenge
Private equity (PE) is playing a very important role in funding deals where secure lending is not an option. Most transactions we see are funded by PE investors or trade buyers, the former of whom are typically looking for medium and large-size companies.
Funding for start-ups is very challenging due to a number of factors. Typically, a start-up is too early for private equity and many of the venture capital funds so they will rely on investment from High Net Worth Individuals (HNWI) or Angel Syndicates. Even with some of the tax reliefs available to most start-ups such as SEIS/EIS, private investors are still looking to minimise their risk so start-ups must be able to clearly demonstrate the commercial viability of their product or service.
There is also a high number of start-ups in Scotland coming from university spin-outs, government-backed accelerator programmes and technology hubs which makes the market for early stage investment very competitive.
Scotland is seen as an attractive place to invest. However, Brexit is still an unknown and causing some uncertainty for buyers.
Brian McMurray, partner and head of Equity Funding at Anderson Anderson & Brown
Overseas investors may be the answer
For larger businesses private equity from overseas can be available. Both the United States and the Far East, including China, have a lot of money around for bigger assets. That is a very active area for us at Brodies.
We have one large energy acquisition opportunity at the moment where there are a number of bidders, including big international consortiums.
In terms of outlook for Scottish deals and investment, it’s positive in a number of areas, but in others there are issues to grapple with, especially for smaller businesses. So, I would say it’s a mixed picture.
On Brexit, generally, deals will continue to be done. We’ve been amazed by the way people are getting on with things, rather than waiting, which is a good sign. Some people see opportunities as well. There is a lot of welcome resilience out there.
Michael Stoneham, banking partner at Brodies law firm
This article first appeared in The Scotsman’s Deals 2019 supplement. A digital version can be found here.