How Brexit prepared UK private equity firms for an era of unknowns

We all remember the frenzy surrounding the countdown to Brexit. From retail to housing to recruitment – very few sectors were immune. Private equity (PE) was no exception, with many UK firms preparing to pack their bags, fearing they’d no longer be able to market to European investors. PE specialists were labelling it the greatest ‘unknown’ ever faced by the industry, and potentially the most economically damaging.

Much like ripping off a plaster, however, the anticipation was worse than the reality. Sure, there was an initial leaving party – those who swiftly switched headquarters to Ireland or Luxembourg. Headlines proclaimed that huge swathes of PE executives were being courted by other European countries, and reasons to remain were fast dwindling, but according to Private Equity International, the UK fundraising environment in 2021 reached new heights, with PE funds raising to US$732.57 billion. This represents a 19.38% year-on-year increase versus 2020 and a 1.83% raise compared to pre-Covid levels in 2019, indicating that London has been able to navigate through the different challenges and remain a key financial hub in Europe.

We have also seen that the loss of equivalency has forced PE firms to hone in on their priorities. Instead of stretching their investor communications out across the whole of Europe, many have begun to think more carefully about targeting specific countries thanks to new investment hurdles – namely being newly recognised as a third-country, requiring them to go through the National Private Placement Regime (NPPR). This loss of equivalency has forced firms to take a step back, focus on their business strategy, and target specific investors in specific locations.

Preparation for the global turbulence

The pandemic, conflict in Ukraine and new revelations surrounding climate change rendered Brexit just one of many ‘unprecedented’ challenges facing PE firms and their investors. By compelling firms to consider how to pivot strategically in the face of so much uncertainty, Brexit gave the UK’s PE industry a head start when significant unknowns became the order of the day worldwide.

By compelling firms to consider how to pivot strategically in the face of so much uncertainty, Brexit gave the UK’s PE industry a head start when significant unknowns became the order of the day worldwide.

Above all, it prompted many to get on top of their due diligence processes, which are now essential for companies everywhere in light of political and supply chain instability, and growing expectations surrounding ESG. In a survey conducted by BDO in late 2021, more than half of UK private equity firms interviewed said that they have changed their investment strategies to make them more ESG-focused. The current PE landscape is going through a real transformation, with ESG as its core.

Unlocking deal flow with due diligence

UK PE firms can and should run with this head start by making sure they are at the forefront of innovations in RegTech – which will be vital to automating and speeding up due diligence processes. By leveraging data to create actionable insights on target companies, rather than relying on in-person assessments, PE executives who would have otherwise spent weeks pawing through hundreds of due diligence documents are free to focus on value creation.

Improved tracking and validation of supply chain data is also game-changing from an ESG perspective, allowing firms to identify the sustainability- and climate-related risks and opportunities to which they are exposed. IQ-EQ conducted an industry poll at the start of the year and 40% of those interviewed said that the most challenging issues for 2022 would be meeting ESG expectations. This prompted us to review our products and tech platforms accordingly and make further enhancements to our RegTech platform, MaxComply™️, and our ESG service offering, IQ-EQ Compass.

Good governance is another critical area at play in due diligence. Greater scrutiny on the ability of portfolio companies’ management teams to manage risk and uncertainty is increasingly essential. Recent events have bred a new generation of risk-conscious C-suite, and reforms on the UK’s audit and corporate governance are currently underway to keep the UK’s legal frameworks for major businesses at the forefront of international best practice.

It is no wonder, then, that we are seeing record levels of dry powder in the private markets, with many firms holding fire amid high valuations brought on by inflation. However, improvements in due diligence will likely see deal flow rise over the coming months, as PE firms become more confident in their ability to assess the factual statistics and validate future value creation of their targets quickly and accurately.

If they can get their risk management right, this could signal the start of a golden era for PE firms, with periods of great uncertainty known to breed great entrepreneurs and pioneering technology. Private equity firms would do well to recognise the enormous opportunity in that, and the role they can play as funders.

This article was originally published by Private Equity News.