UK private company valuations may not have experienced the rollercoaster ride seen in public companies over recent years, but there have been some subtle shifts, according to BDO’s latest Private Company Price Index. 

The prices trade buyers have paid for companies during the nine months to the end of the first quarter of 2024 fell marginally, closing out at 9.4x, down from 10x in Q2 2023. Meanwhile, private equity has trended closer to public markets over the past year, paying average multiples of 11.2x in Q2 2023, rising to 11.5x in Q1 2024.

Indeed, the index shows a growing divergence over the past three quarters between the average valuations trade and private equity buyers are paying. This is even despite UK interest rates remaining stubbornly high, leaving private equity buyers having to stump up more equity in deals than has historically been the case. The European Central Bank announced a rate cut at the start of June, which may well herald further rate cuts from central banks.

Dividing lines

So what’s behind this? Part of the reason for valuation multiples in private equity deals rising may be the amount of capital it has raised in recent years, but not yet deployed. With $1.2tn sitting uninvested globally in buy-out funds, 26% of which is more than four years’ old, according to Bain & Co analysis, private equity is under pressure to invest or face the unsavoury prospect of releasing investors from remaining commitments. As Jamie Austin, head of global private equity at BDO, says: “The pressure of dry powder is starting to get to private equity. Firms need to invest this capital, especially as it is not just high, but also ageing.”

But there are other reasons, particularly as it is in no investor’s interest just to get capital out of the door. One of these is that private equity and trade are targeting different types of business. With the pressure to generate returns against what has been a challenging backdrop, private equity buyers have been focused on buying businesses with a clear and, if possible, relatively quick path to creating value.

“The differential in valuations between trade and private equity is partly down to dry powder and growth rates targeted,” says Austin. “But it’s also because trade has a longer-term view, while private equity has to become more confident over time about how it can generate returns. There are more specialist funds that have a sharper focus on value creation.”

Peter Barkley, partner at WestBridge, shares that view. “Private equity would rather pay a high-quality multiple for a high-quality business than take a bargain for a mediocre business,” he says. “The trade/private equity delta is likely to reflect the view that trade acquisitions are lower-quality businesses that need the strategic input that trade can provide.”

Barkley is seeing this play out when exiting portfolio companies. The firm recently sold software business Eque2 to Bowmark Capital, a deal in which WestBridge “didn’t take any reduction on our price expectation”, he says.

Barkley adds: “When we are exiting businesses in today’s market, we are seeing high-quality businesses tend to have a higher value to private equity than to trade. The exception here is where trade has a strategic imperative for buying the business and so it might outbid private equity. Of course, many of these trade buyers may also be private equity-backed businesses acquiring add-ons.”

All this means that in situations where trade buyers are targeting the same companies as private equity, it can be a competitive deal market. Chris Hunt, group M&A director at Rentokil Initial, says his company has been outbid on UK and US targets by private equity buyers during the past year. However, he adds that on the whole, Rentokil Initial and other trade buyers are tending to fish in slightly different waters from financial buyers in the current environment.

“Private equity’s leveraged finance model tends to suit high-margin and revenue-growth businesses that typically command high multiples,” says Hunt. “For us, these are nice to have, but not essential because we can overlay our IP and innovation and ways of working, taking a company’s innate resources – its people and customers – and grow them.”

Next chapter

So what’s in store for the rest of the year? While a recent Bain & Co survey of more than 1,400 private equity general partners suggests quite a gloomy picture – nearly 40% are not expecting the deal market to bounce back – some advisers are reporting more optimism in the deal market than there has been during the past 12 months.

“Dealmaking got off to a quieter start than anticipated,” says Keely Woodley, head of deals and business consulting at Grant Thornton. “We are seeing signs of a pick-up as we move through the year, however, with banks becoming more supportive of new transactions. They have more appetite to lend today than they did 12 months ago and that may lead to an increase in valuations.”

One of the big roadblocks to getting deals done had been a price expectations gap between buyers and sellers, although this looks to have narrowed in recent times. “A lot of vendors have held off selling their business because there has been around a two turns price expectations gap between them and buyers,” says Hunt. “An improving economic climate might motivate them to do the work required to put the business on the block, so there could be more supply side – and that is likely to be matched by more buy-side appetite.”

Another, partly related, factor that will aid dealmakers is greater visibility on company performance as we move through 2024. “I hear a lot in the market about deals taking longer to get done,” says Doug Lawson, CEO of M&A data company MarktoMarket. 

“One of the big factors is that it has been challenging for buyers to understand what the underlying earnings are in a business because we haven’t had a normal year since 2019. There has been a lot of noise from lockdowns, the technology bonanza, rampant inflation, geopolitical uncertainty.” And there are hopes that this will be a more ‘normal’ year.

Despite this more positive backdrop, few are predicting much of an increase – if any – in prices paid for private businesses. And that’s even if, as is widely expected, UK interest rates start to fall. “If interest rates do go down, we will see a pick-up in private equity activity, especially if sell-side supply increases” says Austin. “If that happens, valuations are likely to stay largely where they are for private equity, although trade will have to pay up in auction situations as the market normalises.”

Barkley agrees. “If interest rates fall, I’d expect it to have more of an impact on volumes than on valuations because we’re not going back to a zero interest rate environment,” he says. “Lower interest rates will help trading and cash flows recover and so there will be more deals struck at acceptable valuations.”

The one caveat to that is if there is a shortage of supply, especially for the kinds of deals that private equity are targeting. “If sellers don’t come to market,” says Austin, “we may see valuations rise because of the pressure on private equity to deploy capital.”