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Private Capital Could Help Drive SMEs Forward on the Road to Recovery

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Tough challenges remain on the horizon for many UK SMEs after two years of Covid-19. Although we now seem to be at the ‘beginning of the end’ of the pandemic, the financial strains on small and medium-sized enterprises are likely to remain, not least because government-backed business interruption loans are yesterday’s news.

Now that those temporary measures are no longer on the table, businesses are having to think about what permanent solutions are available to them to sustain them through the next stage of recovery and growth. Whether further bank lending will be forthcoming on favourable terms, or at all, is by no means certain, as many SMEs found to their dismay after the financial crisis. One alternative funding option worth investigating is private capital. It could be a game-changer for smaller companies.

Private investors are ready and willing

There are two main ways private capital can be deployed to support businesses. Private equity investment – where investors provide funding and take an equity stake in the company. And mezzanine finance – which is a hybrid between bank debt and private equity, where investors provide loans, usually with a small equity “kicker” as part of the deal.

Though it is the major corporate private equity deals backed by large institutional investors that garner all the headlines, there is plenty of activity going on in the smaller end of the market too. According to the private equity industry body, the British Venture Capital Association (BVCA), in 2020 around 90% of the companies that received this kind of financial backing were SMEs.

For unquoted SMEs, one of the major sources of private capital is high net worth investors (HNWIs) who are keen to back high-quality companies with solid business models and future growth potential. Demand among HNWIs is strong: research among our client base last year found that more than half had increased their liquidity over the course of the pandemic, so that they would have cash standing by to invest in good opportunities when they arose.

Agility in action

Not only is this kind of private capital ready and waiting, it can be incredibly flexible too, so that it can be tailored to meet each SME’s specific requirements. And it can offer far more than purely financial support.

While banks and institutional investors have rigid rules they must stick to about who they can fund and on what terms, at the smaller end of the market, independent private capital providers have the flexibility to make their own decisions based on the merits of each investment proposition. For instance, they can commit to follow-on funding rounds for private equity investments if they think it is appropriate to do so: something that few other types of investors are able to consider. Similarly, they are unique in being able to offer innovative structures for mezzanine finance deals. This could include loans with final bullet payments instead of traditional amortising loans, which enables cash to be deployed within the business instead of being sucked out relentlessly in repayments. Or loans with fewer restrictive covenants, easing the burden of having to meet onerous conditions in a volatile trading environment.

Private investors are typically entrepreneurs or seasoned businesspeople themselves. They understand the pressures SMEs are under, and the opportunities that are out there. In many cases when they are investing direct into companies they have selected themselves (whether investing alone or via a professionally-managed investment collective such as ours), they can offer the benefit of their skills and experience, by providing practical guidance and advice, and even access to contacts and introductions.

Because they are investing their own money in companies they have hand-picked, they have the best interests of every business in their portfolio very much at heart. This is a different approach to a fund, where managers invest other people’s money and tend to concentrate on looking after certain portfolio assets in particular, usually the biggest ones.

Private capital is focused on long-term gains, not short-term targets, so investors are prepared to give businesses time to do what they need to do to shore up their underlying business model, develop their strategy and come back fighting as the recovery unfolds. For all these reasons, private capital investors should be seen as trusted partners, with whom the company can form a good long-term relationship.

To find the most appropriate source of private capital funding, a good place to start is to speak to a corporate finance adviser, who can connect companies with potential investors, help them get investment-ready and guide them through the process.

Agility has become a buzzword during the pandemic as businesses have had to pivot quickly to adjust to changing norms, but the need to be agile is not over yet, and when it comes to finance, it pays to look ahead and to think outside the box. For those that need funding that is flexible, innovative and available to support them on the road to recovery and into the realms of growth beyond, private capital could be a route worth exploring.

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