Mid-market and bolt-on deals set to drive private equity M&A

With the exception of the post-pandemic deal frenzy seen in late 2021, much of the past four years has seen flat levels of M&A activity among the vital private equity buyer class.

A succession of shocks, from the ongoing effects of Brexit and COVID-19 to global economic instability and the uncertainty generated by Russia’s war in Ukraine, have led to many private equity firms reducing their dealmaking activity.

This is not for the want of funds, though, with recent data from S&P Global Market Intelligence and Prequin indicating that private equity and venture capital funds are currently sitting on a record $2.62 trillion (approximately £2 trillion) in dry powder (unspent or uncommitted funds) as of July 10 2024.

Despite these vast cash reserves, private equity activity has remained low as investors continue to bide their time and wait for improved dealmaking conditions to return. In the first half of 2024, UK private equity activity fell by a fifth compared to the same period in 2023, according to figures from KPMG.

However, there are significant indications that activity could be poised to recover rapidly, with a general feeling that the underlying fundamentals for private equity dealmaking are currently far stronger than they have been for some time.

For the past two years or so, the question has largely been ‘when’ not ‘if’ private equity investors would begin to deploy the huge cash piles they have amassed over recent years. Increasingly, it appears that this time is coming closer.

Despite this optimism, there is no doubt that a huge degree of risk and uncertainty remains – as demonstrated by Prime Minister Sir Keir Starmer’s recent proclamation that the new government’s first budget in October would be “painful”.

As a result, it seems likely that a recovery in private equity activity will be conducted with the same kind of caution that investors have demonstrated over recent years and that a resurgence in activity will perhaps begin with smaller deals at the mid-market level and an increase in bolt-on transactions – as opposed to major deals and investments.

Economic conditions continue to quell activity
From an M&A perspective, 2024 has been defined by strong optimism, tempered by continuing uncertainty. After entering a shallow recession towards the tail end of 2023, the year so far has seen the UK’s economic landscape beginning to brighten after a long period of uncertainty and difficult conditions.

Inflation has fallen sharply from the highs seen over recent years, while a lengthy run of successive interest rate increases was arrested earlier this year, with the Bank of England subsequently holding rates steady for much of 2024.

In July 2024, the Bank of England finally delivered a long-awaited interest rate cut from a 16-year-high of 5.25 per cent to 5 per cent, with a recent Reuters poll indicating that a majority of economists expect a further cut in November.

However, Bank Governor Andrew Bailey cautioned that future rate cuts would be “cautious” - pointing to the ongoing fragility of the UK economy. Having hit the Bank of England’s 2 per cent target in May and June 2024, inflation has since crept up, rising to 2.2 per cent in July, with the BoE indicating that they expect it to hit 2.75 per cent by the end of the year.

The persistence of these challenging macroeconomic conditions illustrates why the UK is yet to see an increase in private equity dealmaking during 2024, despite underlying fundamentals being significantly improved compared to a year ago.

In July, KPMG reported that there had been just 656 UK M&A deals with private equity involvement during the first six months of the year, down 20 per cent compared to 822 deals during the same period in 2023.

Looking at the same period, Grant Thornton stated that the expectation at the end of 2023 was that the UK deals market would stabilise at the start of 2024, with activity picking up in the second half of the year. According to their analysis, these forecasts have been broadly true, but significant headwinds have remained.

Grant Thornton stated that "the market is still cautious, and transactions are taking a long time to close”, adding that a difficult fundraising environment means that investors were being more selective with acquisitions and that due diligence processes were being enhanced.

The report said that, despite a significant reduction in inflation and an interest rate cut, “analyst consensus estimates at the end of 2023 have proven to be optimistic and the BoE cuts are now assumed to be both more limited and coming later”, with base rates and debt service remaining a concern.

These headwinds have thus far tempered any recovery in private equity dealmaking, but the consensus is that (despite the fall in activity) conditions have improved significantly and, furthermore, there are indications of the trends that could drive an increase in PE activity during the final half of 2024 and into 2025.

Mid-market and bolt-ons demonstrate resilience
In KPMG’s report covering the first half of the year, the company found that mid-market deals with private equity involvement had fallen 11 per cent from 360 in the first half of 2023 to 321 in the same period of 2024.

While this is not an insignificant decline, it is far shallower than the overall 20 per cent drop in private equity activity. Furthermore, the figure for 2024 was 25 per cent higher than those seen pre-pandemic in H1 2019.

This resilience indicates a preference for mid-market activity among private equity buyers, with firms more confident about conducting smaller transactions at a time when economic uncertainty is still a prevalent concern.

This trend was further demonstrated by the prevalence of bolt-on transactions during the first half of the year, with KPMG reporting that around 60 per cent of private equity-related deals were conducted by buyers that are existing platform businesses of a private equity company.

A similar trend was evident in the Grant Thornton H1 report, which found that 438 of the 711 transactions tracked during the first half of the year were add-on deals, compared to just 168 platform deals (down from 203 in H2 2023).

Another key area of resilient private equity activity was inbound M&A involving UK-based companies, with KPMG reporting that 42 per cent of all private equity-related activity during the first half of 2024 was from overseas buyers – with close to half of that figure involving US-based buyers.

This could potentially speak to the ongoing caution of UK-based buyers and private equity firms in comparison to their transatlantic counterparts. This view is reinforced by Pitchbook data showing that overall US private equity deal activity increased by 12 per cent during the first half of the year, compared to the same period of 2023.

The comparative boldness of overseas buyers perhaps reflects a higher level of overall economic confidence. According to Reuters, Bank of England counterparts the US Federal Reserve and European Central Bank (ECB) are each expected to cut their rates by a total of 75 basis points this year – a far quicker rate of cuts than the BoE is pursuing.

As with much UK private equity activity seen during 2024 thus far, Grant Thornton US National Managing Principal, Private Equity, Greg Westfall reports that much US activity in the first half of the year was driven by add-on transactions – potentially providing further evidence that this is a trend that will persist in the UK even as activity picks up.

Why bolt-ons?
Perhaps the best explanation for the prevalence of bolt-on/add-on private equity transactions during 2024, and the reason that this may define a recovery in activity levels, is the simplest one: caution.

While underlying conditions are widely held to be stronger than at any point over the past two (and potentially as many as five) years, global economies continue to be fragile and vulnerable to a multitude of adverse headwinds.

As a result, private equity firms are likely to wait for economic growth to return in earnest before they begin plunging their cash reserves into riskier new investments. In such a scenario, bolt-on transactions provide an opportunity for private equity firms to invest and yield returns without exposing themselves to higher levels of risk.

This is a view echoed by Ivo Hobson, Director and Head of UK at private equity firm Mutares, who said in an interview with PE Hub Europe earlier this year that he feels that bolt-on transactions would become a strong M&A theme for the remainder of the year.

With many private equity investors seeking to enhance and expand their existing portfolios, add-on transactions could present the ideal route. Hobson commented: “I think many people are thinking about add-on activity because in the current market environment that’s one way to create value.”

This perspective was shared by KPMG UK Head of Private Equity, Corporate Finance, Alex Hartley who stated that, while private equity firms were “back in the market looking to complete transactions [...] the quality threshold for doing deals remains high” in spite of stronger economic and political stability.

Hartley continued: “Currently, around two in three private equity deals are bolt-ons, and this strategy is likely to remain popular for those looking to grow and create value in the current environment.”

One private equity firm that has been extremely active in pursuing bolt-on acquisitions for years now is LDC. In 2023, the firm invested over £50 million in funding for its existing portfolio of 90 businesses and supported 46 bolt-on transactions, whilst also investing more than £300 million to acquire 14 new SME businesses.

At the outset of 2024, LDC Chief Executive Toby Rougier said that the firm would seek to ramp up this activity further, commenting: “Our success reflects the resilience and entrepreneurial spirit that make medium-sized companies the backbone of our economy. Now, as we see signs of market conditions improving, it’s the ambitious leaders behind these businesses who will lead a resurgence of M&A; activity in 2024 – and we remain committed to partnering with them.”

What does this mean for UK small business owners?
Last year, a study conducted on behalf of Handelsbanken Wealth & Asset Management found that one in five owners at small and medium-sized businesses were planning on selling all or part of their business within two years, while a more recent Marktlink survey of 1,066 SME entrepreneurs found that 31 per cent had considered selling over the past year.

Clearly, there are a significant number of owners at small UK businesses who have considered or are actively considering an exit – or at least an acquisition by a bigger company that can help secure them financially.

However, political and economic uncertainty have meant that conditions are far from ideal for business owners seeking a profitable sale that reflects the true value of their business. As a result, many will have thought better of choosing to go to market – either waiting for better conditions to return or cancelling their exit plans altogether.

While uncertainty persists (particularly given the growing likelihood of significant tax increases at the new Labour government’s first budget in October), economic improvements may mean that some small business owners are once again considering the possibility of going to market.

A genuine recovery in private equity dealmaking, driven by a focus on mid-market deals and (perhaps more pertinently) bolt-on transactions by private equity platform companies, may provide an excellent opportunity for these kinds of owners to attract well-capitalised buyers able to offer a strong valuation and the kind of investment that could help to secure their company’s survival and seriously boost its future growth prospects.

Typically, private equity firms themselves will rarely make platform acquisitions of companies with revenues of less than £20 - £30 million. However, if private equity dealmaking increases and continues to be strongly driven by bolt-on activity, then smaller companies with lower turnover may increasingly become viable acquisition targets for private equity portfolio companies undertaking a renewed level of M&A activity.

This effect may even be felt further down the chain. If smaller buyers with the capacity to acquire small and micro-sized businesses are able to identify sectors in which resurgent private equity activity is most likely to be seen, then they may be able to rapidly acquire and merge several of these businesses.

By doing so, they could feasibly build a larger small to medium-sized firm with significantly higher turnover, that could subsequently find itself on the radar of a PE-backed acquirer – potentially enabling them to rapidly secure an extremely profitable multiple if they are acquired.

Sector spotlights – Where will the resurgence begin?


Technology, media and telecommunications
The technology, media and telecommunications sector (TMT) has long been a favourite of private equity firms, attracted by the strong growth prospects, disruption, technological development, diversity and high levels of infrastructure spending the industry offers.

With a new government pushing an agenda of digital transformation and a number of key trends taking shape, the sector could be one of the first to see a resurgence in M&A activity and could prove to be one of the central areas in which PE dealmaking recovers over the coming months.

According to Grant Thornton, the sector has continued to attract strong private equity interest even during the quiet start to the year in 2024, with US investors particularly active. KPMG’s Alex Hartley, meanwhile, named the industry as one in which the company was seeing “a notable resurgence in deals”.

Crucially, the TMT sector is seeing a growing amount of bolt-on M&A activity. According to a recent Grant Thornton report, of the 227 M&A deals seen in the UK TMT sector during the second quarter of 2024, 85 deals (approximately 37 per cent of the total) were bolt-on transactions completed by private equity-backed businesses.

This is a sharp increase compared to the 49 deals seen during the previous quarter (21 per cent of the Q1 2024), with Grant Thornton noting that “Confidence appears to have returned among the active PE-backed consolidators.”

By comparison, private equity platform deals in the sector have remained steady (accounting for 15 per cent in Q2, compared to 14 per cent in Q1), providing another indication that a recovery in private equity activity is likely to be driven by bolt-on deals.

In addition to naming general economic factors that will help to facilitate dealmaking, Grant Thornton also identified a number of key trends that could push even greater M&A activity and private equity involvement in the TMT sector over the coming months.

According to the report, events businesses have begun to fully embrace the post-pandemic return of face-to-face meetings, while better economic conditions have provided a boost to consumer-facing firms. Grant Thornton states that this is beginning to be seen in M&A activity, with the firm expecting “a strong pipeline of media deals to come through in the coming months.”

As we outlined in a recent analysis of telecoms M&A, the UK’s gigabit telecoms push (Project Gigabit), combined with the struggles experienced by many smaller and alternative broadband network providers (AltNets), could begin to drive a significant degree of consolidation in the UK’s broadband telecoms market.

This consolidation now appears to be taking place, with major recent deals including the merger of altnets Netomnia and BRSK. Grant Thornton’s view is that with the market remaining highly fragmented, there is a significant amount of consolidation still to come, likely to be driven by buyers with “liquidity and strong balance sheets”. Given the strong private equity involvement in the altnet market, it seems certain that much of this activity will be shaped by bolt-on deals.

Crucially, Grant Thornton also point to the potential impact of the new Labour government’s digital agenda, with the party centering much of its election drive on increasing the efficiency of public institutions and services through digitisation and new technology.

The party’s digitisation and tech-related plans span a wide array of public services, from healthcare, research and data protection to policing and rail. Grant Thornton write that, while it is too early into the new government’s tenure to gauge the success of these wide-ranging plans, “its reliance on digitisation [...] will only increase the appeal of TMT assets.”

Finally, another interesting finding from the Grant Thornton report was an increase in private equity exits in the sector. As with platform investments, exits have been somewhat slow over recent years, with economic challenges leading many private equity firms to hang on to assets longer than they typically might.

However, the report notes that, with economic concerns easing and TMT valuations increasing, more private equity firms with holdings in the sector are bringing their assets to market, leading to them being “scooped up by a flux of private equity buyers.”

Grant Thornton tracked 25 of these secondary buyouts during the first half of 2024 and, should valuations in the sector continue to increase amid the tailwinds outlined above, then more of these deals could be on the way.

Healthcare
As with TMT, the healthcare sector is a fast-moving, tech-driven industry that has attracted strong private equity interest for many years now and appears to be another sector that will help to drive growing private equity M&A activity.

The sector has proved relatively resilient amid lower levels of private equity dealmaking (with Grant Thornton identifying the medtech sub-sector as a key factor in this regard). At the close of 2023, Bain & Co estimated that private equity buyouts in the global healthcare sector had hit 383 last year, up from 353 in 2022 and significantly above the average seen in the three years pre-COVID-19.

However, it has not been immune from the challenges facing private equity dealmaking, with Grant Thornton reporting that bolt-ons in the UK market were down 48.6 per cent during the first half of 2024.

Despite this dip in add-ons, they have long defined private equity activity in the sector. Furthermore, with Grant Thornton reporting a near 56 per cent increase in platform deals during H1 2024, it seems that private equity firms could once again be shaping up to fund buy-and-build growth strategies in the healthcare industry.

In a recent interview with HealthInvestor UK, LDC partner Aziz Ul-Haq discussed the role of private equity in the UK healthcare market, focusing in particular on how bolt-on acquisitions have been driving growth in the sector.

According to Ul-Haq, businesses across the UK healthcare market have offerings that are directly transferable to other global regions, meaning that buy-and-build M&A strategies can be used to drive entry into new markets.

He cites LDC’s investment in UK healthcare comms agency Fishawack. During a three-year partnership, LDC provided Fishawack with £18.5 million in follow-on funding, enabling the firm to complete five international acquisitions, increasing revenue by 300 per cent, headcount by 250 per cent and helping the company to establish a strong presence in Europe and North America.

Aside from geographic growth, Ul-Haq also discussed how bolt-on activity can enable companies to access new products and services in order to adjust to, and take advantage of, changing market conditions.

Discussing LDC’s approach to the healthcare sector, Ul-Haq stated: “At LDC, we’ve been partnering with healthcare businesses for more than 20 years and have specialist teams based across the UK that support our portfolio companies throughout the entire lifecycle of an acquisition.”

“Our origination team supports management teams to map out existing markets, explore new territories, review potential areas for growth and identify targets.”

Despite difficulties in a challenging dealmaking environment, optimism has remained high that the UK’s industry-leading healthcare market will return to strong levels of M&A activity in a more stable economic environment.

Fuelled by investors like LDC, as well as the industry’s near constant technological innovations and disruptions, private equity firms and private equity-backed industry consolidators targeting bolt-on deals should play a central role in this.

With UK private equity activity poised for a resurgence as we approach the final quarter of 2024, it seems likely that this recovery will likely begin to take shape at the lower end of the market. Despite growing confidence, uncertainty remains and – given how private equity firms have operated over the past four years – an element of caution is still to be expected.

Bolt-on deals have defined much private equity activity over recent years and this is unlikely to change, while the resilience of mid-market acquisitions compared to the steeper overall decline in PE dealmaking suggests that many platform acquisitions will target smaller companies.This means that SMEs in attractive industries, such as healthcare, green energy or TMT, may be in a position to attract direct investment from a private equity firm to drive them to the next level of growth.

Owners at smaller businesses and buyers consolidating micro-companies, meanwhile, may be in a strong position to become targets for private-equity-backed firms ramping up their bolt-on activity.

Ultimately, the expected resurgence in private equity activity looks like it could deliver a significant boost in investment for smaller UK companies and enable them to target ambitious growth at a time when the economy finally seems to be turning a corner.

Click here to view an A-Z list of 200 private equity firms active in the UK

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