10/February/09

Battered Balance Sheet?

As businesses take a bruising from the economic slowdown, Brian Cummings of Private Equity firm, Enterprise Equity looks at how private equity can play a role in moving from recession to recovery...

If you listen to the accountancy practices, many are remarking on the number of phone calls from clients asking ‘So, what are my legal responsibilities as a Company Director?’

Indeed, the speed and severity of the economic slowdown has surprised many. It’s also clear that conditions are going to be tough for at least another year. The optimists see things beginning to pick up by the end of 2009, but it is now apparent that the economy is unlikely to bounce back quickly due to the combination of financial crisis and recession.

As a private equity investor, many folk look at what we do and say that there must be a queue of people at our door seeking investment. To a certain extent this is true, but similar to many of the callers seeking to clarify their responsibilities as a Company Director, they may have left it too late.

And that’s a real shame – particularly for those local businesses that have generally sound fundamentals but balance sheets which lenders consider over-leveraged in the new banking paradigm. These are the businesses which I would encourage to consider all the funding avenues open to them, including fresh equity, before the first signs of stress appear in the banking relationship.

Having early discussions are important for a number of reasons. In the same way a marriage has a better chance of success if it is built on a reasonable courtship (as opposed to being rushed at the point of a shotgun!), it allows time for relationships to be built and also time to understand the essentials… and the potential.

But why consider a private equity investment? Well, it could not only repair a battered balance sheet but provide money to finance growth: a private equity investment might turn a crisis into an opportunity and provide the courage to transform the business in readiness for that upturn.

Put simply, private equity brings the focus, experience and alignment of interest to fix businesses. When the going gets tough, private equity doesn’t tend to walk away: it can provide the cash and time to fix the problems and secure a viable, profitable business.

The other side of the coin is to leave it too late i.e. any value that there was back then, has subsequently been eroded. Look at the fate of the Retailer Woolworths, which collapsed a few months short of its hundredth birthday with debts of some £385 million and huge job loses as a result of store closures. Three years previously private equity made a failed £840 million bid for the business. No doubt there would have been some tough decisions involving cost cuts and redundancies. Indeed some parts of the business might have been sold off. We will never know if it would have succeeded under private equity ownership, but it probably would have been Woolies’ best chance of survival.

In a much broader context, private equity and venture capital have a role to play through this recession (particularly when Northern Ireland’s low activity levels are compared to GB’s). Firstly, it is sitting on cash. Despite the credit crunch, money is waiting to be invested in a world where cash is in short supply.

Secondly, it invests right across the economy, from University start-ups, to growing businesses looking to expand into new markets, through to established businesses that need support through this period.

Thirdly, venture capital and private equity are relatively long-term investors, particularly compared with investors in public companies, who are constantly looking for short-term returns. Private equity typically stays invested for five or six years and often longer. In other words, private equity can offer an antidote to the short-termism which has contributed to the current problem.

Fourthly, private equity has a compelling track record at generating strong returns across the economic cycle - investing at the bottom of the market is something the private equity industry has done through other downturns. It should lead to decent returns for management teams and investors in due course. Indeed, pension funds are going to need it more than ever after the savaging they have suffered in recent months.

However, I’m not saying that private equity is perfect. There will be failures, many notable for their size. But when you look at what it is good at - fixing broken businesses and helping businesses to expand and become more profitable - then it has an important role to play in putting us back on the path of growth.

At a time when many are seeking to reduce their exposure to our SMEs, private equity’s supportive long-term outlook could make all the difference. But don’t leave it too late.


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