This article was originally published in December 2020..

The spring lockdown did not stop UK M&A in its tracks, but activity slowed. Faced with the fog of economic uncertainty, some buyers put their chequebooks back in the drawer, and vendors pressed pause. Since the first lockdown ended – and despite a second – activity has picked up. It picked up in anticipation of good news on the vaccine front rather than because of it. Even with Brexit questions still unanswered, deal announcements now come thick and fast as this most unusual of years approaches its close.

Data published by MarkToMarket reveals that this autumn has been almost as busy as in 2019. Some 306 UK M&A transactions completed in September 2020, compared with 349 in September 2019 – just a 12% year-on-year decline. The September 2020 figure compares with the lockdown low-point in May, which saw just 167 deals announced. Given the uncertainty back then, it is surprising that any transactions closed, let alone 167.

Pet care, pharma services, insurance, home security, gaming, and e-commerce logistics, among other subsectors, were all lockdown winners and multiple transactions have been been completed in each space since the summer. Recent weeks have seen the purchase of annuity provider Rothesay Life for £2.8bn, a £3bn approach for G4S, and Hg Capital’s acquisition for £1.5bn of Hyperion Insurance. Yes, the chequebooks are well and truly back out.

What about valuations? Surely some combination of the pandemic, our parlous UK public finances, and Brexit would serve to cool the ardour of even the most aggressive buyers? Yes and no. The data suggests that valuations have declined, but not by much. The average multiple of EBITDA paid in the month immediately before the spring lockdown was 11.5x, compared with 10.5x in September. The average multiple of revenue was 2.4x, and this fell to 2x in September. Declines, yes, but smaller declines than one might have expected.

From my private equity sector vantage point, I would observe that valuations in PE-land don’t appear to have declined at all. In large part this is because there has been a flight to quality. Those businesses that would, even in a normal macro environment, sell but not easily are simply not being marketed. Only high-quality, robust businesses that have continued to perform well throughout lockdown, or which have rapidly and sustainably recovered from it, are coming to market. These quality assets are attracting high multiples. Buyers are now excited by resilience as much as they always have been by growth.

One other reason why private equity transaction valuations remain stubbornly high is the wall of money – meaning the sheer quantity of equity sitting uninvested in private equity funds. By my estimate, UK funds are sitting on around £40bn of ‘dry powder’. Even our free-spending chancellor would regard this as a significant figure.

This equity is committed by fund investors, but not indefinitely. The typical PE fund investment life is five years. Capital not invested by the end of this five-year period cannot be used to make other, new investments. Private equity fund managers whose five-year investment life is coming to an end and who still have plenty of dry powder may be inclined to stick their chins out and pay up for good assets. As the clock ticks louder, investment committees look increasingly for ways to say ‘yes’.

My analysis of private equity market activity shows that, during lockdown, many funds failed to make a single new investment for a period of six months. Once lockdown ended, many of those same funds appeared to make up for lost time by competing for, and completing, a flurry of what look like highly priced investments.

Valuing businesses has always been part art, part science. The pandemic has made life in this regard even more difficult. Those who have been in the financial markets for too long will recall fondly the price earnings ratio, which in turn gave way to EBITDA-based valuations. Today, with some companies’ revenues impacted by covid-19 and costs distorted by furlough payments, we are likely to see information memoranda in 2021 presenting historic performance based on EBITDAL – earnings before interest, tax, depreciation, amortisation… and lockdown. I fully expect to see profit and loss accounts recreated by ingenious advisers as if the pandemic had not happened. Getting to the bottom of what earnings really are for M&A valuation purposes is likely to become more, not less, challenging.

All of that having been said, the private equity market is nothing if not quick to adapt. Businesses are being bought and sold in significant quantities, and fresh funds are being raised. In fact, this summer saw the completion of our market’s first virtual fundraising. An entire fund was raised without the fundraiser meeting investors other than via Zoom. Whatever happened to pressing the flesh and kicking the tyres?

And, finally, what about the outlook? The UK private equity market’s best vintages this century have been 2001 and 2014. I expect long-term returns from investments made in 2021 and 2022 to be excellent too. While the wall of money may seem high, so too is the likely need for it. Corporate balance sheets damaged in 2020 needing fresh equity; founders at the helm of family-owned businesses wanting to de-risk following a difficult twelve months; and the backlog of delayed sale mandates, all point to a busy year or two for UK private equity funds.