Michael Mowlem looks at the impact of the recent Budget, the implications of the US election and wider macro-economic factors on the investment environment.
So, in the end, the CGT bark around the Labour government’s budget was worse than its bite. The rises to capital gains tax which were announced were far more moderate than many feared. This is encouraging because it suggests that the Government recognises the risks involved in long-term investing, and the value that private investors and entrepreneurs deliver to UK plc, fostering a robust and sustainable economy by growing small and medium sized businesses (SMEs).
After all, well over a quarter (29%) of the total UK private equity and venture capital funds raised last year came from private individuals according to the BVCA, and in total, private capital investors poured £20.1 billion into 1,500 UK businesses, nine in ten of which were SMEs1. So, any policy that jeopardised that would have been a major own goal in terms of delivering economic growth.
Elsewhere in the Budget, the increase to employers’ National Insurance Contributions (NICs) both rate but in particular the reduction in the threshold at which they start being paid, coupled with the rise in minimum wage also stand out as having potentially significant implications for UK SMEs – particularly those in sectors which rely on large numbers of people, some of whom may work part-time, to carry out their operations. As ever, we’ll be bringing our extensive expertise and support to our portfolio companies, working with them to ensure they are well-positioned to make any adjustments.
Looking ahead, the increased costs to companies will clearly need to be taken into account in our decision-making when appraising new investments. This is unlikely to materially decrease the number of attractive opportunities on offer but we will be looking carefully at the potential impact and factoring it into valuations accordingly.
A further change in the Budget was the decision to include certain asset classes within the scope of Inheritance Tax. The changes to agricultural property relief and business property relief could impact long term owners of such assets to trigger an exit or partial exit to fund such liabilities. The latter could create increased volume of investment opportunities in founder-owned businesses for Connection Capital.
While many of us here in the UK have been focused on the extent and scope of potential CGT (and other tax) changes, another major political event on the other side of the Pond could have far greater consequences for global economies. The outcome of the US election looms large over the outlook ahead.
Promising macro-economic signs
Politics aside, broader investment decisions by private equity firms and investors are made against the backdrop of micro-sector trends and macro-economic factors. Typically, the UK looks to the US for the economic direction of travel and the signs right now are promising. US employment is generally stable, despite small spikes in US jobless rates reported in recent months. While these led to sudden and sizeable market corrections (which subsequently reverse more slowly), a recent study2 of US corporate profit margins suggested these were at highs not seen since the 1960s, and that therefore reductions in staffing levels are unlikely.
The US interest rate cut in September, the first in four years, was also a significant turning point. According to research by Chatham Financial3, the average time interest rates remain at their peak before falling is 11 months - and encouragingly, this time around it took just two months longer than average for rates to be cut. Though the ball started rolling in Europe and the UK ahead of the US, this move by the Fed, coupled with expectations of a further reduction in November, suggests that more material reductions in Europe are likely. Inflation is also down materially from the major spikes seen in 2022/2023 (the first for 40 years across the West) falling from almost 10% to between 2% and 3%, albeit with some continuing volatility amid oil price rises.
These are positive indicators, and here at Connection Capital, we’re seeing them translate into an uptick in activity, with a wide variety of new opportunities across private equity, private debt, funds, co-investments and property. We continue to look across our markets to find good quality prospects in niche areas where we can drive real growth and which offer potential for material outperformance, while also structuring deals to ensure downside protection. Our recent investment in Winder Power is a good example of this, and our current healthy pipeline offers many more opportunities with high growth potential.
The past few years have seen some extraordinary macro events, and despite recent improvements in conditions, the challenges are far from over. For us, whatever the landscape looks like ahead, navigating our way through it means picking investment opportunities very carefully and protecting downside wherever possible. It’s an approach that yields rewards in good times and bad.
1: BVCA Investment Activity, 22 August 2024
2: This time may well be different, Kleinworth Hambros, 2024
3: Historical interest rate tightening cycles, Chatham Financial, 2024