Volatility and complexity have dominated the private equity landscape over the past 18 months. Persistent inflation, global political instability, successive interest rate hikes, and deepening socioeconomic inequality have contributed to heightened levels of uncertainty.

As we enter Q2 2024, market activity is finally picking up, with early signs of returning investor confidence and appetite to accelerate dealmaking activity. But to drive strong returns in these new conditions, PE investors must focus on the fundamentals of value creation.

We increasingly see firms in the UK dedicating their efforts to:

• Identifying and investing against long-term macro ‘trade winds’ that are tied to enduring priorities, which have the potential to drive investment success over a horizon of 5+ years
• Conducting early, thorough diligence well ahead of a process to truly understand the nature of the target business, and associated opportunities and risks
• Having a well-defined value creation plan that includes a long runway and plenty of optionality from day 1 of the acquisition

In this piece, we aim to highlight three key ‘trade winds’ that we expect will drive significant opportunities for PE investors.

1. Net Zero and the Energy Transition

The Climate Change Commission estimates that £50bn will need to be invested every year until 2050 to achieve the UK’s target of Net Zero. While this creates huge opportunity, the investment landscape is complicated by inconsistent and changing regulatory, compliance, and funding policies.

Against this backdrop, PE investors must ask smart commercial questions to make sure they ‘back the right horse’, and find niches that will remain relevant despite the volatility.

Questions that investors might consider include:

• Is the business underpinned by regulatory requirements or ‘opt-in’ policies?
• Is the business reliant on a single source of government funding or does it have access to multiple streams?
• Is there a risk of business model shift from people-based to technology-based?
• Can you internationalise the business?
• How much of the business’s revenue is recurring / re-occurring versus one-off?

Examples of businesses that we have seen do well and garner significant investor interest in the last few years include facilities management and buildings management systems, energy efficiency enhancements (e.g. solar, lighting), ESG data analytics, consulting and benchmarking, energy broking, telematics, and supply chain tracking.

2. Digital Renewal

Appetite for digital transformation remains huge. It is estimated that £20bn will be spent on digital transformation this year in the UK, and that amount is expected to grow to £65bn by the end of the decade.

Three years ago, most CDD was focused on measuring the extent of ‘white space’ in the market for adoption of first-time systems that replaced legacy manual processes. Nowadays, there is more of a focus on how to integrate systems more efficiently and how to make better use of data and insights gathered.

PE investors have seen opportunities in businesses offering products and services that use technology to streamline operations, increase efficiency, improve customer engagement, and maintain regulatory compliance. Of particular interest are companies that are doing this by adopting the latest technologies – for instance, augmented/virtual reality, big data analytics, blockchain, cloud computing, and generative AI.

When assessing a business in this space, some key considerations to bear in mind are:

• Is the business customer-focused or solutions/service-focused? Has the business evolved to accommodate the demands of their largest customer rather than truly being a specialist in a particular skillset or domain?
• How is the business differentiated? Is it demand-led (i.e. has unique competency, skillset, methodology, partner knowledge, or relationship) or supply-led (i.e. talent platform with capacity)?
• Does the business have a strong sales pipeline and sales capability to drive demand? Or is it simple an ‘order taker’, reacting to inbound demand?
• Can the business prove good ROI for its solution (software or service)?
• How sticky is the solution offered by the business? How easily is it replaced or displaced by competitors?
• Do customers prefer ‘best-in-breed’ solutions or monolithic stacks in this domain?
• Is the underlying technology/vendor solid (are they ‘backing the right horse’)?
• Will the business be disrupted by or benefit from moves by Big Tech and/or bleeding-edge tech advancements?

3. Social Infrastructure

Public procurement spend in the UK in 2023 reached more than £300bn. As a growing and aging population continue to increase the strain on public services, policymakers in the UK have recently begun to focus on ramping up efficiency and innovation to improve service delivery.

Recent policy initiatives like the Procurement Act 2023 are expected to open the door for SMEs to take greater share of overall public sector spend. We see an opportunity for PE investors to make smart investments that are underpinned by a stable and growing source of public spending.

The obvious question of interest to investors in this sector is whether changes in policy will ultimately affect the businesses they are considering. However, some more nuanced questions to consider might include:

• Who is the buyer (this is often different from the user/consumer in the public sector)?
• How is the business funded (e.g. single vs. multiple source, short-term vs. long-term initiative)?
• What is the customer concentration? Is the business overly reliant on one main customer? Is there an opportunity to diversify the customer base?
• Are there regulatory constraints (e.g. procurement processes, mandated tender periods, TUPE regulations) that make it difficult to underwrite long-term business growth?
• Will the solution provided by the business be brought in-house within a public body?
• How price sensitive is the business?

Examples of businesses that stand to benefit from upcoming policy changes in this space include facilities management, procurement platforms, staffing agency services, legal add-on products and services, law enforcement software, children’s services, and public health services.