Two years ago it was simple: PE firms backed deals with debt. But with banks closing ranks, potential acquirers are having to find new ways of funding their ambitions. Mark Dunne reports

For Matrix Private Equity, the management buy-out of the Antiques Trade Gazette in October has become as rare as the artefacts the newspaper covers each week. The firm backed a team led by managing director Anne Somers with a £4.5 million investment in exchange for a minority stake in the business.

This was one of four transactions completed by the firm this year, but what makes this different from the others is the way it was funded. HSBC put in £2.5 million of debt, making it the only deal Matrix has managed to secure bank finance for this year.

For the other three, we used our integrated finance product, where we write all of the debt and the equity,” says Matrix director Mark Wignall. “The Antiques Trade Gazette deal won bank support even in these conditions as it is a low-risk, resilient asset given that it is pretty much the only title in its industry.”

It is not just Matrix that has struggled to get debt into its deals. Accountancy firm Grant Thornton’s Securing Finance survey reported that 51 per cent of businesses admit to having difficulty in winning bank support to fund their M&A plans.

Survival of the fittest
Richard Kennerley, head of specialist and acquisition finance at Clydesdale Bank, admits that he is not backing as many deals as he has in recent years: “We, like a lot of other banks, are being selective about the transactions that we are supporting as there is a degree of nervousness around the economy and in terms of how deep this recession is going to be.”

He adds that the market has fallen away, but good deals will continue to get the funding they need. “I would go back to the old adage that strong management teams in good businesses in strong sectors are always supportable,” he says.

Wignall disagrees and describes the current conditions as unprecedented: “I have been doing this for 21 years and have never known an environment where profitable companies can’t get credit to purchase assets.”

This lack of banking support has led to firms such as Matrix going the extra yard to get deals done. “Lack of debt is going to be a major issue in 2009. Our ability and desire to write all-money deals, debt and equity, will be an attractive offering next year.”

Do it yourself
Another option is for companies to fund deals using their own cash. Leon Ferera, a partner at law firm Jones Day, has worked on several deals this year that have been funded off balance sheet or by using existing debt. Although he believes that this has been made possible by shrinking deal sizes. A year ago, he was advising on transactions worth hundreds of millions of pounds, but recently these have tended to range from single-digit millions to around £60 million.

Wignall believes that the only external options for companies to fund their M&A ambitions that have not suffered from the struggling economy are receivables finance, invoice discounting and factoring. “These remain extremely attractive products for smaller companies. Although its patchy, I’m of the view that it can be secured for those who know how to access it.”

Ferera claims that companies failing to attract funding is not the only reason deal numbers are falling – time has also been a factor. “At the moment, deals are just dying. People start talking in September, but by the time they get anywhere close to agreeing terms the market has dropped so the buyer wants to change his price and the seller says, ‘sorry, the deal’s off’. That is happening a lot.”

Kennerley agrees with Ferera’s concerns. “We are seeing multiples coming down and pricing going up,” he says. “Deals are generally taking longer to work through, because very often the quality of due diligence is becoming more and more of a focus.”

Next year, dealmakers will experience the same funding problems due to a continuing lack of bank funding, according to Ferera, but volume may still rise. “We are going to see more deals, but they will be smaller. They will involve strategic buyers, and maybe the private equity players are going to start coming back into the smaller deals rather than the mega-deals we have seen in the past few years.”

Kennerley agrees that the recession will continue to bite: “We don’t anticipate funding as many deals in the current financial year and certainly not going into 2009. Next year is definitely going to be quieter in the deals space. So while we will fund good deals, we are certainly being more selective and will continue that trend going into 2009.”