It’s been interesting to observe the media frenzy around private equity. The language is so vivid: the usual “amoral asset strippers”, “people choppers” and “the dark side of business”, while Damon Buffini, managing partner of Permira, has been described as a “master of the universe”. I wouldn’t quite go that far, but I did enjoy the last definition I heard about a private equity executive: “Someone for whom investment banking is insufficiently well remunerated.”
It’s not hard to see why this particular asset class is eyed with such suspicion. It generates vast wealth, it’s a business in a hurry for change, and most of all, it’s owned and operated privately – ostensibly by privately wealthy individuals not answerable to anyone apart from their own (offshore) bank accounts. Throw in good, old-fashioned jealousy and you’ve got a toxic mix.
And actually, the industry has felt little need to do anything about this until now. Why should it? It has been able to concentrate single-mindedly on its search for value, and none of its time bothering to explain its actions to activist shareholders and cynical media with access to publicly quoted numbers and mistakes. But at some point, a price must be paid for those private freedoms, rather unfair financial advantages and no effort at public goodwill. You have to pay sometime for your licence to operate.
But ironically, there’s a great story to tell about the performance and benefits of private equity, and not just for the lucky few. Recent research by Ernst & Young demonstrates that PE-owned businesses grew their enterprise value by an average of 26% per annum over a three year period.
The benefits of this growth then spilled into secondary financiers (ie the PE firms that took on the financing of those businesses after the initial acquisition period), thus giving the lie to the prejudice that PE firms are glorified asset strippers rather than business builders. No savvy financial institution is going to take on a shagged-out business – they want to see where future sustainable value will come from.
Other data support this, and provide some comfort for ordinary mortals too. The Centre for Private Equity Research at Nottingham University calculated that, as far as employment is concerned, after dipping an initial 5% in the first year after buyout, it rose by 21% after four years. Productivity doubled, innovation stepped up and there were higher levels of employee empowerment. How much would a publicly quoted company chief executive give for the ability to spend months single-mindedly focusing on how to re-engineer and re-grow a business, then have a year or so for the company performance to go down before it goes up again in that hockey-stick shape?
At least for the moment, the boot is transferring to the other foot as more openness and transparency is demanded from the private equity sector, and this is where it gets interesting. Although private equity firms are peopled by financiers, they have come a long way from the days of the Kolberg Kravis Roberts smash and grab on Nabisco in 1988. These days, the best way to achieve maximum value from most deals is by adding value to the assets, not by stripping them for a quick sale. That means understanding how to make the most out of the brands involved. One private equity-backed chief executive recently summarised the classic pattern of private equity discipline as: 1) cut costs/re-structure; 2) drive organic brand growth; and 3) drive brand extension and expansion.
The private equity industry would now do well to transfer this understanding of brands to themselves. There is clearly a job to be done for the industry generally if it is going to escape the Gordon Gekko-type associations that persist in people’s minds. Individual PE companies would benefit from a better, more brand-led approach too. The better the reputation of their own corporate brand, the better they will be able to attract the best people to themselves and the companies they acquire, and the less resistance there will be to the changes those companies need. It could also help the process of attracting investor funds.
There’s a great story to be told about what private equity really does, and the benefits individual PE companies can bring. The time has come for them to start telling it. What a refreshing change it would be for employees of PE-targeted companies to welcome rather than dread their arrival at the gates.
Rita Clifton is chairman of Interbrand