Simon Walker, BVCA Chief Executive defends private equity
Dear Sirs
Michael Gordon ‘The private equity boom was a clumsy trick’, is wrong to suggest that the industry’s success is simply a matter of financial engineering. Private equity is a governance model, not a corporate structure.
Buyouts are building better companies across the economy. They range from fast-growing university spin-outs to mature enterprises which need re-energising. Companies from Hertz to Hovis owe their survival and strength to our industry.
Private equity is part of a continuing attempt to diminish the principal-agent problem, by putting the investor close to the business through a controlling stake, and by shortening reporting lines for key decisions. There is a profound difference in how a business operates when the board nominally calling the shots actually owns most of the company. Contrast that with the influence an investor with a 0.5% shareholding has on a public company at an AGM.
The breadth of shareholdings in listed companies has had some good effects – but it has actually diluted the voice of a business’s main owners. Private equity has stemmed the tide of shareholder marginalization and genuinely advanced corporate democracy. Repeated international studies show it also significantly enhances productivity.
When a public company is taken private its ultimate ownership – pension funds and investment institutions – may in fact remain the same. Private equity brings an agreed strategic focus driven by owners who have bought into an enterprise at a common cost basis. Management can focus obsessively on the real problems of a business without the distractions of being a public company.
When a division that has been a low priority for a conglomerate joins the portfolio of a private equity owner, it gets the focused attention and tailored strategy that enables it to grow. Its new owners can make decisions for the long term without being prisoner to its parent’s quarterly results.
Importantly, three-quarters of all private equity investment is for sums of £2 million or less in small and growing businesses. To claim the growth of these firms is mere financial engineering is absurd. If the process were as automatic as Mr Gordon suggests, why haven’t all firms done equally well and generated equal returns? And why does private equity plough significantly more into research and development and corporate investment than listed companies?
Private equity has taken advantage of cheap debt over the last few years, and plcs have sometimes neglected their shareholders by failing to do so. According to evidence given to the Treasury Select Committee, buyout firms have relied on debt no more heavily than at similar points in previous economic cycles.
No doubt some have over borrowed – all businesses make mistakes. Most big company failures in the UK have been public companies.
Private equity is not a magic bullet. But credit down turns have happened before. Major firms like Carlyle, Bain, Apax, KKR and Permira have survived them. There will be buyouts that go bust, just as there will be plcs that collapse. But even buyouts that fail may well leave behind repaired and improved companies.
Institutional investors have been voting with their feet. Pension funds and investment institutions are highly sophisticated. They have chosen to invest in private equity – rather than firms like Fidelity – because they have seen how the best-performing private equity firms have outperformed the market. In future, debt is going to be harder to get - but that won’t stop investment in buy outs. At a time of economic slow-down, private equity is going to be particularly well-placed to fix broken businesses and grow value for investors. That won’t be down to fancy financial engineering, but to good old-fashioned hard work.
Simon Walker
Chief Executive
BVCA – The British Private Equity and Venture Capital Association.
