The private equity (PE) industry has had a rough three or four years. After a slew of heavily leveraged and rather massive buyouts - that in many cases delivered stunning returns to the PE houses which didn’t appear to have done much for their investee businesses - and some unseemly press related to job cuts and lack of transparency, the British Association of Venture Capital (BVCA) commissioned a review of public conduct for its members.
The result was the Walker Guidelines, issued last year and to which many firms signed up. But even before they’d started to get their PR in order, the credit crunch hit - making the old PE model (buy a company with a tonne of debt, crack the whip on the management and squeeze the balance sheet to pay it down, then flog it on for a handsome equity multiple) somewhat difficult to execute.
That’s not all: having raised some spectacular sums of money (see slide nine) from investors desperate to see the kind of returns unavailable in the public equity or debt markets, many PE firms have also been left with stacks of cash they can’t (or won’t) invest. Deals have been hard to come by (partly because the prices for companies are still high and there’s no debt to inject into them). There’s masses of debt from older leveraged deals just waiting to roll over and out of bed (because the banks are frit). And even City folk are turning against the industry.
It sounds pretty doomish, doesn’t it? But it needn’t be. For a start, there’s still plenty of money being raised. True, it’s a lot less than a couple of years ago, but a total of £32bn for 71 private equity funds in the first quarter of the year isn’t loose change. PE firms are looking to developing markets - where there’s both growth and relatively cheap assets for sale - to invest a lot of this cash. But they’re also keeping their powder dry for opportunities in the UK.
That’s the argument put by the PE managers I’ve been speaking to, anyway. And it makes a lot of sense. Wait for the corporates to start running low of cash, and when they need to flog a division or two, back the management team to buy it. That on its own is obviously a good opportunity to invigorate British business. But I’d love to see them go a stage further.
Bold PE firms could start to wean themselves off both big deals and massive leverage. By committing more of their own cash to deals, they’d reduce their reliance on the banks. And a bank is more more likely to inject debt into a deal where the PE firm has more to lose. Yes, the return goes down as a result. But that just places the emphasis on PE managers to drive better performance from their investments, not just crank the handle on a rather exploitative financial engineering machine.
Better yet, looking at deals in the mid market - where companies are nimble, more responsive to PE strategies and can innovate or grow even during a recession - would win them huge plaudits from the business community and government. The lending banks have seen their reputation with business plummet - but these investment bankers could save the day. Heck, they might even set up umbrella funds to plug the equity gap - and become super-Business Angels in the process.
Best of all, the industry’s centre of gravity would move back to people with real skills - in turnaround, portfolio management and strategy - rather than financial engineers and wheeler-dealers. So c’mon private equity: this is your chance to be heroes.
