Into the Light: the changing face of private equity
Private equity is
regarded by many as the unacceptable face of capitalism. The common
view of private equity is that it generates returns for the wealthy
at the expense of jobs and incomes for ordinary people. It is widely
– and too often correctly – criticised for a callous attitude to
other stakeholders and an unhelpfully short-term view of business
development.The description of private equity as “hard-nosed” and
“only in it for the money” by Martin Brassell of Inngot at ACCA
SME's Alternative Finance conference this week is typical: “Where
private equity has been involved, you can see the treadmarks”, he
said. Private equity has a serious image problem.
private equity firms haven't been too concerned about their image in
the wider community. But it seems that this is changing. The theme of
the European Venture Capital Association's (EVCA) Symposium in Vienna
last week was how to deliver value not only to investors, but to
society as a whole.
In an inspiring
speech, Thomas Van Koch of EQT Partners issued a stirring call for
fundamental redefinition of the role of private equity:
is there to provide good returns to investors. But that's not enough.
It needs to develop partnerships with companies in order to deliver
value for all stakeholders in society.
too, emphasised the role of private equity investment in delivering
economic growth and jobs. From time to time there was a reminder that
PE investment is primarily about delivering returns for investors.
But this was largely drowned out by the calls for the value to
society of private equity investments to be more widely recognised.
So what is driving
the private equity industry's new-found interest in delivering
economic benefits as well as investor returns? In a word, regulation.
Regulations regarding capital, liquidity and transparency are being
significantly tightened for the private equity industry, just as they
are for banks and insurance companies. Firms are currently grappling
with the recent Alternative
Investment Fund Managers Directive (AIFMD), but as Investec warns
in its Private
Equity Insights report, “any assumption that the current raft
of regulation is “it” for private equity is potentially
dangerous”. When one panel at the EVCA conference was asked what
their main concern was about investing in Europe, all the panellists
responded “unhelpful regulation”. It's clearly a considerable
policy-makers with private equity business models is also a concern.
There is growing pressure to close down tax havens, and
recommendations from international institutions such as the IMF and
from highly-regarded economists that wealth, and the returns from
wealth, should be more highly taxed. On the first day of the EVCA
conference there was a discussion of tax planning and the use of tax
havens, in which the participants concluded that helping clients
avoid, or evade, tax perhaps wasn't all that great for the image of
private equity. “Don't do things regarding taxation that if
reported in a newspaper you would be embarrassed to admit”, said
one panel member. Image, indeed. Substance? At this point, not so
If the private
equity industry's desire to improve its image is driven entirely by
the desire to avoid unwanted regulation and interference, then we
should expect policy-makers to resist. After all, regulators are only
responding to the perceived risks that the private equity industry
poses both for investors and for the economy as a whole. Systemic
risk is not limited to banks and insurance companies. And there is
little doubt that tax avoidance and evasion seriously affects
government finances in many countries. If the private equity industry
really wishes to be seen as delivering value to society, it does have
to change its attitude to taxation.
equity's problem is not simply one of image. There is a gulf of
understanding between the public sector – and indeed the public at
large – and the rarefied world of private equity investment.
Private equity is widely seen as having an unhealthy focus on
delivering short-term returns at the expense of long-term
sustainability for the businesses they own. It is true that some
parts of the industry do prefer quick turnaround and resale of
acquisitions: but long-term stable investment in companies – 10
years or more - is actually much more typical of the industry. The
health and sustainability of the businesses they own is an issue for
private equity firms too. Van Koch warned that private equity firms
that failed to deliver sustainability “would fail”.
policy-makers, regulators and the public at large do not understand
private equity, it is hardly surprising if policies and regulations
are devised that do not suit it – such as accounting standards and
regulations that force firms to compromise long-term returns for the
sake of liquidity, when their liquidity needs could be adequately met
by well-functioning collateral transformation and repo markets and
their main challenge is delivering capital growth in a world of low
returns. Private equity can be too private for its own good.
no longer works in the financial industry's favour, and private
equity is no exception. If policy-makers, regulators and the public
at large are to appreciate its role in generating growth and jobs, it
will have to become far more transparent. Just as Mark Carney wishes
a light into shadow banking, so the private equity industry must
come into the light.
equity into the light is bound to expose problems, just as it has for
banks and insurance companies. There are undoubtedly firms out there
whose practices leave a lot to be desired. But a few bad firms
tarnish the image of the whole industry, to the detriment of
everyone. Transparency will force the industry to put its own house
in order. Van Koch called for creation of an independent body to
“police” the investment industry with a view to ensuring that
firms act openly and honestly. Good firms should have no problem with
this: after all, as Van Koch said, “we have nothing to hide”.
Only those who have hitherto used the cloak of opacity to hide bad
behaviour have anything to fear from transparency.
There are huge
benefits to be gained from bringing private equity into the light,
both for investors and for the economy as a whole. The opacity of
private equity tends to blind it to new investment opportunities:
some investors at the EVCA conference had never heard of Bitcoin,
for example. In the course of a panel discussion on smart
cities, Anne Glover, the new chair of EVCA, asked whether any of
the investors in the room (about 200 people) invested in smart city
infrastructure and technology development. Not a single hand went up.
It seems all their investments are in traditional asset classes. No
wonder they are experiencing poor returns and the economy is starved
of capital investment.
how investors could support entrepreneurial development of smart city
infrastructure and technology solutions. “Where are the
entrepreneurs?” she asked. But in reply, Paula Hirst of Future
Cities Catapult pointed out that many of the solutions already exist
– they have been developed by public sector and third sector
providers, whose funding needs are not being met because of
misunderstanding and prejudice regarding private equity involvement.
This is perhaps understandable given previous bad experiences with
PFI schemes. But private equity's new interest in delivering value to
society as a whole should enable new forms of
collaboration which deliver both value for money to service providers
and long-term stable returns to investors. Bridging the gulf of
understanding between the public sector/third sector and private
equity would enable much-needed capital to flow into key sectors such
as city technology and infrastructure.
Encouragingly, the EVCA conference participants agreed that there needs to be a new partnership between the owners of capital and its beneficiaries. But in the final panel of the conference, Sir Brendan Barber reminded everyone what a true partnership should look like. Job creation is great, but the quality of jobs matters as much as the quantity: returns for investors should no longer come at the cost of depressed wages for workers. And opaque corporate structures that enable owners to make unilateral decisions affecting the jobs and livelihoods of thousands have to become a thing of the past. In the new partnership model, all stakeholders should have a voice.
Private equity's new-found interest in delivering economic growth and jobs must be far more than an image makeover. There need to be some fundamental changes in attitude and behaviour. The aim of investment should be to benefit all stakeholders in society, not just a lucky few, and bring prosperity to the whole economy.