Private equity acquired an unfavourable public reputation during the years preceding the 2008 financial crash. Critics indicted private equity houses for overleveraging distressed companies, stripping their assets and generating huge returns at the expense of company employees. Such practices may have been common among a small group of specialist houses only, yet this bad reputation is commonly held of the wider private equity community. Private equity (which typically hold investments in portfolio companies for 4–5 years) was commonly viewed as an investor class indistinguishable from hedge funds (which concentrate on speculative investments with a 6–18 month time horizon).
The RSM Tenon Private Equity report comprises a series of interviews with a range of UK based mid-market houses with the clear aim of providing them with a shop window to restore
their proper profile in the post-crisis period. Rather than emphasising financial engineering for shortterm gain, private equity firms are focusing on long-term growth. In the wake of the global credit crisis, private equity firms are shifting from large, highly leveraged deals to midmarket transactions with a sensible balance of debt and equity to promote sustainable growth.
The key themes of RSM Tenon’s Private Equity Report are summarised below.
Private Equity and Growth Capital
For companies seeking growth capital, private equity firms fill the void left by the contraction of bank credit. Since the Lehman collapse, private equity deals typically involve 60 percent
equity and 40 percent debt. As their equity shares have risen, private equity firms are devoting greater attention to value creation via longterm sustainable growth. To that end, private equity firms are playing a growing role in the merger and acquisition activities of portfolio companies. For example, Sovereign Capital provides serial funding to support the “buy and build” growth strategies of companies situated in markets undergoing consolidation.
According to Sovereign’s Andrew Hayden, private equity firms bolster the M & A capacity of resource constrained companies:
Historically a lot of acquisitions have faltered or failed to happen because the owner-manager who wants to make an acquisition is diverted from their business by the process. A private equity house will take that strain away by handling the M & A and corporate finance. With private equity, companies also have the financial firepower to be more opportunistic.
Bobby Hashemi of Risk Capital Partners echoes this view, noting the readiness of private equity to perform due diligence of investment targets and to impart strategic and analytical rigor to the acquisition process:
A rigorous conversation about possible investment in itself invigorates a company by getting the directors thinking. Private equity wakes a company up, lifts their game–there’s the discipline of the accounts being prepared at the right time, of having board meetings to talk about strategy.
Private Equity and Owner-Managers
The transformation of private equity involves a reframing of the relationship between private equity firms and owner-managers, who are emotionally and financially vested in their companies and understandably suspicious of an investor class long portrayed as an asset-stripper. As Martin Rowland of Lloyds Development Bank puts it,
We’re asking the owner- manager to give up a degree of control, and for some that feels like selling the family silver.
To build trust, private equity firms must clearly articulate what value portfolio companies can derive from private equity involvement that they could not achieve on their own. “We are not here to kill businesses by imposing unnecessary procedures, and we’re not attempting to corporatise them by adding layers of process. Our emphasis is on capitalising on the ethos which made the business attractive in the first place….To con people and take away their equity isn’t a sustainable model”.
To forge durable partnerships with owner-managers, private equity firms draw on long experience to help companies navigate crises and competitive challenges. Charlie Johnstoneof ECI Partners observes:
One of the understated attributes of private equity is the contacts and experience we can provide – which is additional firepower for companies. We’ve invested in 250 companies in the last thirty years; we’ve seen all the scenarios of crises and opportunity which companies can face. This means we can really help them at their flex points and give them confidence in tough times.
Johnstone emphasises the importance of a proper timeframe for the private equity firm’s exit from the investment. Many owner-managers view “exit” with trepidation, reflecting the common perception of private equity firms as financial engineers pursuing quick liquidations. To counter this view, private equity firms are conveying a clearer understanding of investment timelines and performance expectations. “The four- to five-year investment focuses the mind on delivering projects more quickly than would otherwise happen without the timeframe.”
Private equity professionals concede that they cannot tell their portfolio companies things about the business that enterprise managers do not already know. But private equity firms
can prompt business managers to think about old issues in new ways and to spur change in companies that have become bogged down in day-to-day procedures and reached an impasse
on forward growth. As external shareholder, the private equity investor may be better positioned than the owner-manager to see the strategic direction the company must go to augment shareholder value. Jonathan Gregory of Matrix Private Equity Partners says:
We do not run their business but we guide it; we can see what isn’t right because of our helicopter view.
As external professional investors, private equity firms also provide discipline and clarity to entrepreneurial companies whose resources are dispersed across multiple initiatives.
Shani Zindel of ISIS Equity Partners observes:
Private equity brings focus and ‘crispness’ to a company’s decision making. Entrepreneurs tend to be creative and want to try different things, often at the same time. A private equity house would say, let’s look at those ten ideas and identify which will add the most value to the business with the least risk. That gives you a greater chance of success, and then we move on to the next one.
Having seen many businesses, private equity firms recognise the need to strengthen corporate governance procedures and operational practices at their portfolio companies. But Zindel emphasises the importance of working within the company’s existing culture:
We will talk about the need for professionalism in processes and procedures, but we will not tamper with the culture.
The new paradigm of private equity highlights the role of private equity houses as strategic partners fully vested in the company’s success. As ISIS’s Zandel notes:
The bottom line is that our money is at risk. If it doesn’t work out, we all lose our jobs. If it does, we all win, usually ten times more for management than us, and deservedly so. Private equity can be completely life changing for them. The goal is for everyone to do well out of the investment.
A Summary of RSM Tenon’s Private Equity Report
Steve Brown, Head of Private Equity