Its name strikes fear. Its opponents claim it decimates jobs. Does ‘vulture capitalism’ just get a bad press?
The reasons that Mitt Romney suffered such an unexpectedly crushing defeat in last year’s US election are myriad and complex. But there’s little doubt his lengthy career at Bain Capital was among the most toxic factors. It seems that, in the court of US public opinion, it is better to be an apologist for the gun industry or a proven adulterer, like other presidential nominees, than to have the words “private equity” on your CV.
Romney was derided by Barack Obama, who called him a “pioneer of outsourcing” and Republican rivals (the Texas governor Rick Perry slammed his involvement in “vulture capitalism”, while Newt Gingrich said he had “looted” companies and “broken families”).
It was another blow for an industry that is among the most criticised of financial services: only 5 per cent of private equity investors surveyed by the European Private Equity and Venture Capital Association thought it had a positive image. But private equity isn’t going away – in fact, every sign points to it regrouping in 2013, with increased investment, huge deals in the pipeline and a growing recognition of the importance of HR.
Private equity (PE) works by creating “ leveraged buyouts” of businesses which have the potential to grow (or reduce costs) quickly. It differs from other investments because the acquired company’s debts are used to finance the deal or, as author Josh Kosman put it in The Buyout of America: “Imagine a homebuyer purchasing a house and making the bank responsible for repaying its own loan.” PE firms make their money by charging a fee for their management expertise and taking a slice of the eventual sale.
At the height of the pre-recession boom, it was possible to load a company with debt, reduce its cost base (most commonly its workforce) and find a willing buyer in little more than a year or two, a strategy known in typically robust Wall Street parlance as “buy it, strip it, flip it”. But in a struggling economy, the only real way to profit is to build a longer-term, viable business. As Simon Gough, director of specialist employment agency Interim Partners, says: “The days when they came in and stripped a company for quick profits are gone.”
If you thought this was a niche concern, think again. Three million people in the UK, 16 per cent of the private sector workforce, are employed by businesses which are partly or wholly owned by PE. It takes in everything from Boots (the largest PE buyout in the UK at £11bn) to the company that owns and runs Formula One racing. CVC Capital, the country’s largest PE firm, has around £29bn worth of assets under management.
The sector took a predictable battering during the credit crunch, but is bouncing back decisively: PE firms spent £566m in February 2013, up from £191m a year earlier. Last year’s largest purchase, of developer Annington Homes, came in at a healthy £3.2bn.
That ought to auger well for the wider economy, but it isn’t hard to find Romney-esque horror stories, such as the fate that befell Birds Eye, which closed its Hull factory at a cost of 600 jobs within six months of being taken over by Permira in 2006.
And then there’s EMI, bought by Terra Firma in 2007 for £4.2bn, 60 per cent of it debt. Singer Lily Allen, not a noted financial commentator, predicted of her new bosses: “They don’t know what they’re doing. They will fail.” Two thousand jobs were cut in 2008, lender Citigroup took control of the business and by the time it was sold in 2012 the bank had written off £2.2bn and the PE firm £1.7bn.
While Mike Wright, professor of entrepreneurship at Imperial College Business School, acknowledges such disasters, he feels many of the common criticisms of PE come from those with an axe to grind: “There have always been some deals that have been about exiting quickly, but it’s only ever a minority. Some of the negative effects being described are often based on anecdotal cases, and the talk of cutting jobs may in fact be a necessary reorganisation.”
If the businesses were healthy, Wright points out, they wouldn’t be up for sale. And his research shows PE may not be such a bad steward: reviewing 49 studies, he and his co-authors found job losses among PE-owned companies were no greater than the industry norm. Though wages tended to grow more slowly, the best firms valued HR and respected employment rights.
Investing in HR is part of the new economic climate for PE firms. Their returns hover at around 6 per cent a year, half the level of six years ago. “The leverage game is much harder to play now,” says Andrew Campbell, director of the Strategic Management Centre at Ashridge Business School. “PE firms are having to focus on improving businesses. They prefer companies where management and leadership can make a big difference.
“In order to perform, the top team often has to make big changes, which can be tough for a lot of people either because they lose their jobs, have to commit to new contracts or have to work extra hard. But there’s no advantage in slashing and burning or upsetting the staff unless it is likely to result in better long-term performance.”
Gough says firms see value in bringing in an “HR heavyweight” who can help them get more from their existing workforce without cutting corners, and usher in more professional people practices. “HR is being used for positive purposes, to grow the business and create a partnership,” he says, with firms employing an HR director to take a view right across their portfolio, actively manage the most troubled companies and judge the capabilities of management teams. Though they might only have 20 staff at head office, the biggest PE firms employ hundreds of thousands through their acquisitions.
Good HR also has a vital role to play at the point of acquisition, says Wright, “to explain what’s going on”. Employees may be unaware of what private equity is, or may be fearful of its negative connotations. Strong HR leaders can show PE firms the value of investing in staff, helping curtail their worst excesses by being part of a longer-term commitment to growth.
But if it sounds like the industry has had a cuddly makeover, there are clouds on the horizon. When the economy rebounds, and short-term profits are feasible, firms may forget their promises and look for a quick exit. Already, levels of debt in deals are creeping back to pre-2007 levels. The Bank of England is afraid that many of the PE deals made at the height of the crash may run out of cash in the next couple of years. Still, the juggernaut rolls on: Romney, for instance, is back in private equity, working for his son’s US firm.
Gone to the dark side - part or fully-owned by private equity firms
Agent Provocateur
Boots
Burger King
Center Parcs
Cineworld
Del Monte
ghd
Merlin Entertainments
Miller Group
New Look
Toys R Us
Virgin Active
Securitas
Weetabix
Comeback trail - European PE deals by value
2006 - €929bn
2007 – €1,113bn
2008 - €681bn
2009 - €332bn
2010 - €483bn
2011 - €519bn
2012 - €530bn