Benjamin Franklin said: “It takes many good deeds to build a good reputation, and only one bad one to lose it.” There is truth in this for the private equity industry; much of its socially valuable contributions go largely unnoticed while its missteps are widely publicised and serve to tarnish the sector’s reputation. One need look no further than the Financial Times or The Telegraph (two publications not known for their hostility to free enterprise) to see regular criticism of private equity and the way it does business, especially its leveraged approach to buy-outs.
A recent Due Diligence column in the FT is a classic of the genre, setting out the regular critique of private equity in a discussion of the potential sale of The AA: “they buy companies, leverage them up, pay themselves juicy dividends and leave their targets over-indebted and far too vulnerable to the slightest shock, with little room for error.” Despite this somewhat crude account of private equity business practices, it has had cut through into the political sphere – although more so in the US than the UK. But where the US goes, the UK quickly follows.
In the United States, Senator and former presidential hopeful Elizabeth Warren last year set out her Stop Wall Street Looting Act 2019, which squarely took aim at the private equity sector and many of its business practices. Included in the Act were 100% taxes on monitoring and transaction fees and bans on dividends for two years after a transaction, as well as forcing PE funds to share responsibility and liability for a target company’s debt and closing loopholes on carried interest. While the Act was not passed into law, the fact a serious presidential candidate proposed an all-out assault on the private equity industry demonstrates the strength of feeling with US politics.
In the UK, there has been little criticism of private equity from mainstream politicians, but Covid-19 and the increased scrutiny of businesses that will accompany the economic recovery could change this. In February of this year, criticism of private equity came from an unlikely source in the form of Guy Hands, founder of Terra Firma. Speaking at a conference on alternative investments, Hands claimed the industry was too insular and said that rather than caring about improving companies and creating jobs, instead “We tended to only talk about ourselves – the funds we raised and the pay cheques received.”
One might think if private equity has friends like these, who needs enemies? Fortunately for the sector, it does not have any high profile political detractors in the UK, yet, and crucially, private equity does have some friends within government. When it emerged that private equity-backed firms would be excluded from the CBILS and CLBILS schemes because their leveraged financial structures meant they fell foul of EU state aid rules, HM Treasury lobbied hard for exemptions for private equity-backed firms. Despite the Treasury being largely unsuccessful (exemptions were granted for smaller firms), its efforts show there are those in government who understand the value of private equity to the economy.
To a large extent, private equity’s wider reputation problem is the result of availability bias. People, including politicians and policymakers, have a tendency to think that issues that come easily to mind occur more frequently than they do in reality. Private equity only makes it into the mainstream news following a high-profile business failure (often a distressed asset to begin with), while its successes are buried in trade publications or celebrated at industry awards evenings. As such, when influential people from outside the world of private equity come to form their views, they are much more likely to take a dim view of the sector as these negative stories come to mind much more easily.
Fortunately, private equity still has the opportunity to change this perception. With a significant number of businesses requiring injections of equity, and private equity sitting on a large amount of dry powder, the industry can play a key role in ensuring that many businesses can survive the downturn and become profitable once again. However, there is a risk this type of action could be branded as ‘vulture capitalism’ with private equity firms charged with sweeping up assets when they have no choice but to sell.
To mitigate this risk and demonstrate the value of private equity to the wider economy, private equity needs to make its case to government that it is a force for good. At a fundamental level, this would involve making clear to MPs and those within government what private equity brings to the table and the motivations behind its business model. Beyond this, the industry should explain to decisionmakers the vital contribution private equity has made to economic growth and building British businesses, and that the sector is responsible for the employment of millions of people. As the economic crisis begins to bite, private equity can use its resources and position to recalibrate its reputation. But it will have to do this quickly; a failure to get on the front foot is only likely to result in a solidifying of the sector’s already mixed reputation.