Off message: In defence of private equity

‘Private’ and ‘equity’ are two words that can make the sternest person turn away in confusion, boredom or sheer disgust. But if I can describe it in terms of ‘Hollywood superstars’ and ‘sex in unusual places’, will you read on?

Around one in five people in the UK now works for a company owned by a private equity firm. In Europe last year, private equity deals amounted to £118bn, up 41% on 2005. This means a lot of companies are suddenly moving from public ownership on the stock market into the clutches of private equity, which the Transport and General Workers’ Union recently summed up as “a dangerous form of ownership based on debt and extraction of wealth at the expense of good management, jobs and the welfare of employees”.

Sex sells

Back to Hollywood and the sex (sorry for the delay). My favourite way of describing how private equity works is in terms of the film Pretty Woman. You’ve got Richard Gere (or his character Edward Lewis), who is in town to buy a company, take it to pieces and sell it on for profit. He soon picks up Julia Roberts (Vivian) on Hollywood Boulevard and whisks her off to his hotel where they help the night shift staff by polishing the grand piano in their own unique way.

It turns out he doesn’t care about the company he is about to asset strip – his job is to “screw people for money”. But by the end – under the influence of Vivian and her incredible pout – he chooses to work with the company and “build ships together”.

This is the core of the row over private equity: do firms want to grow the companies they buy or do they just want to take them to bits for personal gain? Have they watched Pretty Woman to the end or did they turn off half way through when Edward was still a rotten piece of work?

Detractors cry that private equity is in it for nothing more than a smash and grab. One example used is the AA, which gave more than 3,000 staff the boot under its new owner Permira. Another complaint is that these companies load themselves with masses of debt – usually five times the original investment – which puts the future of the company in doubt. There’s also no tax on money used to make interest payments on the debt, which saves investors millions but is said to be unfair to other businesses that can’t use this perk.

Finally, because private equity firms don’t have to answer to shareholders, there are all sorts of suspicions about murky goings-on behind the scenes.

It’s this final point which is the nub of most of the complaints – a fear of the unknown. But it’s telling that, when it comes to commenting on private equity deals, unions tend only to wheel out the example of the AA time and again. If it’s such an all-consuming evil there should be plenty more examples that spring to mind.

Stiffened resolve

A recent study by the Work Foundation showed that, while a third of private equity firms reduced employment levels, two-thirds actually expanded the number of jobs. The same report found that jobs were generally lost in the first year of private equity ownership, but in the majority of deals staff numbers grew by 36% over six years. The British Venture Capital Association (BCVA) modestly says that in the five years up to 2006, private equity companies increased their worldwide staffing levels by an average of 9% a year – significantly higher than in FTSE 100 companies, which only grew their workforces by 1%. The BVCA adds that its members paid £26bn in taxes for their troubles.

Private equity bosses say their phenomenal successes show how hard they work with management teams to grow businesses, making them run more effectively and efficiently. The Work Foundation found that strict performance measures, regular appraisal and ramped up HR systems are the norm when private equity takes over.

Sometimes jobs have to go, but if this makes the firm more profitable in the long term – and thus able to keep employing people – surely that’s a good thing. And one man’s shareholder accountability is another man’s mire of red tape that is slowing down the success of the company.

Whatever turns you on

The simple fact is private equity can be – and often is – a force for good (the successful clothes retailer New Look and Travelodge hotel chain have both grown staff and are incidentally owned by the same lot as the AA). It’s good for you, too – some of the biggest investors are pension funds.

Of course, the ultra-secretive industry only has itself to blame if paranoia and unease spread about how it makes its immense sums of money. As Vivian points out in Pretty Woman: “The bad stuff is easier to believe.” But they are not all-powerful illuminati-esque types and the way Sainsbury’s sent one of the most powerful private equity consortiums in the world packing is evidence enough of that.

It basically comes down to motive. What do firms want from each deal? To put it another way, are they Gere pre- or post-kerb crawl? I’d have to say in most instances they have that rosy glow that only a hooker with a heart of gold can bring.

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