A recent Financial Times article on the woes of private equity in an era of high interest rates contains many ironically coded admissions against interest. Before we get to the industry’s clever new gimmick, that of dumping companies on the big new fools, here their employees, we’ll look at some of the conversations about oh how hard it is to be a private king when the Fed is no longer behind.
The reason for opening the canard is that private equity funds cannot sell companies that:
High interest rates and sluggish new listing markets have made it difficult to sell holdings and return money to investors. That has made it more difficult to raise new funds because pension funds, endowments and family offices have less capital to allocate and a growing array of other options.
The people who use these funds and their investors probably know how to invest. The first rule of finance is that all problems can be solved by price. The problem here is not that these companies cannot be sold, but that their private managers do not like the prices they can fetch.
A related issue, which may not be visible to many readers, is that large private investors such as public pension funds, have historically expected and had private funds that have succeeded in returning funds to them quickly, in a historical period of only about 4- 5 years between the time it takes to invest and the incentive of a private company of sales to sell a decent part of the goods purchased at the mark of 4-5 years to facilitate the collection of new funds. These investors need their money to be in business. So when they get distributions, they need to reinvest, and since almost all of them have private equity holdings that are going up and up, the money needs to go back to private equity funds on a large scale.
Money tied up in old deals is not good for the economics of the industry. Private equity fund managers receive high management fees in the early years of their investments to reward them for all that work buying companies. They also raise huge amounts of money to buy high-profile Wall Street firms that house children for jobs, as well as financing costs to consolidate debt. Hence the enthusiasm for a new way to launch, or at least unload, those companies that no one will buy at the price their private equity managers want to see. And from the article:
Another way to say that the pressure is starting to bite is the recent announcement by Blackstone, the largest and most well-known PE firm, that it has launched a “shared ownership plan” to give employees in their portfolio companies a share of equity. The plan will start at Copeland, which Blackstone bought for $14bn last year. When the climate control group is finally sold, its 18,000 employees will receive a payout commensurate with the PE firm’s profits from the deal….
Ownership Works has helped organize workforce sharing schemes worth around $400mn in 88 companies and aims for $20bn over ten years.
For private companies struggling to attract new investors, these programs have many attractions. First, they allow PE sponsors to argue that they help address social inequality…
Such claims are likely to resonate with investors concerned about the role of PE in directing most of the profits from productivity gains to investors rather than workers over the past few decades.
Ahem. For those who have followed the issue of increasing wealth to the top, the way to share the benefits of the profit of production with the workers is with higher wages, not by giving them less salary than they should get and giving them equity or equity chits in the equation. more than the fair market value of the business.
Granted, employee ownership can be more motivating and productive when employees truly own the company, instead of just along for the ride, as is the case here. But even so, programs that promote share ownership may warn that they may represent a risk to the financial health of employee-investors. They have been very exposed to the fate of the company because of working there. If there is a disaster, such as an explosion at the main factory, its employees may be deprived of large wages or lose their jobs. Having some or most of their capital tied up in the company increases their exposure.
The article then turns to a discussion of how private firms can better adapt to lean living in the current high interest rate environment:
High interest rates have dramatically changed the game for the private sector, forcing a rethink of how they do business. Between 2010 and 2021, lending accounted for half of all PE operations, according to StepStone experts….
Using less leverage, private equity firms must find other ways to deliver strong returns, as investors seek better results because the relative risk-free rate is so high. “Moving forward we have to do things differently,” said McKinsey senior partner Amit Garg. “The question is how.”
The obvious form of sustainable profit is operational changes that increase revenue, reduce costs or both. PE firms have always said they are doing this, but the power has made some of them less active than they could be.
This would be laughable except for the fact that private equity has done a lot of damage by pretending to have a better management mousetrap but for the most part it’s just being smart about predatory companies not driving too many into the hole.
I expect some in the nut gallery will argue, as we have, that private equity seems to bring improved results working with smaller deal-sized companies, which are often bought with less debt than larger acquisitions. However, insiders pointed out that this does not mean that the Department of Private Tenders has led to efficient operations. Instead, they argue that some private equity buyers are good at spotting “growth” companies, well-positioned players in sectors that are slated to underperform, and buy them at good prices.
Consider this paragraph a little later in the article:
Tried and true methods include better management. Some PE firms focus on new hires for the newly acquired portfolio company’s board and management team. Others retain full-time in-house staff who provide services to multiple companies. A third way is to recruit a list of experienced managers to advise the company’s leaders.
At Goldman Sachs’ private equity division, “value accelerator” experts provide advice on everything from selecting the right headhunters and consultants to developing IT platforms and redesigning management processes.
Help me. These “tried and true methods” have been around for decades yet the story effectively admits that they don’t bring the desired benefits. The author does not know or agree that those “in-house consultants” like KKR Capstone are another way to extract fees from a private equity firm. Those services are billed to the portfolio company and the consultant/accelerator company is another profit center in the private company empire.
It was interesting to see that many of the comments on the article were critical of private equity. This is a big departure from a few years ago, when skeptics (including Financial Times journalists) would be described as jealous haters. Some examples to choose from:
AKA alias
It is sad that the same institutional investors who complain about ESG, are all in private equity, despite their bad history of ruining the long-term prospects of firms through the use of high power and one-sided management plans, increasing market concentration in the US health sector. and elsewhere, reducing the quality of service for the elderly in nursing homes and low-income tenants, and other vulnerable and less-afflicted sections of society, treating their employees poorly, and increasing wealth and income inequality, in part through the use of special tax breaks earned and maintained. through powerful “persuasion”, otherwise known as corruption of the political process.Despite this record, the sacred institutions that seek to “do good while doing good” with ESG devote a large amount of their portfolios to investments that have a negative impact on society, undermine good and transparent corporate governance, and contribute to the corruption of national governments.
Thomas Rainsborough
The PE industry has a small group of intractable problems.Overshared, property owners who have done this are performance chasers from the era of zero rates who will get the kind of returns that performance chasers often get. And now they are too big to enter the exit markets, interest rates have normalized and are returning to what PE is, falling. Passive investing has reduced the active cash flow in the public markets so IPO markets are not repeated and PE is seen as a bad seller given its history of listing duds. Real companies with shareholders do not like to buy from them because they are considered poor owners who absorb future value. PE holding values based on listed comps are chimera. So they played a package between them and a couple of great LPs. That’s what happens.
a parasol
Great, so they can’t even sell cr!p now and present it to the workers, no doubt in lieu of wages…Maybe the workers’ families can eat the shares they are given?
It is strikingly similar to the fall of the Soviet Union, where workers were given goods from the factories they worked in, rather than cash to buy food. So the workers had to sell their produce on the street to support themselves.
Shawn Corey Carter
The ‘resale’ of PE, allowing moms+ pops to finally be allowed into the party with affordable financing and IPOs of PE houses (sorry, I mean “Asset Managers”) is a strong sign that things are about to go downhill for joe. in society being the last one holding the bag after everyone has long since disappeared with their (our) money.Yes the early stage investors will be burned, but so will the jobs of hundreds of thousands who are part of the machine as a wage slave, but who don’t really benefit from the machine.
One student expressed doubt that any buyer would be interested in buying a company with significant employee ownership. Answer:
A horse
I work for a PE backed company with one of these programs and you will be happy to hear that they give us zero control over anything.
So one of the opposites of the Fed’s bleak thinking about inflation is that it is not well positioned to control the collateral damage done to private stocks. But the industry went through a period of stagnation after the foreclosure crisis of the late 1980s (luckily for them, overshadowed by the S&L crisis) and came back. So while we can hope that the industry will be reduced in size, like kudzu, it is also possible, like lamprey eels, to come back with a vengeance.
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