Private Equity – an often necessary motor for change

06 Oct
06/10/2016

As a matter of definition, Private Equity is equity and related investment into private companies not listed on the stock exchange. Its timeframe is medium- to long-term in nature and characterized by active ownership. Hence it endeavors to build better businesses by strengthening management expertise, delivering operational improvements, promoting innovation and helping companies to access new markets. Private Equity is an overall term covering the whole life cycle of companies from Venture Capital in start-up companies, growth financing, Management Buy-outs/-ins (MBO/MBI) to investing in distressed situations (e.g. turnaround). Mostly it is defined to include infrastructure investment in renewable energy, airports, roads, rail, water, PPPs, etc. additionally.

Private Equity investment has a significant role in the economy. Institutional investors such as pension funds and insurers supply Private Equity with capital, which Private Equity managers invest in portfolio companies. The returns from these investments are used by the institutional investors to meet their long-term liabilities. In these times of low yields, Private Equity’s importance in order to sustain e.g. the pension system has only increased. In this regard, Private Equity investors are guardians for other peoples’ money, seeing to that the funds are put to work and harvest returns significantly above the level of inflation.

But, Private Equity as a sector is a misunderstood and often underestimated source of change in the economy. Often the immediate perception of quick greed simply comes in the way. The Private Equity sector should address this perception more actively through how it conducts daily business and demystify itself through e.g. more transparency. The prevailing negative image of Private Equity (locusts/”Heuschrecken”-debate) is very unfortunate and bad for business.

But look closer and another image emerges of the Private Equity industry. First of all, it is huge. Overall, there is according to Invest Europe (former EVCA) EUR 564 bn capital under management in the European Private Equity market alone, managed by 2’029 eligible Private Equity firms. Since 2007, European Private Equity has backed in excess of 21’000 portfolio companies, to the tune of more than EUR 271 bn. Now that’s a force for change.

Secondly, as indicated above, what is particularly interesting is that Private Equity is completed by professional investment companies through highly specialized experts in a serial manner. It becomes an institutionalized way of private ownership, where there is a co-ownership between Private Equity investors, founders, portfolio companies’ managers and often previous owners. It’s like a financial marriage for a certain time span. Thereby, they inject not only capital in a serious way, but dynamism, innovation and expertise into the companies they invest and hence indirectly into the economy.

That is something the world needs more of in many settings. Why?

Because exactly these investors fulfil many important functions in capitalism that others can’t or don’t want to fulfil. They:

  • Develop companies in a very devout manner and need to commit much time to that process, something most owners (at least, when they are not themselves active in the company) do not have
  • Use their experience in a serial manner and should hence be able to provide better input to the companies they own
  • Leverage their networks for their portfolio companies
  • Own companies that no-one else right now wants to own (bridging function)
  • Develop companies in a more targeted manner
  • Own assets for a certain period, until realization (exit), which does not need to be endless. That means they can bridge ownership periods. This also according to the credo: “Own something when you can use/own it best”, but get out when your contribution is done. This contributes to efficiency and productivity
  • Align the interests and incentives of the different stakeholders to a larger extent (especially owners and managers) than what is the case in publicly traded companies
  • Invest in highly risky companies and technologies that no others understand or are willing to develop or save (start-ups or companies in downward spirals with huge losses)
  • Provide innovative financing solutions

Overall, the Private Equity sector creates huge values for and hence wealth to society. So as an example a revealing study from Invest Europe showed in 2013 that Private Equity-backed companies account for less than 6% of total private sector employment in Europe, yet they account for up to 12% of all industrial innovation, while their spending on research and development (R&D) accounts for 8% of all industrial spending on R&D. There were other equally important relative indicators of the sector’s performance in terms of its effects on productivity, competitiveness, profitability, job creation, etc. This wealth creation is good and desirable, since it assists us in solving (other) societal problems. We need more of this highly conscious ownership.

How should you as an entrepreneur approach the Private Equity sector? We have extensive contacts to the Private Equity industry and know how to best work with their investment teams, so they can solve challenges you might have. Talk to us! Because, Private Equity is a viable alternative.

 

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