What's your opinion about all the hoopla surrounding private equity lately?
—Dev Patel, Chicago
We think it looks a lot like a movie we’ve seen before, from its exciting action scenes to its scary parts, to its larger-than-life heroes and their headline-grabbing foes.
It even seems like this movie is going to have the same ending. It will be a contentious climax and a swift resolution that leaves a few people disappointed but most people feeling like they got their money’s worth at the show.
In other words, we think the controversy surrounding private equity today is pretty darn similar to the clamour that accompanied what was called the leveraged buyout or LBO movement in the late 1980s. And that resemblance can only tell us one thing:
that capitalism is working, with its cycles and ever-increasing competitiveness.
WINNING: Jack and Suzy Welch
So, to answer your question, we think the hoopla is just hoopla. When the industry eventually cools off, most people will see the latest run of private equity for what it was, a galvanizing mechanism that made several thousand companies more productive and made the US economy more competitive than ever.
Now, that conclusion might not sound surprising from us, given our typical pro-business stance and the fact that Jack spent the 1980s involved in dozens of leveraged buyouts.
But our view on private equity today also grows out of more current participation. Over the past six years, Jack has worked with Clayton, Dubilier & Rice, one of the oldest private equity firms in the world. That experience has confirmed for us why private equity deserves not the disdain you sometimes hear, but appreciation, as well.
Private equity almost always creates thriving businesses. It makes a company’s vision clear and its goals measurable. It tightly aligns goals with compensation systems. It creates an exciting ownership mentality, unleashing renewed passion from employees. And it does all those things fast.
We’re often asked: “What’s so special about that? Can’t regular companies do all the same things?” Some do, of course, but too many do not, and the reasons are myriad, including entrenched management, inertia, fear of change, bond rating concerns and neglect, which is most often “imposed” on orphaned businesses.
Left to their own devices, too many companies also fail to install the kind of governance you find in private equity firms. There, owners and managers have real skin in the game and they take the place of directors who fly in every other month to maintain the status quo.
In the private equity environment, board meetings centre not on questions such as, “Has anything happened to embarrass us lately?” but on comments along the lines of, “Let's find every opportunity for growth” and “Forget the quarter. Make the investment.” Put it all together, and no wonder private equity makes companies so competitive.
Yes, that competitiveness has, in turn, made some high-profile entrepreneurs very rich, like Stephen Schwarzman, whose Blackstone IPO made billionaires out of, well, founders. But private equity has also been responsible for widespread wealth creation, with the pension funds of teachers unions and all types of employees in the public and private sectors as major beneficiaries.
Indeed, private equity has done more to enhance the security of retirement funds than most other kinds of investment. The winners: not only several thousand bankers, but millions of ordinary workers.
And, yet, the debate over private equity continues to intensify.
Witness the recent call for an increase in the industry’s tax rates. Incidentally, that’s a repeat scene, too—in the late 1980s, Congress imposed a levy on corporate pension fund withdrawals that were being used to fund LBOs.
Whether or not tax legislation is passed in the US, the private equity cycle will play out. Look, private equity thrives when businesses, underperforming for whatever reason, can be bought at attractive prices with low-cost money. Inevitably, though, those kind of deals start to dry up. That’s what happened last time around.
With EBITDA multiples (that is, earnings before interest, taxes, depreciation and amortization) climbing from 5-6-7-8-9 and credit getting more expensive and restrictive by the day, private equity firms nevertheless continued buying less-promising companies at a premium. The poster child for this dangerous dynamic was Federated Department Stores, which declared bankruptcy in 1990.
Today, a property available at a single-digit EBITDA would be a rare and wondrous sight. That’s why, perhaps, so many are beginning to suggest that the private equity heat wave is starting to cool.
That’s not a bad thing. It’s natural.
In the near future, credit will undoubtedly tighten, activity will slow and there will probably be our own era’s version of a Federated or two. But the $13 trillion (Rs 533 trillion) US economy, more competitive and resilient than ever—thanks in part to private equity itself—can handle what comes.
And when this movie reaches its conclusion, you can be sure most people will be looking forward to a sequel.
Write to Jack and Suzy:
Jack and Suzy are eager to hear about your career dilemmas and challenges at work, and look forward to answering some of your questions in future columns. Jack and Suzy Welch are the authors of the international best-seller, ‘Winning’. Campaign readers can email them questions at winning @livemint.com. Please include your name, occupation and city. Only select questions will be answered.