The reputation of the private equity industry is one that has undergone significant transformation in its relatively short history.
Corporate raiders, vultures and job killers are all terms to have haunted the industry, but was this ever a fair or accurate depiction? Or did private equity actually create jobs and, more importantly, better manage companies that contributed the US economy?
The Private Equity Transformation
At its inception around the middle of the 20th Century, private equity firms were known as buyout firms. They rebranded themselves as Leveraged Buyout Firms (LBO Firms) during the debauchery that was the 1980’s, rebranding for a second time into private equity during the 1980’s hangover.
The industry then went through an ironic “Golden Age” in the mid-2000s, when Steve Schwarzman’s lavish and gregarious lifestyle (and birthday party) truly pulled the industry by the collar into the direct spotlight, exposing an industry full of overleveraged deals, cheap debt, and bloated egos. It was uncomfortable for many executives, who were not prepared for the public backlash they got.
When asked who was to blame for this backlash, COO of The Riverside Company, Pam Hendrickson, simply said “us.” Hendrickson remarked that nobody in the industry was expecting to be thrust into the public spotlight and they should have been better prepared for it.
Private Equity Today
Given private equity’s tumultuous past, has the current state of the industry changed, and does its future look promising? Luckily, yes. Some of the current trends we’re seeing include:
Middle Market PE Taking the Reins: Mega firms have taken a backseat to the middle market private equity firms in terms of deal volume and deal flow. Mid market firms, with an average minimum of $300 million to approximately $5 billion maximum in funds currently running, are more cautious investors and put significantly less debt into their deals. Pitchbook, an unbiased private equity data provider, found that middle market private equity deals were taking up the majority of deal volume, and they were getting larger in size. In the last few years, many middle market private equity firms were winning deal titles in terms of quantity.
Mega Firms Adjusting to Middle Market: I would be beyond shocked if we would ever see an overleveraged deal again. Large PE firms like TPG, KKR, Carlyle, THL Partners, have built up middle market buyout arms to adjust with the changed deal environment. According to Pitchbook, leverage multiples (how much debt is put in versus equity) have dropped to around 2.5-3:1.
Competition: PE firms have experienced a significant amount of trouble closing deals or even finding companies at the right value. It’s hard to compete against strategic buyers (conglomerates) that are rich with cash to pay off debts, and have short-term synergy opportunities to help the target company easily fit into the their product portfolio. Deal prices get driven up, and with many conglomerates hiring PE executives to run their buyout arms, sourcing deals has become a lot more difficult.
LPs In Control Again: Many PE funds expired in 2012, and many more will expire within the next few years. Firms are going out and fundraising for new deals, but limited partners are now more likely to tighten the deal terms on the funds (both performance-wise and management fee-wise). You see stories like KKR, Carlyle, and Bain Capital offering varied deal fee prices to satisfy their investors. But of course, above all, performance will be king.
SEC Registration: Last year, PE firms managing $150 million and above were required to register with the SEC. While there was a lot of paperwork involved, private equity now has the SEC to help keep itself in check. Despite some grumblings, this is overall very good for the industry, which has struggled to educate the public about its influence with companies in their everyday lives. Prior to SEC registration there was a sense of internal ethics with bad deals (or dividend recaps gone bad), but the SEC should help clean up any future messes, if and when they happen.
The Future of Private Equity
The current state of the industry is all well and good, but we need this to be consistent if the industry is to become more respected, like the way the venture capital industry has inserted itself into the public spotlight. The future will probably involve:
SEC Tightening Up On PE: The SEC has openly declared that they will be looking more closely into private equity’s practices this year. If the industry continues to work on cautious, smarter deals, it shouldn’t need to worry about any upcoming probes.
PE Back In Politics: We are hearing rumors that some key US-based executives are considering careers in politics. Gabriel Gomez just resigned from his post at Advent International and has launched a campaign for the open Senate seat in Massachusetts (recently vacated with John Kerry’s departure), and GTCR’s Bruce Rauner is seriously considering running for Governor of Illinois. Both Gomez and Rauner have previously worked with the Democrats (Rauner is an advisor to Rahm Emmanuel), so they may get a better chance in the political spotlight than Mitt Romney.
Advocacy Groups Working Harder: While the PEGCC is working on the carried interest tax debate, an advocacy group known as the Association for Corporate Growth (ACG) has been collating data on privately-backed companies vs. others within every state and district in the U.S. Moreover, they have been educating Congress about the PE industry.
While these predictions are a positive sign for the future, I truly believe that the private equity industry still needs a complete rebranding. The industry has transitioned from buying majority stakes in companies, to providing expansion capital to rising stars within various industries and sectors. The PE industry therefore needs to start referring to itself as supporters of “growth capital.” In addition, the industry also needs to hold itself accountable for its past failures, if it is ever to paint a new picture of the PE industry.