Ethical Performance
inside intelligence for responsible business


private equity is discovering that it too needs a licence to operate

February 2007

Private equity firms never tire of boasting of the stellar returns their backers enjoy. Gone are the days when private equity meant venture capital for cash-starved start-ups. Big companies are now within its sights, the latest being the French media group Vivendi, which last month rejected a €40billion (£27bn, $52bn) bid from the US private equity group Kohlberg Kravis Roberts.

But success invites scrutiny (see page nine). With 19 per cent of the UK private sector workforce employed by private-equity-controlled companies, and FTSE 100 companies being targeted, the curiosity is understandable. When a private equity figure like Roberto Quarta says the industry needs to safeguard its licence to operate, it's clear that keeping shareholders happy is no longer enough.

The reputational challenges now facing the industry are of its own making. Focused on its shareholders, it has largely ignored its wider responsibilities. Posh dinners in the City in aid of worthy causes can't gloss over the huge profits made by a few. Crucially, proposals to widen the reporting requirements for public companies to include private equity firms have been deflected. An air of arrogance hangs over private equity.

Private equity must become less secretive. Private equity firms are extremely sensitive to risk. Due diligence is invariably very thorough. The social and environmental information relevant to a target's performance is collected, but remains within a small circle. Greater transparency is needed, within the bounds of commercial confidentiality.

'Strip and flip' merchants have given the impression that private equity is for the short term. Yet the expected hold period for a private equity investment is a respectable three to five years, providing opportunities for stewardship. Pension funds are the single biggest capital contributor to private equity. This has implications for their trustees and for government agencies.

Private equity also provides venture capital to clean-technology firms developing answers to environmental problems. It is a major backer of wind power and solar energy, for example. Other areas are more controversial. The sector claims it is a net job creator, though its restructuring plans can initially lead to job losses. One study found a 5.4 per cent annual rise in jobs between 2000 and 2004 in firms controlled by private equity groups - eight times the growth rate in the EU.

Right now, public companies feel disadvantaged by private equity's flexibility and ability to align the interests of managers and shareholders. But the boot could soon be on the other foot. Private equity may find managing pressure groups and regulators even trickier than keeping an eye on debt spreads.


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