Private equity. A means of giving companies access to major resources to fund growth and plan succession or the unregulated, parasitic face of the worst excesses of modern elitist capitalism?
The truth probably lies somewhere in between. Much of the concern in legislative circles is that when a company becomes embroiled in a PE deal, the debt is loaded onto the company as part of the leveraged buyout rather than the investors. Risk is over loaded onto one side while the rewards are perceived to be loaded on the other.
When markets mature or disruptors emerge to change the dynamics, servicing the debt loaded onto the business as part of the leveraged buyout prevent it from making the investments necessary to adapt. Sales fall but the buy-out debt must be serviced, plunging companies into losses that become unsustainable and failure often follows.
The controversy surrounding private equity deals arises in the “2-20” fee structure imposed on the newly acquired company and the ability of investors to leverage further loans against the acquired company to pay dividends to shareholders of the private equity firm.
The former means that should an acquired company be a great success, the private equity business takes a 2% management fee and 20% performance fee on money generated. If the acquired company fails the 2% management fee on the money being managed still stands regardless. With almost $6 trillion in assets under management, that is a lot of guaranteed revenue.
The latter is a process by which private equity firms purchase a company, load it with debt, leverage additional loans against the company for annual dividend purposes, and enjoy the beneficial tax breaks of dividends payments versus traditional revenue streams. The acquired company, however, remains on the hook for the debt which, along with fee payments, depresses profit margins and can lead to large scale corporate collapse.
When the main protagonists in the private equity field are wealthy individuals and institutional investors, the perception that PE deals are a case of the rich eating the poor is hard to shake. When Toys “R” Us crumbled until the weight of its $5 billion debt built after the takeover by Bain, KKR and other leading private equity companies, more than 30,000 jobs were lost. While the value of their initial stake was wiped out, it was negated by hundreds of millions in fees and charges taken during their period of ownership.
But private equity deals do facilitate positive change. They focus on efficiency improvements, aggressive profit generation and ambitious growth plans. Access to capital and resources allows companies to pursue strategies they would otherwise be locked out of.
But how does the private equity modus operandi of loading debt onto the acquired company affect overall business valuation? For every highly publicised failure such as Toys “R” Us or RadioShack, there are a wealth of smaller deals that have borne fruit under the control of private equity investment.
Ludlow Wealth Management Group – the North West advisory business is about to be sold to Mattioli Woods Plc as part of the latter’s expansive M&A strategy.
Mobeous, the current PE investor, funded an ambitious MBO just four years ago and refinanced/funded the continued growth within Ludlow under a new CEO. The results have been impressive with growth of more than 50% over the past 2 years, year after year of more than 25% profit margins and a trebling of profit / earning valuation.
The sale of Ludlow is reported to be around £36m, which is a significant premium on the “book” value of the business.
Circet – Advent International is in negotiation to sell its stake in the French telecoms infrastructure giant with many of the company’s current managers looking to increase their share.
Advent joined forces with Circet in early 2018 and the relationship has seen a sustained increased in performance. Revenue has almost trebled and, according to Plimsoll’s latest analysis of the business, the valuation of the company has followed suit.
The partnership between private equity has allowed Circet the resources required to expand outside of the French market and pursue a more international strategy.
The relationship between Chryso and Cinven started in June 2017 has seen the company grow through international expansion and a “buy and build” M&A strategy. The financial results have been significant, with year-on-year sales growth and a 25% increase in the overall value of the business in that time, according to Plimsoll’s latest analysis.
Cinven’s involvement in the business has seen significant investment in R&D and implementation of best practice that have left behind a strong proposition that attracted such a major company in Saint-Gobain.
These are just three examples of how the private equity revolution does add value further down the corporate food chain. While there are well-publicised instances of corporate failure linked to private equity such as Toys “R” Us, deals of this sort give smaller companies access to resources otherwise out of their reach. In many cases, private equity has helped companies of all sizes across industries to achieve unprecedented expansion and improvement.
Plimsoll specialises in completing valuations and performance analysis on companies. If you are considering private equity investment as a means of advancing your own company’s growth and improvement ambitions, make sure you have an in-depth understanding of where you sit in your own markets and the position you are starting from.
For more information about Plimsoll and how we can help you, please visit our dedicated site.