How Does Private Equity Ownership Affect Target Businesses?
As mentioned before, the main aim of PE ownership is to increase investment and productivity; hence a good way to evaluate the success of a leveraged buyout would be to look at the number and value of patents issued by target companies compared to non-PE owned companies. It is estimated that in the 5 years building up to 2011, the patents granted by PE backed firms had a market value of €350bn which is roughly 1.5 times the total amount of PE investment in the same time period, this alone suggests that the target company in question should expect to be 50% more wealthy as a result of patent laws alone by the end of a PE firms acquisition (Frontier Economics Limited, 2013). This though does assume that the PE firms pays off the all the debt it initially loaded up the target firm with as debt, being a liability, counts as negative wealth. These figures are corroborated by the European Central Bank; the economists there calculated that between 1991 and 2004, private equity spending accounted for 8% of industrial investment in Europe but 12% of industrial innovation in the same time period. That’s a large progression which is magnified when one considers the other investments PE firms bring, such as technology designed to improve efficiency and allocation of resources (otherwise known as ‘yield management system’). Furthermore, when we combine these figures with the expertise GPs bring to target businesses, the macroeconomic benefits of these leveraged buyout deals become all the more clear, benefits which include increased national income and increased productivity. Regardless though of the impact on the wider economy, this rise in the value of industrial capital raises the value of the company by increasing the long term productivity, which is without doubt a benefit iv . Additional research carried out by the European Central Bank claims (using data) that the ratio ( b ) of the impact of £1 of private equity finance relative to the impact of £1 of industrial research and development on productivity was 2.6 in Europe between 1991 and 2004 (Popov & Roosenboom, 2009). In some sectors of the economy though, like biotechnology, where technological advancement is a far more important factor in determining productivity, the b value was as high as 9. This adds weight to the argument that GPs do actually make profit by providing sustainable impetus to a target firm, instead of the often false notion that they make personal profit by cutting costs (think asset stripping and redundancies). Even with this thought in consideration, one of the main criticisms by the public of private equity firms is their tendency to sell target firms assets to make a quick profit (or more likely to pay off debt) and leave the sick company in long term disarray. There are countless examples I could draw upon, many of them though are reported in such a way that seems to disproportionately demonize the principle of the free market allocation of capital. Why is this? Well, I feel that the main reason is that the (vast majority of the) British public has a desire to righteously maintain a nationalistic sense of decorum. This may sound a bit abstract at first but it is worth considering that many news corporations wouldn’t print stories about banker’s bonuses, asset stripping and tax avoidance unless they knew the public would react to it. Furthermore, none of the listed topics are in any way illegal and they don’t directly impact the average workers way of life (if so, possibly very slightly negatively in some cases, but the detrimental effects are still arguable). The point of my argument here is that there is often a fair amount of unfounded scepticism surrounding asset sales by private equity firms born from its seeming lack of ‘fairness’, yet by analysing the dynamics of such sales, I intend to show that they are for the greater good. I will start by looking at what circumstances would force a GP into selling an asset (for example some freehold property in a hotel chain, take Permira’s acquisition of Travelodge in 2003 (Peston, 2008) for example). To start with, let us accept the premise that the GP would only want to sell to make personal gain, and personal gain here is in the form of profits which are only achievable if the target firm is stronger than it was when it was acquired. Hence, given the market for assets in the UK is as good as ‘free’, the PE firm will sell the asset if it is likely to yield a greater profit by being sold on the free market as opposed to being sold together with the rest of the target company when the PE firm
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