Private equity’s reputation is once again in the spotlight. With the supermarket Morrisons in the industry’s crosshairs, the public memory is reminded of previous scandals involving other household names.
The multi-billion-pound bidding war for a major employer, headquartered in the north of England, has understandably attracted the interest of ministers and opposition politicians sensitive to the electoral implications.
But private equity investment presents a political opportunity for the government, as well as a risk. These mega deals grab the headlines, but they actually represent a minority of private equity deal activity.
The bulk of the industry in the UK — the mid-cap market — operates on a much smaller scale, working to scale up SMEs. In 2020, according to KPMG, the average deal value in the UK mid-cap market was £63 million, less than 1 per cent of the £9.5 billion offer for Morrisons.
We work with private equity firms every day, advising them on the political and regulatory outlook for the businesses they buy, manage and sell. Our perspective gives us a different angle from which to view the industry, not as a few gargantuan buyouts but a feverish competition to support and capitalise on growth.
These mid-market deals are the bread and butter of what private equity does: providing growth capital and expertise to help established companies scale up, before exiting at a profit with the company in a much stronger position. Not all deals work out this way, but many do and the industry should do more to explain its wider contribution to the economy and society.
In particular, the mid-market sector could play a key role in the government’s levelling up agenda. The UK has a longstanding and large tail of low-productivity firms, as recently pointed out by former Bank of England Chief Economist Andy Haldane. Government initiatives — such as the British Business Bank — help, but they can never operate at sufficient scale to be transformative. Private equity, with its well-advertised stockpile of dry powder, can do so.
In 2020, almost 60% of mid-market PE deals were with companies in London and the South East. Partly, this is due to the predominance of business and financial services, which made up almost half of all deals, that the capital specialises in.
But proactive efforts on the part of government to work with the industry and investment banks could help to rebalance this geographical spread. In particular, financial support for SMEs outside London and the South East to support preparation to attract investment would pay for itself in the medium term.
The private equity practices that generate controversy — large-scale lay-offs, asset stripping and leveraged buy-outs — predominate in the public debate about what private equity does. This is an unfair characterisation of what is, like any industry, large and diverse.
Industry figures themselves have done little to counter this image, believing political noise will eventually fizzle out. Private equity firms pay a lot of attention to political and regulatory risk affecting the businesses that they are buying and selling, but curiously they take it less seriously when it applies to them. This is a mistake.
In the post-Brexit, post-Covid environment, it is increasingly politics that wins out over economics, and a more statist status quo has emerged across the main political parties. Fairness is now at the heart of British political economy and private equity firms cannot avoid being implicated.
Economic value is no longer measured merely in billions invested or raised through tax revenue, but how investments are made, where, and what their wider impacts are, especially on local economies. Notably, the Treasury recently launched an investigation into the differential geographical impact of PE deals across the UK.
In short, all corporate actors have to take more seriously their wider responsibilities to the societies in which they operate, hence the large and growing interest in ESG issues. Private equity has been lagging in this area.
And regulatory change is coming down the track. The government is currently considering changes to corporate governance rules, notably with a likely expanded definition of so-called Public Interest Entities — companies that are big enough to warrant special regulatory attention. This will capture many PE firms themselves, and also many more of their portfolio companies.
Private equity has a better story to tell than the one that is told about it in the media. It is much more than the predatory industry it is often portrayed as and, regulated appropriately, it can make a valuable contribution to the government’s wider redistribution agenda. Rather than simply trying to stamp on deals that it perceives as a threat, the government should take a more proactive approach to shaping private equity investment towards its political priorities.