It’s a tough business and an easy target – but is it deserving of its pirate reputation?
Comedian Rodney Dangerfield might be long gone to that great comedy club in the sky, but I thought of him this past month while looking at recent books on Amazon. Two sprang to my attention: Plunder: Private Equity’s Plan to Pillage America and These Are the Plunderers: How Private Equity Runs and Wrecks America. These are weighty tomes: Plunder… is written by the former special counsel for private equity at the US Department of Justice, while Gretchen Morgenson of These Are the Plunderers has won a Pulitzer Prize.
But aside from their use of pirate imagery and constant use of the word “plunder,” these two books paint a picture of private equity that I haven’t encountered in many, many decades. People who run these funds are billionaires who live in glass towers in Midtown Manhattan. They run large (which is a synonym for evil) funds that are private (also evil) and are accountable to nobody (tell that to the pension funds who often invest in these funds). They rip apart companies and destroy the lives of workers, furthering the gap between rich and poor. They use “offshoring tactics to reduce the tax obligations on themselves and their investors.” And when they are done, they purposefully push companies into bankruptcy … I think just for spite, but this is not made clear.
These books present far too easy a target: they never mention venture capital and job creation, or that the ill-gotten booty is usually passed on to pension funds, both public and private, to fund the retirement of non-billionaires.
So let’s step back and look at some data that comes from Na Dai, at the School of Business SUNY at Albany, titled “Empirical Research on Private Equity Funds: A Review of the Past Decade and Future Research Opportunities,” published last year in the journal Review of Corporate Finance. To understand fund returns, rather than use traditional measures of cash-on-cash returns, he uses measures to compare the performance of funds to public equity markets. While most studies conclude that private equity funds outperform the S&P 500 net of fees, the relative performance drops when other public equity benchmarks are used or when different sample periods are used.
Other topics are examined. The persistence of private equity performance was first noted in 2000, where the performance of a fund is positively associated with the performance of the next fund raised by the same private equity firm. Recent literature, however, finds that the performance persistence has been diminishing somewhat and is partly driven by common economic impacts on funds that overlap in time. It seems that the “initial success in VC investments stems not so much from choosing the right companies or from nurturing them but from investing in the right places at the right times.”
ESG issues are becoming far more important. “Around one in three general partners has now hired sustainability officers. More private equity firms are requiring ESG disclosure when they perform due diligence of their portfolio companies.”
The past decade has also seen a rapid emergence of various innovative vehicles for private equity in the financing of new firms, including accelerators, funding groups, and crowdsourcing platforms. Accelerator programs provide seed capital, co-working space, networking, and educational and mentorship opportunities to startups. However, basic services such as funding and co-working space do not seem to affect new-firm performance on their own; only when private equity bundles these with inputs from schools or other sources of broad-based learning is there a positive effect on new firms.
So how does this compare to the image in the books? Private equity is a tough business. Performance persistence is dropping, and today’s hot hand can go suddenly cold. ESG issues are gaining in importance in the private equity world. Finally, these funds can help in the creation of new firms. Private equity firms may not be full of angels, but they certainly aren’t made up of pirates.
Jim Helik is a contributing author to the Managing High Net Worth and the Commodities as Investments courses published by CSI Global Education. He is also one of the first holders in Canada of the Human Resource Management Professional designation from the Society for Human Resource Management.