By Tim Fazio, Atlas Holdings
The public perceives private equity along a storyline like this: A PE firm buys a business, lades it with unsustainable amounts of debt from undisciplined lenders, and strips out cash to pay itself and its partners a large dividend. Eventually, the business goes bankrupt, leaving behind fractured communities and thousands of displaced workers.
A well-publicized example of this narrative: the Toys “R” Us bankruptcy.
There’s no denying that PE-owned businesses have, on occasion, failed and their owners acted irresponsibly. But we in the PE industry have also done a poor job telling the story of how much good PE investment and ownership does.
As a PE investor for 23 years focused on buying and operating industrial manufacturing and distribution companies that face lots of challenges, I would argue that Toys “R” Us-type situations are the rare exception – and that we can do much to improve the industry’s image.
Here’s what people largely don’t know:
- In the United States, PE owns 23% of middle-market companies and 10% of larger businesses, the Economist reported recently. Of the 2,300 PE firms out there, the five largest employ more than 1 million people, a Boston Consulting Group study found. (In the private sector, only Walmart employs more.) And in the industrial area in which my firm specializes, the nearly invisible mid-market companies PE owns contribute significantly to U.S. manufacturing competitiveness.
- PE firms often bail out failing companies, applying capital and expertise and repositioning them to thrive. Harvard Business School researchers in 2017 demonstrated that PE investments help improve productivity, product safety and labor safety and increase the variety and availability of products for consumers. Regarding jobs, the Harvard academics found employment levels at PE-owned companies were sustained or increased at rates comparable to those of non-PE-owned companies. That debunks the idea that PE firms destroy many of the businesses that they touch.
PE firms have a vested interest in building up rather than burying the companies they buy for five key reasons:
- The most important driver of the success of a business is the quality of its workforce. Who would want to work at a company that drives its businesses into liquidation or doesn’t care about the safety and welfare of its employees and communities?
- Attractive deals come more easily to responsible PE firms. Business owners don’t want to sell to PE firms that have destroyed companies. Family-owned businesses don’t want to see legacies and reputations ruined, and corporate sellers don’t want the headline risk associated with the failure of a former division — or the liabilities that could revert to them. Sellers want responsible owners and often accept lower prices from the right buyers.
- Investors demand that PE firms demonstrate their ability to improve operations and create value. The era of financial engineering and the overuse of leverage as the primary means for generating investment returns is long past. As with every market, competition within the PE industry has forced higher standards of performance – and virtually all PE firms have responded by building their operational skillsets and value-adding strategies.
- PE investors also require responsible, sustainable operations. Many LPs are pension funds representing the very workers affected by PE ownership. These funds care about how employees are treated. In addition, LPs including charitable foundations and endowments require the PE funds in which they invest to meet formal ESG criteria in addition to investment-return criteria.
- Simple economics. PE firms that improve the sales and performances of the companies they buy make the most money. Take, for example, Yeti, the maker of ice chests and drinkware. In 2012, Cortec Group invested $67 million in the company; a recent IPO valued Cortec’s stake at $1.3 billion, roughly 20 times its initial investment, dwarfing anything that asset-stripping could have produced.
To change the perception – and performance – of PE, we must continuously improve the operations and growth prospects of our companies.
We must create long-term businesses that have reason to exist in an increasingly competitive global environment and operate collaboratively with all stakeholders, including employees and local communities.
To support that effort, a group of industrially focused PE firms formed Industrial Exchange, which aims to help small and middle-market companies thrive by sharing best practices and education programs online and at events such as the IndEx 2019 conference May 6-8 in Miami.
As the general public learns more about the investments and improvements the PE industry is continuing to make — an area where the industry must continue to step up its game — I’m confident that the public perception of the business will improve as well.
Tim Fazio is co-founder and a managing partner of Atlas Holdings, a private equity firm, and chairman of Industrial Exchange. Reach Tim at email@example.com or +1 203-622-9138.