Where is private equity?
As a sector, private equity’s purpose is to invest money to help its portfolio of investments grow. The private equity execs I know can run businesses, restructure balance sheets and know when a strategic pivot or management change is required. Which is why it is so surprising that the PE sector appears to be missing in the huge effort to combat the effects of Covid-19. There are some General Partners (GPs) and their portfolio companies who are working hard on vaccines and treatments, but these tend to be among the healthcare specialists. There are some new philanthropic funds, but well-paid PE executives donating money is the least they can do. For such a well-capitalised, liquid and innovative sector, this seems to be a significant reputational risk.
Unlike with the Global Financial Crisis (GFC) of 2008, in this crisis, the challenges within the economy and financial system are the effect not the cause. The banks have done a good job of proving that they are part of the solution, rather than the problem. The scars from the GFC are still raw for the banking sector and they did not want to aggravate the wound. If anything, this is an opportunity to burnish their reputation and prove that they are fulfilling their very basic purpose of supporting society by providing capital where it is required. They are also at the forefront of announcing cuts to boardroom pay, although in the UK they did require some coercion to maintain their capital levels and not pay dividends.
One might have assumed that private equity would have learned its lesson from 2008 when it came under intense pressure and would be keen to show it is doing its bit. It is harder for the sector than for the banks - after all private equity’s role in society and to the economy is not as essential as the banks. But they do play an important role in capital and corporate growth.
According to those in the industry I have been speaking to, firms are spending a lot of time ‘taking care of their portfolio’. As Apollo’s $2.3bn net loss for Q1 2020 demonstrates, portfolios need significant care and attention. In the UK, portfolio companies employ 843,000 people, so providing support to those companies is essential. It would be churlish to argue that it is self-serving for private equity execs to focus on their own investments, if they did not then the economic impact would fall on society at large.
What then are the risks from this? We have identified three:
First, it is unclear what that portfolio activity has been and what it means in practice. Some GPs have set-up micro-sites focusing on charitable giving or posted updates to their blog, but I question whether that is meaningful transparency. As all recent crises have demonstrated, what a company does to manage the crisis is crucial, but how they communicate it is just as important, particularly during the post-crisis reflection. From a reputational perspective, we are advising GPs to think carefully about whether they think the way they have communicated their actions during the crisis will stand up to future media, regulatory and investor scrutiny.
Second, GPs need to carefully calibrate how much of an opportunity this crisis might be. With all that dry powder and target companies in financial distress, there may be some rich pickings and in five or seven years when the firm sells whatever asset it bought at a steal today, its investors the Limited Partners (LPs) and the GP will make a handsome profit off society’s misery. In recent years, socialising losses and privatising profits rarely ends well for the subject of this financial sleight of hand. Just ask the banks.
Third, ESG may turn out to be a mixed blessing. One of the features of the last few years has been record fund raising and LPs want those record funds to grow even bigger through canny investments and exits. However, it may be that in the current environment the recent focus on ESG creates an interesting dilemma for private equity firms and LPs alike. The LPs will need the best returns they can get, especially given the impact of the crisis on the value of their public market investments, but they will all have a meaningful commitment to ESG. Will they continue to pursue that as they have in recent years, or will it play second fiddle to the LPs own fiduciary duties to their investors? If ESG does remain at the forefront of LPs’ concerns, then the private equity firms will need to think carefully about how they account for their activities during the crisis.
An alternative approach would be for the sector to go beyond just protecting the portfolio and use its sector knowledge, broad networks and deep pockets to act as a convenor for tackling many of the issues posed by the Coronavirus crisis. It would be the industry equivalent of Burberry making PPE, or McLaren Formula One manufacturing ventilators.
To return to the original question, no doubt the sector is working hard to support and protect its portfolios and its investors’ money. However, it is not being as transparent as it might be and is potentially missing a trick in not making the full use of its resources to support society at large. It needs to be very careful in trying to use the crisis to its advantage.
As any banker knows only too well, doing things because they are part of the normal course of business does not provide immunity from moral opprobrium. Every private equity executive should want to be able to hold up their head when asked what they did during the crisis, whether that’s by an LP, a portfolio company employee, a regulator – or a friend.