A Modest Proposal for Private Equity Firms

One thing people in a position of power often have trouble understanding is that it is sometimes necessary to cede a bit of one’s authority to minimize interference in the long run. In that way, you get to choose the concessions you make, and you have the further advantage of looking gracious and cooperative. The alternative is to stonewall, and while you may preserve your rights longer, the fight takes time, money, and energy, and may cost you allies and reputation. And you run the very substantial risk of having changes foisted on you.

Private equity firms are now getting so powerful that they are getting more scrutiny. While the EU has decided for the moment to steer clear of imposing further regulation on private equity firms, two blockbuster deals in the US (Blackstone’s acquisition of Equity Office Properties Trust, and the pending buyout of TXU by KKR and Texas Pacific Group) and the threat they are perceived to pose to public markets in the US are likely to lead, at a minimum, to Congressional hearings.

The Financial Times in an editorial today, “Invading the Privacy of Private Equity,” offers a sensible idea of how private equity firms can gain the upper hand in the debate, namely, via better disclosure:

Deals that are done in the dark look dodgy. The public’s logic is simple – why keep it quiet unless you have something to hide – and that logic has made it easy for Britain’s trade unions to portray private equity firms, which value their privacy, as asset-stripping, profiteering vultures, growing fat by firing workers. To counter that impression, buy-out firms must be more open.

Damon Buffini, managing partner of Permira, a large European private equity outfit, agrees that more disclosure is needed. But there is confusion about what that means in practice.

Two things private equity should not be obliged to talk about are their investors and how much individuals get paid….

Instead, the wider world wants to judge two things. First, whether private equity is a good steward of investors’ money, which ultimately belongs to pension funds, insurance companies and individuals. And second, whether private equity is a good steward of the companies it invests in.

To answer the first question we need to know about returns. Private equity firms do report returns to their investors, some of which make them public: from Calpers, for example, the California Public Employees’ Retirement System, we know that Mr Buffini’s Permira has achieved a 74.6 per cent internal rate of return on its 1997 Permira Europe I limited partnership. Private equity firms would do everyone a favour, however, if they published this information directly.

What we know less about is the second: the operating performance of companies subject to buy-outs. When a large public company is bought by private equity it vanishes….

Word leaks out, of course, about whether a company is doing well or badly. Private corporations still have to file statutory accounts. The buy-out firms, meanwhile, can point to their investment returns and argue that they must be doing something right in order to make that much money.

The likes of Permira and KKR are probably doing a lot of things right. But unless they publish more detailed financial information it will be impossible for employees and the general public to understand what those things are. Large companies that have undergone a buy-out should, therefore, continue to publish annual reports as they did when they were listed.

That will make clear whether private equity is making short-term profits by slashing capital investment, or sustainable profits by making the companies that it buys more productive. The public has an interest in that information and private equity owners should benefit too. They will find it easier to sell a company back to the public markets if they release regular accounts.

Private equity is always going to have an image problem: its business is based on making companies more efficient, and that will mean job losses. But it shoots itself in its Gucci-clad feet by being so secretive. Mr Buffini is on the right track and his colleagues at other firms should follow his lead.

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