The stereotype for private equity firms is crude and cruel: They focus on short-term returns at the expense of a business’s long-term health; lever up the acquired business at the expense of it going bust; and cut expenses to the bone, eliminating jobs in the process with no regard for top-line growth.
It’s a very cynical picture, one that’s easy to fall in line with until you realize that in many cases they’re far more innovative than investors care to give them credit for.
But advisors are increasingly prying open client eyes to the opportunities out there in order to furnish returns substantially larger than that which clients have become accustomed.
“At the same time, there are certain ways LBOs can actually make it easier for firms to invest in the long term,” reads a recent report by college professors Joel Stiebale, Kevin Amess and Mike Wright, analyzing hundreds of PE-backed LBOs of UK companies from 1998 to 2008. “Because of their relationships with banks, PE funds can get financing much cheaper than target companies could under their current management.
“And it’s not as though public corporations are being praised for their long-termism—they’re also subject to shareholder pressure for short-term earnings. By taking firms private and ‘away from public scrutiny,’ the authors said that LBOs allow companies to make more long-term entrepreneurial investments.”
The professors found that three years after a leveraged buyout the PE-backed firms filed 40 per cent more high-quality patents than any other firms. Innovation drives profits which drives greater deal multiples once exiting. If profits are the game, PE-backed firms aren’t a bad way to go.
Statistics show that if advisors are going to put their clients into the private capital markets, the best deals to look at are those where one private company buys another private company.
“This suggests that the positive effects of buyouts are concentrated in private firms where financial constraints might be more pronounced, as publicly listed firms often have better and cheaper access to external finance,” states the trio’s report.