2 egregious perceptions envelop the world of private equities. The first is that companies associated with private equity funds are more likely to experience insolvency. The second involves the brutal cost-cutting measures employed by private equity funds, such as massive layoffs and restructuring.

In the following, we discuss the origins of these myths before examining their validities.

 

Private Equity-Backed Firms Uncorrelated with Bankruptcy

2017 marked the apogee of the retail apocalypse – multiple post-buyout bankruptcies plagued the private equity scene. For instance, retailer Toys R Us was bought over by private equity firms Bain, KKR and Vornado[1]. This was one illustration among a spate of many others. Yet, it should be noted there are external environmental forces which culminated in this devastation. At that point in time, the retail market was squeezed and becoming increasingly obsolete due to the advent of e-commerce marketplaces[2]. Going back to Toys R Us, the debt had reached an obscene level. Add that to the glaring, chronic weaknesses inherent in their business model and it is not difficult to see just why bankruptcy was imminent.

On the flip side, there is copious research that disputes the hypothesis that private equity owners increase the risk of financial distress and bankruptcy. The justification lies in how private equity investors select firms – they tend to be less financially constrained than comparable companies. Even companies subjected to a buyout during years when debt financing is widely available do not suffer from higher insolvency[3].

 

Cutthroat Measures Not Restricted Solely to Private Equity-Backed Firms

Private equities have greater freedom to operate and are thought to be more effective because of their stronger leadership and more effective performance oversight. They emphasize on value creation for their exit strategies while public companies require more extensive and transparent approaches to governance (See Figure 1)

Figure 1: Effectiveness of Private Equity vs Public Boards

Private equity funds have to perform. They can only achieve this if the companies within their portfolio thrive. Layoffs and supplementary cost-cutting measures are therefore necessary. In fact, these represent an integral portion of any company, even amongst those not managed by private equity funds. This is staple phenomenon in the corporate realm, be in 2 decades ago with the restructuring of Great Universal Stores back in 2000[4], or the current headcount slash in the financial world[5].

 

Value Adding Properties of Private Equities

The demonization of private equities stems from imperfect information which self-propagates. In fact, private equity is an invaluable asset class as it serves to diversify in a portfolio (See Figure 2).

Figure 2: Effect of Private Equities on Portfolio

 

To find out how to include private equities within your portfolio, click here.

 

[1] Halzack, S. (2018, March 16). How Toys R Us was doomed by a leveraged buyout and shortsighted strategy. Retrieved July 5, 2019, from https://www.latimes.com/business/la-fi-toys-r-us-leveraged-buyout-20180316-story.html

[2] Shiao, V. (2017, October 31). Surviving the brave new world of retail. Retrieved July 5, 2019, from https://www.businesstimes.com.sg/magazines/the-sme-magazine-novemberdecember-2017/surviving-the-brave-new-world-of-retail

[3] Borell, M., & Tykvov ́a, T. (2011, February 15). [Do private equity investors trigger financial distress in their portfolio companies?]. Unpublished raw data.

[4] Weyr, T. (2000, August 29). Great Universal Stores Struggles and Restructures Business. Retrieved July 5, 2019, from https://www.dmnews.com/marketing-channels/multi-omnichannel/news/13094437/great-universal-stores-struggles-and-restructures-business

[5] Tan, A. (2019, April 15). Investment banks, asset managers shedding jobs. Retrieved July 5, 2019, from https://www.businesstimes.com.sg/banking-finance/investment-banks-asset-managers-shedding-jobs