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The truth about Private Equity and portfolio companies
The Service Employees International Union (SEIU) has portrayed private equity partners as asset strippers who add little or no value to the companies they acquire and who act without regard to the welfare of their portfolio companies, employees and local communities.
Those assertions are directly contradicted by a large body of independent research conducted by noted and respected scholars and institutions.
The truth is that private equity investors often save jobs and increase employment over time; improve the performance of the companies in which they invest; deliver superior returns to public, union and private pension funds, university endowments and charitable foundations; build value in companies over time; and drive higher levels of innovation.
PE investment often saves jobs and increases employment over time
• Private equity investment over time often slows or halts existing job losses and can drive job growth in new facilities, according to a 2008 study of 5,000 transactions over 25 years commissioned by the World Economic Forum and led by Harvard Business School Professor Josh Lerner.
• Prior to private equity investment or acquisition, the WEF study found that private equity portfolio companies were, on average, losing jobs at existing facilities at a rate one to three percent faster than their competitors. After private equity investment or acquisition, those same companies initially experienced a dip in employment but by year four under private equity ownership, employment rates rose to slightly above the industry average. (The Global Economic Impact of Private Equity Report 2008, “Private Equity and Employment,” January 2008.)
• The WEF study also concluded that in the first two years of investment, private equity firms increased the rate of job growth at new U.S. facilities built by their portfolio companies to six percent above the peer industry average. (The Global Economic Impact of Private Equity Report 2008, “Private Equity and Employment,” January 2008.)
• Acquisitions of large companies by major, U.S.-based private equity firms between 2002 and 2005 resulted in a direct and positive impact on U.S. employment, according to a study conducted for the Private Equity Council.
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o Across 42 companies, 26,214 net new jobs were created – an increase of 8.4 percent over their combined employment of 310,420 at the time of acquisition. Seventy-six percent of the sample recorded job gains, while less than 24 percent reduced employment.
o Among a subset of 26 firms providing data on U.S. employment, domestic jobs by private equity-backed firms increased 13.3 percent (or 13,861 net new jobs), compared to 5.5 percent for all U.S. businesses and 2.7 percent for large U.S. businesses.
o For manufacturing companies, employment increased 1.4 percent, while employment in the overall US manufacturing sector dropped by 7.7 percent during the same period.
(Shapiro, Robert and Pham, Nam. “American Jobs and the Impact of Private Equity Transactions,” Private Equity Council, January 2008.)
• In 80 percent of the cases studied, employment levels at PE-owned companies were the same as or higher at the conclusion of a PE investment than they were at the beginning. (Ernst & Young, Transaction Advisory Services, “How Do Private Equity Investors Create Value? A Study of 2006 Exits in the US and Western Europe,” 2007.)
PE partnerships improve the performance of their portfolio companies
• Two-thirds of the earnings growth (before taxes, interest and capital expense) at PE-owned portfolio companies came from business expansion, with organic revenue growth being the most significant element. This included the benefits of investment in sales and marketing and new product launches. Cost reductions accounted for only 23 percent of pre-tax earnings growth in U.S. companies and 31 percent in European companies. In short, asset stripping is not the way PE firms build value. (Ernst & Young, Transaction Advisory Services, “How Do Private Equity Investors Create Value? A Study of 2006 Exits in the US and Western Europe,” 2007.)
• Private equity investment makes companies stronger when they enter public equity markets. The share price of companies owned by PE firms for a year or more that went public between 1981 and 2003 outperformed the stock market as a whole over a three-to-five year period. The PE-backed IPOs were on average much larger in size, more profitable, and were backed by more reputable underwriters. (Cao, Jerry X. and Lerner, Josh, “The Performance of Reverse Leveraged Buyouts,” Swedish Institute for Financial Research Conference on The Economics of the Private Equity Market, October 15, 2006.)
• PE-acquired companies outperformed comparable publicly-traded companies in terms of sales (14 percent), earnings before taxes, interest and capital expense (five percent), and profitability (five percent) growth, although there was a one percent decline in asset value relative to peers. (Gottschalg, Oliver. “Private Equity and Leveraged Buy-outs Study,” Policy Department, Economic and Scientific Policy, European Parliament, IP/A/ECON/IC/2007-25, November 2007.)
PE investments deliver superior returns to pension funds, foundations and endowments
• Private equity investments directly benefit pension funds that provide retirement security for hundreds of thousands of teachers, police officers, firefighters and many other public employees across the U.S. In 2007 alone, the top 20 public pension funds, representing nearly 10 million retirees in states including California, New York, Texas, Florida, New Jersey, Ohio, Pennsylvania and Michigan, had a collective private equity investment of nearly $140 billion. (Private Equity Intelligence)
• Between 1980 and 2005, top-quartile private equity firms delivered 39.1 percent on average, annualized net returns, significantly beating the S&P 500 and other public market indices. Those superior returns helped strengthen major public, union and private pension funds, charitable foundations and university endowments. (“Public Value: A Primer on Private Equity,” – Private Equity Council 2007 – analysis of data from Venture Economics and Bloomberg.)
• By 2008, the total net profits distributed to investors worldwide by private equity funds raised through 2007 were $1.12 trillion. (Private Equity Intelligence)
“Strip and Flip” is a slogan, not a fact
• Of all the companies acquired by PE firms between 1980 and 2007, 69 percent were still PE-owned by November 2007. During the period from 1970 to 2007, nearly 60 percent of 21,400 companies acquired by private equity investors remained under PE ownership for five or more years. Over time, PE holding periods have lengthened. “Quick flips” accounted for less than 12 percent of all transactions studied. (Strömberg, Per. “The New Demography of Private Equity,” The Global Economic Impact of Private Equity Report 2008, World Economic Forum, January 2008.)
• The average holding period for PE investors is 5.3 years. Only 16 percent of all PE exits take place in less than 24 months. After five years, buyout investors continue to be involved as majority shareholders in more than 45 percent of their investments. (Gottschalg, Oliver. “Private Equity and Leveraged Buy-outs Study,” Policy Department, Economic and Scientific Policy, European Parliament, IP/A/ECON/IC/2007-25, November 2007.)
PE ownership spurs innovation
• PE-owned companies pursued more economically important innovations than non-PE owned companies, as measured by patent citations, the most commonly used and accepted measure of the economic impact of innovation. Moreover, researchers found a “beneficial refocusing” of portfolio companies’ patenting activities after the private equity investment. (Lerner, Josh, Morten Sørensen, & Per Strömberg. “Private Equity and Long-Run Investment: The Case for Innovation,” The Globalization of Alternative Investments Working Papers Volume 1: The Global Economic Impact of Private Equity Report 2008, World Economic Forum, January 2008.)
PE’s use of leverage has substantially decreased over the years
• From 1987 through 1990, the average level of debt associated with a leveraged buyout transaction was 87.3 percent while the equity contribution was 12.7 percent. The share of debt dropped to an average of 71.65 percent for the period from 1992 through 2000 and to 63.75 percent for the period from 2001 through 2007, while the equity contribution rose to 28.5 percent and then 36.5 percent. (Debt levels in the 2006-2007 period were higher because of the increased availability and decreased cost of credit.) (S&P Leveraged Commentary & Data. Cited in: Vyvyan Tenorio. M&A Quarterly Review, “Anatomy of a Cycle,” The Deal, 25 January 2008. Note: Average equity contribution calculated by the PEC using source’s data)