If you want to keep your business private, bidding for Sainsbury's and Boots is hardly the way to go about it. But the fact that two of Britain's best-known high street names should have received bids from private equity firms points to a lot more than the size and audacity of private equity these days. It also throws into sharp relief the dilemma increasingly faced by private equity: how to be really big and really private at the same time.
Contrary to the impression sometimes created by the industry, the principle of private equity is nothing new. It dates back to the Elizabethan merchant venturers. Private equity firms are just groups of partners who raise money from investors on the promise that they can make more money for the investors than they can make for themselves. They do this by taking stakes in companies or buying them completely—the equity part. The private part is that neither private equity firms nor the companies they run are quoted on the stock exchange (the definition of a public company).
The rise of the public company began in the mid-19th century. Public companies have to reveal much more about themselves than private ones. In this sense, private equity is a reversion to an older form of capitalism. It is also curiously out of temper with the times: the trend has been towards more accountability by business and government, not less.
But in recent years, private equity has risen from comparative obscurity to a prominence it never wanted—and probably never expected. About a fifth of all private sector workers in Britain are now employed by companies owned by private equity firms. Madame Tussauds, the AA and Birds Eye, to take three well-known examples, are all private equity-owned. Although the big private equity firms are mainly American, British private equity firms account for more than half of all private equity investment in Europe. After viewing private equity with some suspicion, major institutional investors such as insurance companies and pension funds now back private equity partnerships.
What is behind the resurgence of private equity? It depends on who you ask. The private equity lobby—in the shape of the British Private Equity and Venture Capital Association (BVCA)—argues that companies owned by private equity firms benefit from a closer relationship between owners and managers than prevails in most public companies. A private company is more insulated against external pressure than a public company, whose directors increasingly fear lawsuits. Private equity firms can also offer managers greater financial rewards than they would receive from a public company.
Critics such as the GMB union, which is campaigning against private equity, argue that private equity's rise owes much to ruthless management, quick turnover of companies and cheap capital—"buy it, strip it, flip it." The GMB points to the example of the AA, which was bought by Permira, Europe's biggest private equity firm, with the loss of 3,000 jobs. But overall, the evidence on employment is far from clear. Many studies suggest that in companies that go from public to private equity ownership, the number of employees increases, although some companies do better than others and it is usually impossible to know what would have happened under different owners.
Cheap capital has been important because private equity firms' transactions are frequently financed by debt issued by the companies they acquire. This is not in itself a bad idea, and private equity firms can hardly be blamed for the world being awash with capital. The wisdom of such "gearing" largely depends on whether a company can safely service its debt—and that is partly a matter of how well it is run.
From the point of view of investors, private equity firms claim to generate higher returns than most alternatives, even after the big fees and profit shares which go to the private equity partners and make many of them very rich. Here again the evidence is mixed. Investors certainly do well out of the most successful firms, but there is a long tail of smaller, less successful private equity firms about which less is heard.
Private equity has a bad reputation among corporate managers. Damon Buffini, managing partner of Permira, has admitted that the industry needs to become more open. Under the aegis of the BVCA, and encouraged by Gordon Brown, David Walker, a City grandee, has assembled a committee to draw up a code of conduct for private equity. More to the point, perhaps, public companies are learning to fight back against private equity firms—ITV and Morgan Crucible, the industrial ceramics maker, have recently seen off bids.
That said, the Sainsbury's and Boots cases are unusual. The Sainsbury family owns 18 per cent of the company and did not want to sell at a price the bidder, CVC, would pay. The trustees of the Sainsbury pension fund also made it clear that a new owner would have to repair the fund's deficit. Since its merger with Alliance, Boots has an executive vice-chairman, Stefano Pessina, who owns 15 per cent of the company and who wants to take it private, with the support of private equity firm Kohlberg Kravis Roberts. Private equity may be less private in the future, but it is unlikely to be less prominent.
