Equity’s Privates

Is private equity evil?

Private equity is in the news. It’s a way to invest in operating companies that aren’t listed on an exchange. It sidesteps the SEC and exchange-driven rules, because those rules are written to protect investors, and private firms are owned directly by the investors without an intermediary.

How did it get to be so important? In the ‘60s and ‘70s a lot of management consultant firms were formed, offering advice on how to improve corporate performance. Sometimes this advice was taken, sometimes not. When their advice wasn’t taken and the consultants were convinced that there was corporate value that could be unlocked, they formed partnerships that could buy out the company and implement the reforms.

As you might expect, the returns on private equity are a mixed bag. Better, more disciplined firms tend to do better; other firms, worse. It’s hard to tell what the aggregate performance has been, since high-performers (like Bain) tend to get all the press, while the dogs quietly dissolve. Some claim it’s no better than the aggregate public markets, since the same economy drives the return from both private and public firms.

But there is one way that private firms have an advantage: corporate governance. If investors question a firm’s accounting, they can bring in their own accountants. If CEOs behave badly in the morning, they can be fired in the afternoon. If you’re worried about pollution, you can bring a soil-testing unit right into the company’s main campus. Private equity investors control their companies. Better accountability usually means better results.

Private equity hasn’t boomed in the last 20 years because it milks companies dry and then casts off the empty shell. It’s boomed because it has created profitable firms that provide goods and services that people want at affordable prices. Nothing evil about that.

Douglas R. Tengdin, CFA
Chief Investment Officer
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