Storm clouds are starting to form over the world of private equity, and with the Democrats now in control of Congress, many of whom were elected on populist platforms, it may not be long before subpoenas begin to fly and calls for increased regulation of private equity become part of a headline.
Private equity has been around for decades, though participation is generally limited to the very rich. Historically, private equity firms purchased businesses and fixed them up, beefing up a company's balance sheet, closing unprofitable units, rolling up companies, and cutting expenses. In other words, they made businesses better, which raised value.
Once they got a company in shape, usually in three to five years, the business would then be brought back into the public markets through an IPO or sold to another private company. If it went the IPO route, the private equity firm made a chunk of change in the offering and often still owned a sizeable stake in the company afterward.
In the past few years, the size and number of private equity firms has ballooned, with some firms now managing up to $30 billion. And wealthy investors have been rushing to put money in such vehicles, attracted by returns that were often better than 20% a year.
But success often brings its own set of headaches, and private firms now face that. In recent months, media attention has dramatically increased, putting a spotlight on how a few private equity firms have reaped big and quick profits by flipping a company in months, instead of years. Critics are complaining that private equity firms are squeezing their portfolio companies through huge special dividends and management fees, as well as adding massive debt before returning a company to the public markets.
Though no one has questioned the legality of such moves - these are private investment companies - there is concern that the desire to cash out quickly is damaging portfolio companies, which can lead to business failures and layoffs. Right now, there are few rules for private equity firms, but there are rumblings that the federal government needs to pay closer attention and tighten its rein on the industry.
Sadly, private equity firms have said little in their own defense, allowing critics to frame the argument. In fact, not a single private equity firm would comment on deal-related matters for a recent BusinessWeek cover story. The notable exception was an Op-Ed in the Financial Times by Roberto Quarta, a partner at Clayton, Dubilier & Rice, who urged his colleagues to get involved in the public debate, pointing out that now German officials are focusing on the industry, which one such politician referred to as "locusts."
If private equity firms decide to continue to stay mum, they may find themselves faced with well-intentioned regulatory burdens that make them less competitive or hinder flexibility. It will be up to private equity firms to educate stakeholders on the valuable role they play in the marketplace, both domestically and globally. No one else will do that job for them.
Fred Bratman is president of Hyde Park Financial Communications.