Deep Dive: Ignoring private equity’s critics is no longer an option

Private equity is failing to find its voice or properly engage with its detractors and the barrage of criticism won’t stop until it does.

The movie Pretty Woman came out 30 years ago. For many private equity execs, however, it is a cultural touchpoint that still resonates. The male lead in the film – played by Richard Gere – is a corporate raider, in town to buy a company on the cheap, break it up and sell the assets for a gain. It is an enduring negative stereotype.

In the real world, it was arguably the 1988 buyout of RJR Nabisco by KKR, and the subsequent investigative book and HBO series documenting the avarice behind that mammoth deal, Barbarians at the Gate, that put the spotlight on private equity and cast it as the “bad guy” of finance.

The spotlight in the past 12 months, however, has been increasingly intense.

“I generally agree with the premise that there has been an increase in anti-private equity rhetoric, and that the industry continues to get more attention,” says Drew Maloney, president and CEO of US private equity lobby group the American Investment Council.

A former staffer for President Trump in the US Department of Treasury, Maloney says the focus on the industry has ramped up as a result of the US presidential election in November. “We are in an election cycle and during presidential election years certain industries get more attention than in non-presidential years.” While political interest in the industry may peak and trough, former presidential hopeful Elizabeth Warren’s eight-point plan to curb buyout house practices, and her characterisation of private equity firms as “vampires” ensured the industry was thrust into the heart of the tussle over the direction of American capitalism.

Warren, who dropped out of the presidential race in early March, had introduced the Stop Wall Street Looting Act of 2019. It took aim at two historic pillars of the industry: the tax treatment of carried interest, and the ability of PE managers to deduct the cost of interest payments from portfolio companies’ tax bills. Among other measures, it also sought to make financial sponsors liable for portfolio company debt. In short, it would have seriously curtailed the business of buyouts.

In response to Warren’s attack, the AIC put up a stout defence of the industry and a month later produced a report detailing private equity’s contribution to the economy.

“Why we saw such a strong reaction to Warren’s plan is because it would hurt the economy, hurt innovation, threaten jobs and discourage investment,” says Maloney. One particularly apocalyptic take came from the US Chamber of Commerce, a powerful Washington, DC business lobby group, which said in a worst-case scenario the industry would cease to exist.

Bernie Sanders, the frontrunner in the democratic presidential candidate race as this issue went to press, has been less specific about what, if anything, he would do to throttle back the industry. He has, however, regularly spoken about private equity in an unflattering way.

The Swedish experiment

So why, given the body of evidence that suggests private equity spurs growth, boosts productivity and bags sometimes eye-watering returns for pension funds, has the industry once again found itself a political target?

“Private equity has focused on what it is good at, investing and growing companies and telling that story to its investors where there has always been a high level of transparency,” says Elin Ljung at Nordic Capital, which invests in the US. “But it did not focus on telling that story to the public markets, which is needed if you want to build trust in society.”

The experience of buyout houses in the Nordics is instructive, pointing to a potential route to success for US firms struggling against a growing backlash. As Ljung recounts: “A decade ago in the Nordics, we had a political debate on private capital in healthcare and this was a tipping point for many private equity firms to become more transparent and to engage with opinion makers and politicians on a broader level.”

This is seconded by Tor Krusell at fellow Swedish buyout house Altor Equity. “What we can see in general, if you look back at Sweden, were overarching challenges [with regards to the perception of private equity], with commentators talking about welfare investments, talking about tax,” recalls Krusell. “Those [challenges] were addressed through increased transparency and increased dialogue. This took a number of years of talking to politicians and opinion leaders. Private equity in Sweden is in a much better place now.”

Speaking on a panel at the IPEM 2020 conference in Cannes in January, former chairman of the British Private Equity and Venture Capital Association Tim Hames, now a senior advisor with FTI Consulting, told delegates the argument in favour of PE is too complicated to sway many members of the public: “Even if you offered me a $1 million budget, I could not get the case for private equity down to three words … It doesn’t fit on a red baseball cap” he said, referencing US President Donald Trump’s famous sloganed hats. The industry should, he suggested, put a sophisticated argument to 3,000 or so “educated opinion formers” and have the patience to wait for the argument to disseminate.


“To go to the next level – to deal with some of this political backlash – we need to allow ourselves to be scrutinised a little bit on the value we create, rather than just the ROI to investors,” industry veteran Carl Thoma said in January at sister publication Private Equity International’s CFO & COO’s Forum in New York.

“We do need to better communicate what we’re doing … it’s in all firms’ best interests to communicate their positive impact,” acknowledges Maloney, but says he doesn’t think the industry is “unique in being a focus for the presidential candidates”.

Private equity was given the chance to make its case on the big stage in November at a hearing by the US House of Representatives Financial Services Committee. One could argue the opportunity was squandered.

One pension trustee was repeatedly asked the same question: what was the best performing asset class for his fund?

“Let’s see. I think this is the seventh time I’ve had to answer this question,” said Wayne Moore of the Los Angeles County Employee Retirement Association in response to Ohio representative Anthony Gonzalez. “It’s private equity.”

Moore was visibly frustrated, as the issues he wanted to raise about transparency and fees seemed to be drowned out by this one fundamental point. Net returns – as far as some on that committee were concerned – trumped every other talking point.

This may not be the right stance to take. Moore made the point that – notwithstanding the net returns – the private equity programme constitutes more than half the pension’s investment management costs. One can argue the net returns make this point irrelevant, but his unease is shared by other investors in private equity funds. Research conducted by PEI at the end of 2019 found 73 percent of LPs agreed with the statement: “Fees charged by private equity funds are difficult to justify internally”.

Net returns have certainly been exciting enough to keep institutional investors coming back with bigger cheques. But the hearing failed to address the other concerns: objections to the absolute dollar cost of private equity and increasing public suspicion of its role in the ‘real economy’.

As New York Representative Alexandria Ocasio-Cortez – who introduced the Stop Wall Street Looting Act alongside Warren – said during the meeting: “I wasn’t sent here to safeguard and protect profit. I was sent here to safeguard and protect people.”

Charm offensive

Maloney reveals that more firms joined the AIC last year “than in any point in history”. This revelation suggests that although the industry might not be a unique focus for presidential candidates, the presidential candidates are a unique focus for private equity.

The AIC’s new strategy appears to confirm this. Recognising the importance of reaching communities in a year when the perception of finance may well determine the outcome of the US election, the AIC has taken the unprecedented step of pushing out adverts in key states ahead of the Democratic presidential candidate debates.

So [before the Democratic debate in Iowa] we went up with a new advertisement telling the story of a pizza and ice cream shop that was family owned and has now expanded through the Mid-West because private equity came in and gave it capital to grow.

Drew Maloney, American Investment Council

“We follow where the presidential debate is happening because that’s where news is aggregating,” says Maloney.

“Before the debate we communicate about the investment, jobs and companies supported in those states. So [before the Democratic debate in Iowa] we went up with a new advertisement telling the story of a pizza and ice cream shop that was family owned and has now expanded through the Mid-West because private equity came in and gave it capital to grow. The great thing about that is that it’s in Iowa where presidential candidates are focused, and it’s actually a popular chain where they go in to campaign.”

In November, after Warren announced her plan, the AIC and EY published what has become a familiar industry weapon – the report showcasing private equity’s importance to the economy. The numbers are staggering: private equity now supports more than 26 million US jobs and contributes around 5 percent of US GDP.

Does the growth of private equity as an owner of the economy mean the industry now has a bigger target on its back?

Private equity controls a far larger share of the economy than ever before, and Ljung says its responsibilities should grow in proportion. “Private equity is such a big industry today and we need to show responsibility and how we contribute to society, not just talk about it,” says Ljung. “We need to put meaningful data on it.”

To this end Nordic Capital has begun to track non-financial indicators at portfolio companies so it can better communicate the private equity story to the public.

“There is an opportunity to show [our] contribution to society with non-financial KPIs and reporting, which [we are] implementing across all sectors in Europe,” says Ljung.

“We look at four key metrics: employment growth, to show we are growing companies; climate, to show emissions and carbon reduction; diversity and gender inequality and then anti-corruption.” Taken together and over time, Nordic Capital hopes they will show the broader contribution the firm is making to improve society.

Countering the negative

The latest poster child for bad private equity practice is Payless ShoeSource, a discount footwear chain acquired by Blum Capital and Golden Gate Capital in 2012, which filed for bankruptcy in 2017 (and again in 2019). The focus given to the failures behind Payless obscures, of course, the many thousands of times when private equity-owned companies don’t go bust but grow and prosper. So why the focus on negative private equity stories rather than positive ones?

Steven Davis, professor of international business and economics at the University of Chicago Booth School, says there are multiple reasons. “The worst private equity employment outcomes are concentrated among buyouts of publicly listed firms, or parts thereof. These deals tend to be highly visible, because the firms are often well known and well covered by journalists and analysts by virtue of (a), their large size and (b), the fact that much information about them is in the public domain due to SEC filing requirements.”

A general tendency prevalent in news reporting to focus on the negative is also at play, Davis says. “Disaster cases attract more attention from journalists than steady success. That’s true of commercial air travel and company fortunes, too. There are few news stories about declining fatality rates in commercial air travel, but many stories after each plane crash.”

Maloney agrees. “We live in an environment where conflict sells and it is often easier to write a story about conflict than highlight positive investments out there.” As a result, “it is incumbent upon us to share those stories.” He says that “smart firms are looking at geo-political, macro-economic, and reputational considerations up front, and trying to tell the story of their positive contributions”.

Burying its head in the sand

But in writing this article PEI was left wondering how hard many private equity firms are really trying. We contacted 23 buyout groups, all firms in the top 100 of the most recent PEI 300 ranking, keen as we were for insight from the industry’s best minds regarding private equity’s place in the world right now, and keen to demonstrate that firms were learning about the need, as Maloney says, to better communicate the story of private equity. Over nearly two weeks, numerous conversations and negotiations about content and boundaries yielded few takers.

“[Criticism of private equity] is our own fault as an industry – we should have started earlier to drive transparency,” says one buyout firm director who didn’t want to be named.

Bain Capital co-managing partner Jonathan Lavine addressed the topic on stage at a student event in London in February. “I don’t think the licence to operate is at risk, but I do think that PE firms need to be a little bit more transparent about the good and the bad – it can’t be in a defensive crouch,” he said.

Lavine said the negative image of the industry was a product of several factors, including the word “private”, the fact it has been reticent to tell its story and its role in the economy, as well as its size. Asked about Bain’s failed investment in US retailer Toys ‘R’ Us which filed for bankruptcy in 2017, Lavine said the firm tried to be “as good as we could, members of the community”.

On stage at the CFOs & COOs Forum in January, Thoma told delegates that back in the early days of the industry, when practitioners were fighting to get pension funds to invest in the space, private equity and venture capital leaders had little choice but to spend time in Washington getting to know their congressmen and senators, telling stories of the industry’s successes in creating jobs and boosting local economies.

“It seems like now we’ve all turned that either over to our lobbyists or our PR firms, or we’re too busy to go. But we’ve got to start to make time to get in touch with Washington, our state legislators, let them know that what we’re doing is efficiently allocating capital, it’s a superior form of governance, and we’re creating jobs.”

Onstage at IPEM in Cannes, Olivier Millet, chairman of the executive board at Eurazeo and the former chairman of France Invest, said GPs need a “political attitude”.

“We have to explain our business not only to our shareholders but also to the employees, to the mayor of the village [in which the business operates].”

The buyout firm director echoes this: “How many private equity firms are engaging with politicians? How many are building strong, long-term relations with politicians and others? You need to start engagement before regulation becomes an issue. If regulation comes first you have lost the opportunity to build trust.”

Has the private equity industry left it too late to build that trust? The main Democratic Party candidates are all being pushed by a large, youthful, grassroots movement to break with business-as-usual economics in the belief that a new model is needed to tackle stagnant wages, a shrinking middle class and climate change. This desire for a new economics can be seen across the globe, with a wave of activism demanding fundamental shifts in how economies work, and what they deliver. Can private equity respond to this desire for new thinking?

Finding a way forward

The firm that arguably gave private equity a bad name back in the 80s, is trying. A KKR spokesperson pointed to the firm’s employee engagement and ownership model, implemented throughout its US industrials business, as an example of its evolving practice. In May, KKR floated Gardner Denver Holdings, a maker of gas compressors and vacuum systems, and the company awarded shares worth a total $100 million to about 6,000 employees. For private equity this is a new way of thinking about the role of a company owner, and a new way of sharing value creation with workers.

Finding mechanisms to share more profits with workers may go some way to addressing one of the most damaging findings in a recent paper authored by Davis and other academics that examined the consequences of private equity buyouts. The paper found that, on a host of metrics, companies acquired by private equity performed better post buyout, but that average earnings per worker fall.

Davis says the data do not allow them to delve deeply into why this is; there could be a number of reasons, from compensation cuts for continuing workers, higher layoff rates for more highly compensated workers or more hiring of younger and less experienced workers (who typically earn less) at newly opened and expanded facilities.

“[Private equity had] better be ready to show how much we have helped … not just to make money and generate returns, but also to transform the economy in which we invest”

Virginie Morgon, Eurazeo

Whatever the reason, it’s a difficult finding for the industry in an age of wage stagnation. In 2018, a Pew Research Center paper found the real average wage in the US has the same purchasing power as it did in 1978, with the biggest real wage gains for the highest earners.

In January, Eurazeo’s CEO Virginie Morgon said the industry will be the first in the firing line this time in the event of a financial crisis, and it “better be ready to show how much we have helped … not just to make money and generate returns, but also to transform the economy in which we invest”.

Where does the industry go from here? The AIC’s response to the Warren plan – a report documenting private equity’s contribution to the economy – was the industry’s tried and tested defensive position. But it is doubtful that hearts and minds will be won by brandishing big numbers. And swing state adverts every few years are also unlikely to turn the tide.

As a handful of industry figures have noted, more firms must be willing to step up and make the case for private equity as a positive social force. Meaningful transparency and new indicators are likely to be needed to prove private equity firms build rather than erode communities, and deliver societal benefits. It is no longer enough to be a returns generating machine for LPs. The success of the industry may increasingly – and perhaps ultimately – be determined by its value to society.