by Ryan Ong
PRIVATE equity likes to disguise itself as the “boring” part of the finance industry, in much the same way Satan disguises himself as a little girl in those exorcist movies. One minute a company is donating money to Greenpeace, and the next it’s buying unwanted orphans from third world countries to club baby seals to death. That’s when you know a private equity firm got involved.
Still, despite combining the social skills of an accountant’s corpse with the ethics of Joseph Stalin, private equity firms are considered respectable institutions:
What is private equity?
Equity refers to ownership of an asset (in this context, we’re talking about companies). When you buy shares on the stock market, you’re buying equity. When you work for free to own a percentage of the company, you’re getting sweat equity. So private equity refers to private ownership of a company; as in “not available for the general public to buy on the stock market”.
An example of private equity would be if your buddy offers to give you a percentage of his company, in exchange for you putting S$50,000 in it. This raises capital for his business. If his business grows significantly, the value of equity in the company grows along with it – so the portion of the company you bought for $50,000 might, for example, be sold for S$500,000.
But if his business fails or collapses, you’ll just have to remember Singapore is a very small island, with limited room to hide the body.
There are companies that specialise in private equity. These firms take money from wealthy investors to put into various businesses (read: buy the businesses). They then attempt to steer those businesses to greater success, through strategic suggestions such as “burn down that homeless shelter for six-year-olds and build a casino over it”. Later, they sell the (hopefully more valuable) business, and both they and their investors get rich.
At present, many private equity firms are showing an interest in Singapore’s offshore and marine industry.
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How do private equity firms make so much money?
There are different kinds of private equity firms, but almost all of them make money the same way: they charge a fee for managing assets, typically two per cent of the total assets managed per year. So if a private equity firm is managing $700 million worth of assets (pathetic by their standards, by the way), that’s $14 million a year.
In addition, private equity firms try to grow the businesses they buy, over a course of five to seven years. At the end of this period, the business is sold off. The private equity firm will get a cut of the sale (often 10 to 20 per cent). Coupled with their already high management fees, you can see why many of these firms can afford to buy their own planet.
Why do so many people seem to hate them?
It’s not uncommon to hear criticisms of the fees charged by private equity firms. Last year, Yale University came under fire when it was discovered that, in 2014, they had paid US$480 million (S$696.1 million) to private equity firms to manage part of the university’s endowment.
The amount spent on tuition assistance, research, and other things universities are supposed to be doing? A sad US$170 million (S$246.5 million).
Private equity firms also attract controversy due to their “buy to sell” mentality. Typically, a private equity firm seeks to buy an under-performing business, drive it to higher profits at any cost, and then abandon it once it’s sold. They don’t really care about the fate of the employees in the business.
So when a private equity firms buys your company, what you can expect is for them to aggressively cut costs (read: reduce benefits and fire people), while using every possible means to pay you less, and make you work more. Back in 2012, US presidential candidate Mitt Romney was attacked due to his involvement with Bain Capital, a private equity firm notorious for these tactics.
But some people see private equity firms as a kind of saviour
A counter-argument is that private equity firms are a corrective measure.
Sure, they’re vultures who result in some people getting fired – but those people were unproductive employees, who could have driven the company to the ground (thus costing everyone’s jobs). Private equity firms might force a business to shut down low margin services or product lines, and sometimes destroy a company’s culture and heritage – but that could mean the employees will start to see raises and bonuses for the first time in decades.
From this perspective, private equity firms are a way to save jobs. They’re sort of like Gordon Ramsay in Kitchen Nightmares, causing breakdowns and kicking people out, but theoretically improving the business.
Of course, that’s a theory that will get you punched in the mouth, if you explain it to the people who got retrenched when their company was bought out.
Featured image Private Equity Forum 2015 by Flickr user Maik Meid. (CC BY-SA 2.0)
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