For many, the words “private equity” bring to mind Gordon Gekko, or more recently, The Wolf of Wall Street, and the mantra that “greed… is good”. It is a reputation not entirely undeserved. Too often we’ve seen the dismantling of businesses at the hands of private equity funds that use junk bonds and leveraged buy outs to suck as much money as possible out of a business, leaving behind a shell of a company that eventually implodes into bankruptcy with nothing left but the aftermath of desolation and desperation for the former workers and the community.
Is private equity the financial equivalent of Bram Stoker’s Dracula brought to life? Yes and no. Although the Gordon Gekko stereotype may be well deserved, not every private equity fund operates that way. Some private equity groups do actually try to build value by improving the health of the business and/or growing the business rather than bleeding it dry. To be honest, even these “good” private equity funds don’t always succeed at building a business up, and instead end up cannibalizing it, so there are no angels here, but there are potential partners.
Partnering with private equity may sound like selling your soul to the devil to those in social justice movements, but there are opportunities for – dare I say it – “win-win” partnerships. The key is finding the right partners with the right opportunities. No, really. Think of this analogy:
You get in your car one day, but it doesn’t start. Do you (a) sell the car; (b) dismantle the car and sell off the parts; (c) spend the money to repair it; or (d) declare bankruptcy after defaulting on the car loan and letting it be repossessed? For most of us, the reasonable answer would be to have the car repaired if the cost is not too high and the car is worth repairing. For some private equity groups, the answer is not as obvious and could be any one of those options or combination thereof. The private equity groups we want to partner with are the ones who see investing in repairs and keeping the car running as the preferred option.
Of course, even with the right partners, not every investment they are engaged in will make sense. Some are going to be sucked dry, some are going to be sold at a premium, but some will continue to be low margin, low growth – but profitable – companies where the exit strategy is less obvious. Even before the initial investment is made, the private equity group needs to have an exit strategy developed, but sometimes things don’t always turn out as planned. Whether as a “Plan B” exit strategy, or as the plan designed from the start, a transition to worker ownership could make sense.
Consider this scenario: A troubled business is in negotiations to be acquired by a private equity group. The business could make money (or already does), but it’s a mature business with low growth and low margins. Instead of bleeding it dry, the right partner might be willing to invest in improving the health of the business, then transition it to worker ownership over a period of time, ultimately realizing a return on its investment from a combination of dividends and the sale of stock at a profitable, but fair, price that reflects the business improvements made by the private equity group. As an added benefit, there may also be tax savings on the group’s capital gains by using an Employee Stock Ownership Plan (ESOP) as a vehicle for the ownership transition.
The scenario runs essentially the same course for a private equity group looking for a “Plan B” exit strategy, but a shortened time-frame for the ownership transition could prove difficult to finance. A shorter transition time also means less time to transition the culture towards an ownership culture, which is as important – if not more so – than the financial transition and transaction.
Finding the right partners and the right situations may present limited opportunities initially, but success could breed more success as more “good” partners and “good” situations pop up. You and I might even start to imagine creating our own private equity funds and our own venture capital funds.