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Fact vs. fiction: study shows how private equity really works

EmmaBy Emma Thorpe on 3 July 2012
Fact vs. fiction: study shows how private equity really works

There has been a great deal of debate about private equity and its impact on the businesses in which we invest. The name ‘private equity’ may give the impression that the industry wants to keep its methods secret. Actually, ‘private’ just refers to the fact that private equity tends to invest in companies that are not ‘public’ (i.e. listed on a stock market).

This month, leading accountancy firm Ernst & Young published an independent analysis of private equity investments since 2004 in large European companies valued at least at €150 million upon purchase, that have since been sold by the private equity investor. They found that these companies proved more resilient and profitable than other companies.

Profit growth can come from essentially three areas: purchase and sales of company assets, cost reduction and what is called “organic growth”, where profits grow through improving the business, such as through increased production and sales. The private equity investment can also increase in value by using debt sensibly when buying a company, then paying it down over the years of ownership (like a mortgage on a house). Finally private equity investors carefully follow market trends and aim to buy and sell businesses at just the right moment to maximise value (again as when you sell a house).

This study shows that it is not the use of debt or making workers redundant or selling off company assets that drives private equity’s success as an investor, in fact the biggest driver was operational improvement of the companies they owned.

These companies have also surpassed other firms in both job and productivity growth. According to the E&Y study, productivity in PE-backed firms increased by over 10% in France, Great Britain and Ireland between 2005 and 2011. Across Western Europe, there was a 2.2% increase in employment in the same period.

The study also found that PE has been working to ensure a steady transition after the sale and transfer of a company to new owners. The result is that companies invested in by private equity continue to improve. In 2010, PE was able to sell 57 companies, more than over the last years, and these companies’ organic revenue is forming an even greater portion of new profits. Though the European outlook remains uncertain, private equity is showing that it can contribute to lasting investment and growth.




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