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In defence of private equity

The proposed takeover of UK supermarket Morrisons by a private equity firm brought out the usual criticisms of this form of investment. However, as IW Capital's Luke Davis writes, such opposition is unfair.

morrisons-private-equity
The deal to take over UK supermarket chain Morrisons has seen private equity firms come in for a great deal of criticism. (Photo by Tolga Akmen/AFP via Getty Images)

This year, in stark contrast to 2020, has seen a flurry of private equity deals announced or proposed. It has also been a record year for investment both domestically and from abroad in companies of almost every size. Not all of this investment, however, has been entirely welcome.

In one instance, the proposed takeover of UK supermarket chain Morrisons by US-based private equity firm Clayton, Dubilier & Rice has raised questions as to the motivations of private equity firms that have bought up British companies in record numbers so far in 2021. The potential move, which was announced in mid-June, sparked a significant debate as to the motivations of the private equity firm involved and the industry more broadly.

Concerns have also surfaced in some areas of the City of London that the takeover could affect jobs, pensions, public services and companies’ futures. Some have even gone so far as to say that private equity could be the wrong choice for many companies – particularly those struggling to survive an ever-changing business landscape.

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Private equity, when done right and for the right reasons, can be one of the most beneficial forms of investment and finance.

Much of this concern stems from private equity’s increasingly negative image in the press and compromised reputation among companies, but is that justified? And if so, are there any exceptions?

As with most questions, there is no absolute answer – nor is there a simple solution, but I hope to show that private equity, when done right and for the right reasons, can be one of the most beneficial forms of investment and finance.

Private equity: the defence

Private equity has come into the minds of many consumers and even more investors over the past few years in the UK, with large firms taking stakes in the likes of Premiership Rugby, and now potentially other household names such as Morrisons. This is perhaps nothing new to most experienced investors and had the names not been so well known, would have remained very much under the radar to the wider public.

There is a perception, perhaps, that private equity companies – at least for the moment – are swooping in and buying up companies at bargain prices, without much concern for other areas of the business or its customers.

To tar a large and diverse industry with a single brush would be wholly nonsensical.

This, to me, seems to miss the mark on what is a vital source of finance for businesses of all sizes. The private equity sector globally has more than $6trn of assets under management. Clearly this vast array of assets and businesses will not be run in anywhere near the same way the world over, and so to tar a large and diverse industry with a single brush would be wholly nonsensical.

There are, of course, examples of where it has gone wrong. However, there are many more examples of where it has enabled a company to grow, transform or restructure without immediate pressure from public shareholders. Private equity has also been among the best-performing asset classes for investors over the past few decades, another indicator of strong growth and performance.

A lifeline for SMEs

More important even than that, however, is the role that private equity plays in helping a critically underfunded section of businesses in the small and medium-sized enterprise (SME) sector. SMEs make up a vital sector of economies the world over, but especially so in the UK, where the companies with fewer than 250 employees contribute more than £2trn to the economy. This is a significant portion of the overall total and much of it is spent in local communities, something which has come to the fore during the pandemic.

In 2020, small companies in the UK received nearly £9bn-worth of private investment that otherwise would not have been readily available from other sources. In the hands of small businesses, this finance is vital to fund significant and rapid growth, both in terms of equipment and employees. Before the pandemic, small companies were hiring at a rate three times higher than large ones, which demonstrates how powerful they will be in tackling potential unemployment as a result of the end of furlough.

In 2020, small companies in the UK received nearly £9bn-worth of private investment that otherwise would not have been readily available from other sources.

This investment also almost always comes with advice, guidance and an outside perspective that can prove invaluable to a business looking to grow, scale or – given the current context – simply survive. Through angel investment and other forms of private finance, entrepreneurs are given access to advice, connections and introductions that can make the difference between success and failure or scale and stagnation.

SMEs make up 99.9% of UK private sector businesses and employ about 60% of the workforce. They are vital to the country’s economy and its growth. The economy in 2021 is already heating up and is set to return to pre-pandemic levels by the end of the year, and its continued growth will be fuelled by the small businesses that provide its foundation.

For example, one of the businesses IW Capital invested in during 2020 was a paper packaging business that pivoted to produce plastic-free personal protective equipment. Since the investment it has seen tremendous growth and has nearly doubled its workforce. This kind of example is indicative of the positive impact of private equity when it goes right.

Luke Davis is the CEO and founder of IW Capital.