What are private equity firms doing in the modern economy?
The term Private Equity is one that many of us have heard at some point, especially in recent years. But the term tends to cause some confusion as to what it actually means. In this article we will go over some of the fundamental principles behind it, as well as the variety of opinions that have been formed, because the private equity process is sometimes controversial.
Private equity firms basically find companies to buy with a long-term or medium-term vision of making them profitable once again. The art of private equity is the ability to identify companies that have great potential, but have not yet realized that potential. The idea is to find the quickest route to profitability, before selling the business for a substantial profit.
Private equity firms obtain their capital from private sources, as opposed to public ones. These sources can be rich people or pension funds, etc. The entire process is centered around the idea that profits should be made quickly and overall rewards should be enjoyed as quickly as possible.
Most governments around the world, as well as the British government, believe that private equity firms contribute greatly to the British economy, improving market discipline and generally making companies much more competitive. Since 1983, the industry has invested more than £80 billion in some 29,500 UK companies.
The process is sometimes criticized in some quarters as being seen as unnecessarily harsh on failing companies. In many cases, the company’s assets will be sold without regard to the effects on the workforce. Sometimes called ‘asset stripping’, it can result in a lot of redundancies, which obviously causes a lot of hardship on the families of the associated workers and has knock-on effects for the whole community.
Another criticism is that many of these important decisions are made behind closed doors without any dialogue between many of the parties involved.
Companies like AA and Birdseye have been subject to private equity firms and as such both have had what some consider to be tough decisions regarding them. This essentially means job losses, the cold side of modern capitalism.
Arguably, these companies would not survive without some type of large-scale investment and reinvestment, and many would argue that they simply accelerate the negative effects of a company’s health and drive it to profitability more quickly. In short, they are a reminder that everything is done for the good of the profit margin and not for the good of the worker.