Private equity can be controversial. Not only are fees on individual funds substantial, but the plethora of funds, ranging from venture to mega buyouts, European growth capital to emerging markets, and spanning every geographical zone and industry sector, means that all but the largest institutional investors need external advice and support. This, in the case of private equity funds of funds, may also entail a double layer of fees.
The public perception of the industry probably reached its nadir in 2005, when Franz Müntefering, then chairman of the ruling Social Democratic party in Germany, accused private equity firms of being “locusts”, chewing up good companies before spitting them out again.
Those comments sparked a great deal of global attention at the time. Today, they appear even more misguided than they did then. Europe’s economic future is not going to depend on its largest companies doing better. Their organisational frameworks make them naturally risk averse, while management, as the banking crisis has shown, in addition to being incompetent, may be completely unaware of what opportunities and risks they are actually facing.
Europe’s economic future depends on its small and medium-sized enterprises (SMEs) expanding to create jobs and wealth for the economy. Politicians of all hues recognise that. But SMEs face problems in accessing capital to allow them to grow. Only a small percentage of SMEs are large enough and sufficiently developed to be able to list on exchanges, while their traditional source of capital from European banks has dried up in the aftermath of the financial crisis and in the face of onerous capital requirements.
Private equity can fill that gap, providing not only capital but also expertise in helping smaller companies to grow and reach the stage where they can list. Even in venture capital – the highest-risk segment of the private equity industry – the future is looking brighter for European private equity. Cities such as London, Paris and Berlin are competing to become venture hubs, emulating Silicon Valley.
What the private equity industry does have to do, however, is recognise that the demands of long-term institutional investors whose time horizons span decades, are not best served by 10-year fixed-life funds, where private equity managers are incentivised to sell companies at the end of a holding period of just a few years, and often to other private equity firms that are raising funds from the same investors. Combining primary funds, secondary funds and co-investment within structures that align the long-term interests of investors with their managers may be the real challenge now facing the private equity industry.