How Private Equity can save Europe
Entrepreneurship is of key importance to the economic recovery of the Eurozone. According to Dörte Höppner, Secretary General of the EVCA (European Private Equity and Venture Capital Association), there is a huge demand for long-term investment capital. Companies that want to grow and finance this growth need capital. But these days, asking a bank for a loan is not the best solution.
“Private equity might be an interesting alternative for company financing, especially because it is much more than just pure capital: it is smart capital that offers access to a unique pool of knowledge and networks. On the other hand, there is a growing supply of long-term investment capital that is looking for high returns in a low yield environment.”
“The PE industry, and here I include venture capital, mid-market players and larger buyout firms, is an industry that exists for a very good reason”, Dörte Höppner said at a conference on private equity, organised by LFF and Ernst & Young Luxembourg. “This industry brings together the supply and the demand for long-term investment capital”.
At the heart of private equity is the relationship with the entrepreneur. Of the billions invested by the PE industry in European businesses each year, the vast majority goes to small and medium-sized enterprises (SMEs). Currently, the PE industry invests in 24,000 European companies and finances about 5,000 firms per year, of which 83% are SMEs. In 2011, European PE firms raised about 40 billion Euros. This has been the highest fundraising level since 2008 and represents an 80% increase compared to 2010. Institutional investors worldwide have 19.4 trillion euro invested in long-term assets. There is lots competition going on between fund managers around the world to get a part of this capital; about 1,800 PE firms are competing for these assets.
“PE and venture capital funds are, in effect, the talent scouts of company investments. They spend an enormous amount of time assessing the potential of companies to understand the risk and, of course, how to manage those investments. Once a PE fund manager invests in a company, either through majority or minority stakes, he is then active and responsible for working in partnership with the company. So PE helps entrepreneurs make their businesses grow. “By helping individual companies succeed, it helps economies grow too”, Höppner underlined. Furthermore, PE-backed businesses can benefit from a simple governance structure because there is far more direct contact between the shareholders and management.
The facts speak for themselves
In her speech, Höppner emphasised the importance of the PE industry for economic recovery by quoting recent studies: PE-backed businesses are less than half as likely to default as other companies. During the 2008 and 2009 recession, the default rate among PE-backed businesses was 2.8% compared to 6.2% for other companies. This indicates that PE makes companies more sustainable. Also, PE-backed businesses experienced greater growth in sales assets and employment than those without majority ownership by a PE firm. In addition, they achieved this growth thanks to operational improvement, in particular from sales growth, improving margins and free cash flow. As a result, PE outperformed the public market with 78% of realised investments making a positive return for its investors.
“It is the proactive strategies employed by PE owners of building the value of their businesses, rather than the additional leverage, that accounts for the majority of this outperformance. Part of the PE value creation came from driving business improvements in portfolio companies, evidenced by strong productivity growth. It also came from carefully selecting and backing the businesses and management teams that had the greatest potential to produce a step-change endowment”, Höppner said.
After hearing all this, it is clear that private equity can be a remedy for a struggling Europe. Apart from that, Europe has enough reasons to remain positive, in particular because of its expertise. Five of the top ten exporters in the world are European countries. Europe is also home to 148 of the 500 richest global companies. The European economy is diversified and hosts sophisticated companies that have shifted to high-quality niche industries with substantial revenue margins and with robust growth potential. Europe’s easy access to Western European markets also creates huge potential for company expansion. EK