Unfair shares
Many of us have worked for companies whose management was rubbish. But we may have stuck it out either because we loved what we do or because we had no choice (there was nothing better available). Either way we were part of the fabric of that business, what held it together in spite of the incompetence of the managers.
These days there鈥檚 a common escape route from the descent to oblivion for badly managed companies like these: they are often taken over and bashed into shape after being acquired by the funds managed by private equity houses.
Following a private equity takeover, the mediocre managers may be kicked out and replaced by better ones, who would be massively motivated to improve corporate performance by being given equity or sold it on very attractive terms. These managers can make millions, sometimes tens of millions of pounds, if they boost the value of these businesses during the three to five years they are typically owned by private equity funds.
But, in many cases, the employees who鈥檝e stuck with the business through thick and thin get zilch, nothing, bupkis. In fact it鈥檚 worse than that, as Paul Myners pointed out last week: there鈥檚 an increase in job insecurity for all, while the business is being reconstructed under new ownership; and some will lose their jobs.
And you don鈥檛 need to look further than that to understand why the campaign against private equity led by the GMB trade union is resonating in the way that it is.
Now as Damon Buffini said to me when I interviewed him on Friday, in the medium to long term employees do benefit as and when a weak company is transformed by private equity into a more confident and competent one (which isn鈥檛 by any means always the case).
But the head of Europe鈥檚 largest private equity firm failed to address the root cause of so much criticism of private equity: the fruits of success at a business in private-equity hands are very unequally shared.
Executives in the companies owned by private equity often make personal fortunes. Partners in the private-equity management firms accumulate wealth running to tens of millions of pounds each. Investors in private equity funds will frequently make returns on their investments well above the norm.
However, if they鈥檙e lucky, staff at companies owned by private equity get to keep their jobs.
My experience of some private equity firms over many years is that they are so arms-length from the employees of their companies that they view employees as statistics to be manipulated, not as people engaged with them in a common endeavour.
This may explain why they so rarely award equity in bought-out businesses to all staff. They seem to regard the spreading of equity to all employees as an unnecessary expense, but this is short-termist in so many different ways.
Sharing the rewards more widely would defuse much of the recent criticism of unfair shares and it could improve business performance.
And it would only undermine the viability of the more marginal private equity deals. I鈥檝e run the numbers on several recent private-equity transactions. And there would still have been very rich pickings for the owners and managers if employees had been given equity that ended up being worth a few thousand pounds per person.
The charge that the spoils of private equity are unfairly divided isn鈥檛 going away any time soon. What should really have worried the Permiras, Apaxes and CVCs this weekend was an editorial in the main section of Saturday鈥檚 Daily Mail attacking the practices of their industry.
Private equity has come out of the ghetto of specialist financial publications and is now being reported on newspaper front pages in terms that are highly unflattering to it. Some of the harm being done to its reputation could have been avoided if the thousands of employees in bought-out firms had been treated as partners in a common endeavour and co-investors rather than as anonymous overheads to be slashed.
The private-equity quartet plotting a takeover of Sainsbury should take note.
I'm 
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What is the issue here? Is it that employees are in threat of losing their jobs or that private equity houses are making too much money? Buffini accused the media and the unions of 'pay voyeurism' last week and I think he has a point. Surely by making a company more profitable and making bolt-on acquisitions to create a larger entity the private equity house provides opportunities for the employees to go on to make more money in the future. If a trade buyer is not expected to incentivise employees through shares or financial bonuses, why should a private equity house?
The idea of PE companies treating employees as partners in a common endeavour would be as worthy as turning the companies they buy into the best and most innovative in the world at whatever it is they do.
Unfortunately neither of these things is what actually motivates PE companies.
I agree with Preston's views. The private equity firms are asset-stripping by another name. Also firms can be traded like shares,between PE companies, with employees counted as so much stock. As there are no shareholders in the accepted sense, the higher echelons of the PE firms can do what they like and there's only themselves to share the spoils.
Further to June's comment concerning private equity having no 'shareholders in the accepted sense', this is not the case. Certainly PE houses do not have the shareholder responsibilities that come with being a listed company but then neither do most other businesses. They do, however, rely upon investment from pension funds and other institutional investors. If these organisations become unhappy with the way the funds are being invested or the level of fees that private equity houses are charging they will stop investing. Therefore to portray private equity houses as totally free of responsibility taking what they wish is incorrect.
What the unions and the tabliods seem to overlook is the fact that private equity firms take on large amounts risk when they enter into these deals. As such they deserve to be well-rewarded for their results should they succeed to turn things around.
No risk - no reward.
If there were no reward, such deals would not be made and the company & it's employees would likely continue their spiral towards 'the wall.'
As such, private-equity deals offer a decent chance of turning already-insecure jobs into something far more concrete.
I concur exactly with what Robert says.
I'm a chartered accountant advising charities on their financial affairs and a Quaker. Employment of staff is a responsibility to be taken seriously and not merely a cost to be cut as part of a financial re-engineering exercise to enrich the directors of a company and their private equity backers.
There is a wider context to this unequal sharing of wealth driven by quite ruthless cutting of costs. What is the environmental cost of sourcing materials abroad simply to cut financial costs?
What pension provision is to be made for staff as opposed to directors? And what responsibilities do private equity funds have over and above paying tax on their profits? There was a lot of talk over the weekend (24 02 07) about the gun culture in parts of London and other cities. Responsible employment practices help to build sustainable communities where individuals feel valued and trusted and able to reach their full potential.
There is a need for a great deal more transparency and accountability over the private equity industry. Let the debate begin!
Part of the problem is that the tax rules are skewed heavily against equity participation by employees. I advise companies on employee share participation and always encounter the basic problem that the best schemes for employees (like Share Save and Share Incentive Plans) can't be offered to employees of private equity backed companies because of the maze of restrictions that the legislation places upon these sorts of schemes.
If employee share ownership is a genuine priority of the government then they should seriously consider a liberalisation of the regime that applies to all employee share plans.
Private equity backed companies would like to extend employee share ownership, but the complex rules governing the taxation of employees' shares introduced in FA 2003 make it too complex and too costly.
What critics of PE seem to forget is that a company can exist without employees. Employees are assets or liabilities of a company depoending on whether or not they are making money, a company has no legal or social obligation to have a certain number of employees but it does have an obligation to its shareholders. If employees want rich rewards, perhaps they too should show initiative.
Whether or not to give employees a share of the equity of the business is not an issue of whether the business is privately owned or not.
From any employers point of view, it is an issue of whether this will actually lead to better performance overall. For a large company, the total result is very far removed from the input of a single employee, yet as a share owner he or she benefits (or loses) regardless, there is virtually no link between the two. Not so for senior managment (although they too should not be rewarded for simply being the manager in a rising market).
Arguably rewarding employees (PE or not) for their individual or team performance can improve overall results, but that's down to the judgement of shareholders (through their management representatives), and if the PE firm agrees with the previous owners on this point, and it adds to the overall value of the business, that's probably the correct decision.
However, if there are rewards to be distributed, being rewarded with shares is equivalent to getting a (non-discretionary?) bonus and being forced to invest it in the same company that employs you. From a risk perspective it is probably the last company in the world you should invest in, as a downturn or bad management could hit both your shares and your income. If it's a privately owned firm, there may be no open market for the shares, so add a big whallop of liquidity risk on top.
Spot on. Its not just normal employees that get squashed, its many of the good senior management as well. Equity companies in common with corporations with a serial takeover model of growth have simple tools. One of those tools is of course to avoid "duplication". But who do you keep? Well..Ive been through two large takeovers and in both cases there was an effort to keep the paperwork clean by "finding the best person for the job". In all cases of appointment however, they did the human thing, and appointed people they knew, regardless of the capability or track record of the existing people doing those jobs. It becomes a company where your track record immediately becomes worthless, and knowing the right people is the most important aspect. Unfortunately you will always lose in this company politics game if you actually deliver on your job, as you can never have as much time as those who wander around with no deliverables!
Many people have share options and the takeover or venture capital is "spun" as a good thing that will payout money to those employees by realising value. However, the truth is that the deal usually involves a venture company coming in at a good rate, but nowhere near the low share option price of original employees. So those original employees now have to try to hold on till the new guard can make a profit, which is often years away...and the law only allows redundant people to keep share options for 6 months...so if you get made redundant you lose EVERTHING.
"William wrote:
Surely by making a company more profitable and making bolt-on acquisitions to create a larger entity the private equity house provides opportunities for the employees to go on to make more money in the future."
But the opportunity doesn't GO to the workers. It goes to the people at the top. Despite the fact that without workers you have no product to sell.
IIRC, Ben & Jerrys have everyone on the same salary (they have twice as much, but that's the only differential). The thought behind that is: if you think the Janitor is getting such a good deal, YOU go round cleaning the clinks out of the pan.
Thanks to William for putting me right about the responsibilities PE firms have. So long as things are going well, then, there will be no questions asked from the said investors. I suppose it was ever thus in an unregulated industry. Chris points out risk-takers must be well-rewarded. I agree, but the degree of reward in relation to the degree of risk taken is arguable. How can one compare the risk involved in taking over something like Sainsbury's, as against investing in a fledgling business, one with no juicy property portfolio? Employee posters in large concerns, please remember that your firm could one day be in a PE firm's sights.
I worked for a successful division of a very well known global telecommunications manufacturer bought out by one of the private equity firms you name above.
For many, many years it had enjoyed loyal customers, loyal employees, and profitable revenues.
Within a couple of years, it had lost them all.
And the process was BRUTAL to those who endured it.
While a feeling of schadenfreude is tempting, seeing those who care for nothing other than money losing so much of it in its pursuit, I take no pleasure in the seeing the company reported recently as having defaulted on bond payments and handed over to its creditors to stave off total collapse.
So let's not buy into the myth that these private equity companies know how to run a company better than the people who built it up in the first place.
I learned something from the experience though. If the company I currently work for should ever suffer the grave misfortune of a similar buyout, I won't hang around. I'll be quitting the next day and leaving them to it.
Never again.
Robert
Why should private equity businesses share the fruits of business success with employees in a way than listed companies do not? Because they are criticised by journalists? Is that how business should operate? Will that promote the efficient use of scarce resources? Surely the fruits of success should be allocated in accordance with the scarcity of the resources (yes that is demand and supply). If we dictate by pressure and regulation that low skilled workers be paid high wages because they work in private equity owned businesses at the expense of higher skilled labour in those businesses, where's the incentive to become high skilled?
If businesses - and not just private equity - behaved in this way they will just find that their most talented people leave and go where they can earn more. Footballers and actors make very large amopunts of money not because it is fair but because their skills are rare in relation to the demand for them. Less skilled footballers do not demand a share of Beckham's pay just because they play in the same team!and I don't hear journalists clamour for successful popstars and actors to share out their earnings with less successful ones. The same is true of managers and investors in private equity owned businesses. As you say not all of them are successful.
Your argument that workers in private equity end up working in higher risk businesses in not true. Where's the evidence for that? Your repeating the propaganda you have heard.
Your thinking is more soviet thinking of the 1960s - asking for resources to be allocated according to adminsrative whim in a way that is totally contrary to the market. The market rewards valuable scarce skills significantly and the returns that people with these skills encourages others to invest in the education and training to acquire them. If people feel they are under paid they can move to other businesses that pay more. It is in the interests of the whole of our society that this continues. If we persist in attacking private equity for its success it will just go elsewhere. Then we will all be losers
City Boy
Mark wrote: 鈥淭he opportunity doesn't GO to the workers. It goes to the people at the top. Despite the fact that without workers you have no product to sell.鈥
I agree with this in the short term. However, when a private equity house disposes of the business, generally in about three to five years, it will be selling a well organised profitable business. Assuming the trend for secondary buyouts (where a PE house sells to another PE house) diminishes as is expected, the PE house will divest to a trade buyer or through an IPO. Then the employees of the company will have the opportunity to further their careers in a well run dynamic business with better opportunities than before the period of PE ownership.
Pretty dumb blog for the Business Editor of the 成人快手. Full of leftie claptrap. Since when does the market allocate returns based on what some journalist thinks is fair? Why is not fair that the investors who puts up the money and take the residual risk get ALL the rewards? If employees in private equity businesses don't like it who is stopping them from leaving?
Re: 'Thomas' (comment no 7)
In light of the current severe restrictions on the issue of all-employee shares in private equity backed M & A activity (as explained by your correspondent Thomas) it is surely necessary for the financial authorities, backed by the Treasury/HMRC, to revisit FA 2003 as a matter of some urgency.
In depth research on both sides of the Atlantic is unequivocal - when the workforce as a whole is given an equity stake in the business, overall performance tends to improve, as compared with peer group companies who do not award equity to rank-and-file employees. (A Hewitt study involving more than 200 companies put the extra ROC at an AVERAGE 2.36 percent pa in those companies which had adopted ESO) All-employee share ownership is not a universal panacea, but it does tend to raise workplace performance levels over time - and that should interest the private equity backers.
If you look at the history of some of these takeovers, and the debt put against the underlying business rather than against the acquirer, then it is rubbish to say the PE companies take the residual risk. This blog is hardly leftie claptrap when you have read some of the other articles, it is barely even pointing out that rewards are disproportionate against activity, rather it is saying that employees should be valued and rewarded - what is wrong with that ?
I agree with the comments about the restrictions on share issues to employees - but that is a fundamental problem to do with the ridiculous taxation differential between shares and share income and employment income. A discussion for another time.
Remember, however that salary bonuses have the same effect!
However the real reason that employees are not involved in the rewards of private equity has to be laid firmly at the feet of the unions.
If they spent less time trying to create a socialist utopia and more time cutting deals that got the best return for their members then everybody would be better off and some of the private equity wealth would end up in the pockets of those who create it.
Why aren't the GMB sitting down with the PE companies and asking where their share of the pie is?
There is no such thing as a typical private equity "buy in" because businesses are different. But there are some general rules. Here is a worked example using Sainsburys as the case.
Always have the exit strategy planned before you start and don't pay too much so that you can't make your profit objectives. Buy the company... sell the property (in this case) pay yourself a tax free special dividend (拢1b+). Now you will need to restore and increase profit levels so manage the operations get back the rent you will be paying the property buyer. .(拢250M +into the bottom line) Normally just screwing everything up and working harder will not produce the necessary results... so now cut the service levels as cunningly as you can so customers don't notice too much (and cut..cut staff as you do it) .. how about longer check out queues, reduced product range, increased stock outs (to M&S Food levels?) hidden price increases and lower quality/price ratios. (can you actually 'Taste The Difference'?). Simplify and outsource overheads (anything transactional like Human Resources and Accountancy(buy me to help with HRM!) ) You only need to incentivise those staff who you must keep because they have irreplacable company specific skills or knowledge.
Even then you will need to load the balance sheet up with debt (and some other financial engineering?). Sell the company on a rising stock market, so someone less risk averse than you ( you've made you money!) will buy. You must aim to make 20% capital gain per year of owning the company. (net of what you pay yourselves as a directors and as partners in the private equity venture.)
There is therefore in PE buy ins a financial engineering component, a management component and 'spin' componant to the process. You you will need to buy people for the latter two. These are the people whom you will have to cut in on your deal to make sure they stay on message.
Call me if you need help!
Employees must vote with their feet if they feel that they are not getting a fair deal. You are your companies most important asset and if you do not feel you are properly valued then find someone who will value you. It is much easier to find a new/better job these days with the job market shifting from favouring the employer to more favoring the employee. The various online recruitment sites such as Monster, CV Ads, fish4 etc now make it very easy for employees to find suitable employers much more easily.
Very difficult, I should think, for new management to enter a business that they know nothing about and boost profits and long-term growth prospects.
I expect a far more common scenario is for existing senior management to suppress profits, arrange finance for a buy-out (with new private equity appointed Chairman & NEDs, to keep an eye on the investment) and then, hey presto, the hidden profits are 'unlocked' and the value of the business escalates accordingly. Or am I just an old cynic?
This is, of course, illegal. But, also, impossible to prove!
And don't imagine that if employees get shares in the on-going Private Equity backed business they can look forward to a secure retirement. When things go wrong (and they often do when saddled with too much debt), PE firms, fearful of breaching bank convenants and being seen with egg on their faces, put through rights issues and dilute employees out of sight.
Don't hate the player, hate the game. Employees have to make themselves valuable to their enterprises and the PE firms that take over their employers. Nobody fires people and reorgs an acquisition for fun. I be sure to compensate management and others of an acquisition the best way possible to get them to stay, provided I wanted them to.
Ah capitalism! It slithers so gracefully through the halls of democracies.
Des Currie