In Scotland, private equity investment increased by 54.5% in the first half of 2021 - a key driver for the business community during what has been a challenging period for business and growth plans.
However it is a source of investment that can polarise opinion. For some, private equity investors represent all that is bad in the 'greed is good' culture. Asset stripping and profiteering at the expense of the workforce or over-burdening otherwise successful companies with debt, that leaves them in a precarious position should trading fortunes change. But while there are some well-discussed examples of that sort of bad practice, private equity investment is mainly done in a diligent and responsible way and the rigours that the investment regimes bring can help to promote and accelerate the type of governance and responsibility culture that is valued in today's society.
Equity investors' money is among the first to be lost (before any bank lending) if a business fails, so rarely, if ever, is investment carried out on a whim. An investment house will invariably spend tens, if not hundreds, of thousands of pounds on investigating the mechanics of the target business. The diligence undertaken allows the investment house to decide whether the target business is in an acceptable position to merit investment, and also allows the business itself to improve its operations by implementing the recommendations made in the diligence reports. Often a '100-day plan' is implemented, asking the company to make positive changes within 100 days of investment being made.
It is telling that companies that have benefited from equity investment are considered as good future investment propositions by both trade players and equity houses alike, due to the discipline involved in responding to incoming investment diligence and the ongoing reporting and compliance requirements of private equity investors.
As seen by the shift away from investment in hydrocarbon-based businesses in Scotland's North east, equity investors respond quickly to compliance and governance changes and will often decline to invest in target companies that are not compliant, not just with legal requirements but also ESG and other valued metrics. The consequences can be severe for those starved of investment but that approach, in the long run, benefits us all and encourages transition and compliance. Companies that already have investment are required to comply and companies that want investment sharpen up their procedures to become more attractive.
Equity investment is also a valuable tool for businesses and plays a crucial role in helping companies to grow, with the spin-off benefits that then arise for communities.
Banks will only lend so much, and nearly always on a secured basis, so that can leave a gap in financing. For businesses to grow and flourish, equity investment is the next stop. That investment does represent a riskier proposition than secured banking but without access to that level of finance, many businesses would be constrained in their growth, with a resulting impact on the country's economy and labour market.
The role of equity investment for owners and managers of businesses is also worth exploring. In a market dominated by trade buyers, the sale prices achieved tend to be lower than in markets where there is competition from private equity houses. You only need to look at oilfield services in the North east to see evidence of that and the difficulties that can arise in selling businesses and realising true value without private equity competition to keep processes genuine.
In times of uncertainty the use of private equity to allow de-risking of ownership is invaluable. On the back of the 2008 financial crash, Brexit, local political uncertainties, and now the pandemic we have seen owners sell part of their shareholdings to private equity houses, which allows owners some financial security at the same time as opening up a line of investment for their businesses.
Managers also benefit. The opportunity to acquire a business from a retiring owner is minimal without the help of private equity investment and that can then help to maintain that business' independence. That in turn generates opportunities for the new owners and reduces the chances of redundancies and attrition through the type of rationalisation that often takes place with trade acquisitions.
Undoubtedly, there are risks involved in accepting equity investment and there are some negative cases that merit scrutiny, however in the right circumstances private equity represents a valuable and responsible investment method, which has benefits for society as a whole.
This article originally appeared in the Scotsman's special deals report on private equity.