How can Private Equity help target companies?
As frequently mentioned, the intervention of an institutional investor in the risk capital of a company is not limited to the contribution of new resources but may enable the company to enter into a new phase of its life cycle, influenced and supported by the collaboration with a professional interlocutor. The issue of the role of investors, who are not only “capital providers”, but real active owners who, working in support of the board and management of the company, contribute to the implementation of growth and value creation strategies, emerges centrally. As proof of the validity of this type of attitude, several studies have shown how investor activism can contribute to achieve higher performance than the market or the reference benchmark. But what exactly does this attitude of active ownership consist of? What are the corporate areas in which, by virtue of and respecting their role, the institutional investor can take part? Taking into consideration also the generalist nature of private equity operators, ordinary business is normally left in the hands of the entrepreneur or the management team, as subjects who have all the elements and information to be able to manage their development. Consequently, the area that most concerns the intervention of the operator is precisely the one with extraordinary nature characteristics, that is, strategic projects and operations that differ from normal company management. We should not forget that, regardless of any type of shareholding held, the investor’s interest is necessarily aimed at the revaluation of the investment, and, for this reason, his intervention will always be aimed at achieving growth and development objectives. Regarding this perspective, two considerations should be made.
In the first place, turnaround transactions are normally an exception, as they represent situations in which the purpose of the investment is the restructuring of the ordinary operations of the company itself, and consequently, the intervention of the private equity operator must necessarily be more invasive. Secondly, each transaction is in fact a world of its own and the attitude of the investor shareholder must always be calibrated on the basis of the investment objectives and the relationship that exists with the company. The areas which, according to the market practice and sector literature, are typically subject of intervention by private capital operators will be dealt with in detail below: Contribution of professional contacts and sounding board effect for the entrepreneurial idea. Support for the review of managerial processes and strategic framework. Support for internationalization, external growth, and creation of new business areas. Financial advice and services. Focus and investment in innovation, research, and development for greater production competitiveness. Support to the entrepreneur in dealing with managerial processes and possible generational transitions. Promotion of ESG practices. Each investor brings with him his own wealth of experiences and contacts, which can constitute a very important opportunity for the company for discussion and reflection. It is about accessing a vision through the eyes of an “outsider”, which gives the company the opportunity to analyze consolidated procedures and practices as opposed to the experience lived in other realities. According to some studies, most companies very rarely compare their management habits with market practices and, as a result, they often simply do not realize the room for improvement they could work on.
It is with this in mind that the investor can become a sort of “sparring partner” for the entrepreneur or for the management, acting both as a support and comfort interlocutor, and as a source of stimulus and “training” for the company in dealing with changes or actions of an extraordinary nature. Obviously, the situation is different when transactions such as buyouts are examined, where, de facto, the investor is the majority shareholder of the company and can therefore directly take positions on the managers and management methods of the company. An element to be considered in relation to this specific contribution concerns the operator’s previous experience, or whether the investor has a consolidated track record relating to the type of investment, or in-depth knowledge of the sector to which the investee company belongs. The investment by a private capital operator is also an important “amplifier” for the company, that is a great opportunity for visibility by the industrial and financial community. This is because, in many respects, the investment is seen as a confirmation of the validity of the business model, as well as the growth prospects of the reference market. In other words, the trust placed by the operator in the company, the entrepreneur or the top management is certainly a good business card to be able to benefit from both in the relationship with other lenders, and with customers and other companies in the sector.
This contribution proves even more crucial in turnaround investments, where the intervention and the contribution of external skills is normally the key to embarking on a successful corporate restructuring process. In a competitive market and in a rapidly evolving context, it is essential to be able to make optimal decisions in a short time and with good forecasting skills. In this context, the comparison with the institutional investor and the contribution of skills, experiences and contacts are particularly beneficial to the company, as well as greater efficiency of decision-making processes. Governance is one of the first aspects where the investor acts for a greater formalization of processes. This activity is aimed at protecting its position, but also that of minority shareholders. A well- structured corporate governance, in its strategic-organizational meaning, is an important source of corporate value creation, which helps to strengthen transparency and the exercise of shareholders’ rights. It is also possible to affirm that a greater investor activism often involves a more efficient use of corporate assets, with a general mitigation effect of corporate risk. Investor intervention usually stimulates the adoption of more transparent and structured management practices. From a survey conducted on a sample of 15.000 companies throughout the world through the analysis of 18 selected management performance indicators, it emerges that companies owned by a private equity investor have a better management quality than other types of properties present in the market. The improvement of management practices can be particularly influenced by the activation of numerous measurement and control activities of company management which are carried out, first of all, with an intensification of the corporate reform. Moreover, very often the intervention of the operator contributes to the creation of a well-defined and structured hierarchical organization, with a greater possibility and capacity of the middle management to autonomously make decisions relating to their specific area of expertise. An organization of this type is normally preparatory to the dimensional growth of the company and is particularly useful in avoiding that the know-how and decision-making junctions are centralized in one or a small number of individuals. In fact, a situation of this type, in addition to being particularly risky, can represent a major bottleneck for growth.
It should be remembered that more complex organizational structures cannot ignore well-defined and aligned schemes of objectives and incentives, which “retain” the management’s loyalty to the corporate strategy. Reference is made here to the incentive mechanisms described in the previous chapters, as well as to their structuring on the basis of a long-term time horizon. The aim is to promote as much as possible a great deal of transparency and alignment regarding the objectives and corporate interests, a fundamental element for the proper functioning of all processes. Secondly, several studies have shown that in companies where there is no active investor, management salary levels often do not reflect the actual contribution of the team to the creation of corporate value. From this point of view, the presence of the investor can in some respects be an opportunity to “restore” a correct monitoring of the performance and activities of the management. Finally, as already discussed in the previous chapter on investments, within the evaluation process the investor also analyzes, according to a management due diligence process, the structure and managerial skills present in the company.
The investor’s intervention can therefore be functional to attract new qualified personnel, whose entry can be facilitated and promoted by the investor’s activity. According to some research conducted by McKinsey, based on the observation of the transactions carried out by eleven private equity companies with a track record substantially higher than the market average, in 83% of successful investment cases the operator provides for the contribution of external expertise, through the strengthening of management, even before the closing of the deal. Another very important activity for which private equity operators often intervene to support the entrepreneur or the management team is the drafting of a well-framed and shared development plan (business plan). In parallel with financial projections and estimates, it is essential that a company periodically rethink its positioning and growth strategy within the reference market. In this regard, the investor’s contribution can be multiple. First of all, the preparation of an industrial plan must start from an activity of framing the company reality, its organization and the strengths and weaknesses of the structure and business model. These considerations are very often not dealt with in a structured way, due to the effect or absorption of the managers in the day-to-day, rather than the lack of a real need to communicate to third parties. We should also consider that this work cannot ignore the analysis of the external reality, that is, the macroeconomic and sectoral framework. The intervention of the private equity operator can therefore prove to be an opportunity for the company to stop and think about market changes and their implications in the various aspects of its operations. It should be considered that in many cases this activity is something completely new for a company, in particular for entrepreneurial realities or family businesses that have always been private.
For this reason, the drafting of the company business plan takes on the role of an extraordinary process, which must be properly planned and conducted. The main objective is, therefore, to create greater alignment and a greater sense of belonging for the main figures responsible for primary decision-making processes. This element, which is difficult to neglect, is at the basis of the overall improvement in company management performance. Parallel to the business planning activity, thanks to the collaboration of the investor, there is normally the launch of a series of extraordinary nature projects, linked to the achievement of specific strategic objectives that go beyond ordinary company operations. It should be remembered that often, as in the case of pre-IPO financing investments, projects of this type are at the very basis of the nature of the operator’s intervention. In this regard, the experience of the investor shareholder can be very useful both for the completion of the projects themselves and for their management and monitoring. For this reason, it is first and foremost essential to identify and equip the company with a corporate development team which structurally operates in support of company management as an interface for the investor. The primary object of the function’s activity is precisely the management of the extraordinary, or the coordination of projects of a strategic nature.
On a practical level, this consists primarily in the definition of times, responsibilities, and methods, but also in a continuous promotion, through the structure and management, of focusing and organizing for the development and success of the projects themselves. The presence in the company of a function of this type is of paramount importance for a company whose priority is external growth or internationalization, where the corporate development team is personally involved in the scouting of new acquisition opportunities, collaboration or other. Its contribution can range up to the management of a corporate reorganization process or redefinition of the business model or, as mentioned, to all activities that are not core of ordinary business management. On the basis of practical experience in literature, it is possible to highlight how in support of this activity it is essential to provide some tools and occasions that make it easy to align all the parties involved and help keep track of the progress of projects, reporting any points of attention. In this regard, one of the tools that should be provided is a “cockpit“, that is a document that summarizes the objectives, times, and methods of implementation of the main active projects. Periodically updated, a tool of this type is very useful as a basis for discussion and updating for alignment meetings, as well as to highlight any decisions to be made and accumulated delays. The cockpit is an extremely operational tool, considered beneficial for the series of positive effects that its use can entail. First of all, its adoption, thanks to the clarity necessary in defining coordinators and work teams for each site, has an effect of making the resources involved responsible. Secondly, the compilation of the cockpit requires the work team to organize a temporal development of the projects, setting intermediate terms and objectives.
The use of this type of tools also allows the investor to stay up to date and informed about the progress of the projects, in order to participate with impressions and comments in the development of the projects in which he is most actively involved. Basically, what is really essential, both for the strategic advancement of the company and for the maintenance of the relationship with the investor shareholder, is to provide for the structuring of processes and functions, with related work tools and roles, which are dedicated to the management and the monitoring of projects of an extraordinary nature. With reference to support for internationalization, as a fundamental contribution to the growth of target companies, numerous studies and empirical cases testify how, in many cases, many companies have to face various problems in the attempt to internationalize and fail to effectively carry out their internationalization strategies due to a lack of funds and human capital. In fact, it is estimated that 35% of European companies that do not invest in foreign markets are in this situation due to the lack of knowledge of the markets and experience in internationalization practices. Given the increasing importance of being able to expand in such a globalized market, a problem of this type can really prove to be an obstacle to the survival and growth of the company.
In this context, the operator can be decisive in terms of greater availability of funds, thanks to the possibility of providing new capital to support the initiatives considered, human capital and strategic guidance to support the definition of the strategy to be implemented. According to a study conducted on a sample of 340 European companies, the main efforts for the creation of added value by the investor in operations in later stage ventures, i.e., in already consolidated companies, they are specifically aimed at implementing successful internationalization processes.55 In fact, numerous studies show that companies owned by private equity operators are more easily involved in cross-border acquisitions, both as buyers and as potential targets. According to some research conducted in Italy on a sample of 154 transactions, in 82% of cases the intervention of a private equity operator contributed to improving the internationalization processes. As can be seen from chart 16, which incorporates the results of the aforementioned study, with a view to growth and expansion of the company’s business, both geographically and in terms of business areas, acting organically, through so-called “greenfield investments”, is not necessarily the only alternative. An equally valid option is to proceed by external lines, or through acquisitions an mergers to consolidate the presence in a geographic area of interest. In fact, growth through mergers and acquisitions can often be extremely advantageous to the extent that it constitutes a timely alternative to enter a new market by acquiring a good share of it right away. Alternatively, there are several tools for creating strategic alliances with local partners, such as trade agreements or joint venture agreements. It is precisely in this aspect that the contribution of the institutional investor can be particularly significant.
The private equity company has in-depth experience in the field of mergers and acquisitions: the investor has all the skills necessary to build and manage an operation of this type, from corporate valuation to structuring and conducting the deal. Skills that, certainly complex and of a specialized nature, are essential in order to be able to consider and implement a growth strategy based on external lines. Growth by external lines is certainly an option in internationalization processes, but also in the creation and access to new business areas, as well as in the acquisition of new technologies to support the expansion and improvement of the range of products and services. Distribution of the number of transactions by internationalization strategy during the holding period affecting company competitiveness is size, i.e., the ability to have the critical mass necessary to benefit from economies of scale and the strength and solidity to compete in the market. In this regard, the specific competence of the investing partner can be decisive in wanting to continue a growth path based on an add-on strategy, i.e., a plan focused on the acquisition by the company (platform) of one or more companies operating in complementary sectors or in new business segments that you want to integrate. It is also possible that the company wishes to internally set up a corporate venture capital division, that is a function whose activity is entirely dedicated to the scouting of innovative start-ups an owners of technologies that can help the company in facing the competition of its sector.
This can allow the company to build a greater competitive advantage over its competitors, being able to count on the possibility of internalizing in advance the skills that are critical for growth within the reference market, thereby “cannibalizing” possible emerging competitors. See for example the case of the American multinational Facebook Inc., which has long started a recurring activity aimed at acquiring from time to time, companies that stand out for the level of innovation and competitiveness within their sector, such as the popular Instagram and WhatsApp services. In all these cases the investor’s contribution, as active owner, is therefore particularly critical both for his knowledge and experience in extraordinary transactions of this type, and for the possibility of being a capital provider, supporting any banking institutions or other alternative sources of financing. Once again, however, a distinction must be made between the presence of the operator through minority or majority participation. It is clear that, in the event that the institutional investor holds a minority shareholding (as very often happens in growth capital operations), his role can be limited to a consultancy, influence and advice contribution towards the majority shareholders.
In the implementation of operations of this type. On the other hand, if the investor holds a majority stake, it can directly influence the strategic choices and promote growth by external lines as the main way to enhance the investment. The entry of the investor, in general, implies an improvement of the corporate image towards the market and the financial community, acting as a guarantee for the soundness and validity of the business idea. Especially in a context such as the European one, historically more focused on access to the banking system as a primary source of financing, the reputational element is even more important, as it provides the company with a tool to be used in negotiating with the credit institution for the access to more efficient financial instruments and more competitive economic conditions. In other words, it can be affirmed that thanks to the intervention of the operator, the company can see an improvement in the contractual capacity towards the banking system. With particular reference to turnaround investments, i.e., involving companies in bankruptcy or in any case in strong financial tension, the intervention of an institutional investor, especially if of a banking nature, has proved in many cases decisive for pool of banks or new financing plans for the revitalization of the company. This series of benefits is then expressed in the possibility of reasoning and redefining, with the support and supervision of the investor, a more efficient corporate financial structure, seeking the right balance between debt capital and equity. In practical terms, it is normally a study for the redefinition of the presence, type, and duration of the sources of financing, with the possibility of exploiting the contribution and income of the operator, and therefore in some cases also the occurrence of the so-called change of control, to redefine terms and conditions with banking institutions. Substantial changes to the financial structure of the company occur, for example, whenever the type of investment is that of the buy-out, where the very nature of the leveraged operation impacts its composition in order to make the most of the company’s debt capacity. On the other hand, in the case of venture capital transactions, where the investment is normally structured without the use of financial leverage and through a capital increase, the investment intervention involves an improvement in the capitalization of the company, effectively placing itself as an alternative to traditional sources of credit. Another fundamental of corporate financial coordination concerns liquidity management. Indeed, efficient liquidity management not only guarantees the solvency of the company, but also contributes to its enhancement. The operator therefore tends to be very focused on monitoring the aspects that have an impact on the level of liquidity, such as the trend in working capital and the level of corporate investments.in general, it can be highlighted how investor intervention can be beneficial for greater focus and more effective management of the corporate treasury. Everything always to be structured taking into
consideration the nature of the company’s business and its specific needs. The very presence of the institutional investor will also improve the management of relations with other lenders, who will most likely benefit in turn from greater transparency and will trust and feel protected by his support. Another great contribution of the institutional investor is the financial experience necessary when, among the future steps of the company, there is a further opening towards the capital market, that is the competence and support in extraordinary finance processes. Reference is made here, for example, to the structuring of various types of instruments, mainly relating to the world of private debt, such as bonds, convertible bonds, minibonds and much more. As already mentioned in the course of the paper, private equity, and private debt, in fact, although sometimes investing in companies that are not too dissimilar, are not competitors, but can in some cases even be complementary. The presence of an investor such as the private equity operator can in fact facilitate the collection of risk capital by the company, thanks to the experience already lived and gained with the investor and to the greater level of attractiveness of the company determined by the presence of an institutional participation. The use of this kind of tools can be very useful for the implementation of internal or external growth programs, or for the implementation of investments to support internationalization or entry into new business areas. With reference to investor support for innovation, numerous studies have shown that the intervention by private capital operators is able to accelerate the business innovation, with consequent effects on the productivity of performance. A possible objection could derive from the fact that this evidence is the result of a cherry-picking effect58, i.e., from the fact that operators invest mainly in companies more likely to generate innovation. In this regard, further research has shown that the intervention of venture capital operators, regardless of the previous characteristics of the company, leads to a significant reduction in the time-to-market of new products. Results of this type derive primarily from a greater availability of funds for research and development but are also largely the result of more or less concrete support for a greater focus on market needs and sector trends, derived in part from the previous experience gained by the operator and any resources employed in the company. In addition, supporting the planning and review of corporate management, management and control activities generally helps to create a more positive and efficient business environment in the use of corporate resources. Wanting to go into more detail, the intervention of the operator in the field of business innovation can refer to one or more of the following fields: Assistance and incentive for the review and solution of problems related to the application of existing products and services, quality improvement through the development of new and optimized production processes, and / or more effective technologies.Assistance to the company in the experimental development phase of new products or services, as well as in the resolution of any complexities and problems deriving from the early stages of industrialization and structuring of processes. Also known as the fallancyof incomplete evidence, is the act of pointing to individual cases or data that seem to confirm a particular position while ignoring a significant portion of related and similar cases that may contradict that position. Protection of the results achieved through support for the application of patents, definition of contracts and management of intellectual property, as well as the search for partners for the exploitation of patents. Facilitation and support in finding and training qualified personnel to be assigned to corporate functions for which technical-scientific skills are success factors. All these areas of activity are very critical success factors for the creation of corporate value, especially in sectors where competition is mainly based on the ability to innovate. Greater attention to these issues, promoted by collaboration with the institutional investor, can result not only in greater company activity linked to innovation, but also in greater economic relevance of the innovation generated. Faster development of new products and an increased level of innovation also contribute to increase the company’s responsiveness to the changing needs of consumers. With this in mind, many operators today emphasize the centrality of the issue of digital transformation, that is, the use of a combination of technologies and methodologies aimed at making business processes more efficient. It is therefore important to invest time and energy in the training of all resources, entrusting the coordination of the project to a dedicated managerial figure with the sensitivity to manage a change in the company’s balance. As already mentioned in the course of the text, a major issue that has become increasingly relevant in recent years concerns the adoption by companies of ESG policies, i.e., practices that take into account environmental, social, and good governance factors that are beneficial for the company and for the community in which it operates. This vision, increasingly focused on the creation of value by the company stakeholders, rather than just for the shareholders, is today at the center of the debate of the industrial and financial community, with the aim of encouraging companies to adopt virtuous behaviors that generate an impact in respect of the environment, of workers, and of society in its complexity.
Following this important signal, in recent years various ESG scores have spread on the market, i.e., rating systems which, similarly to traditional systems focused on corporate solidity, assign the company a score on the basis of which the main institutional investors have started basing their own investment decisions. In fact, we can recall several striking cases of large investors who have decided to take very radical positions with respect to issues of this type, undertaking to divest many of their shareholdings in companies operating with business models and in sectors that are not very sensitive to ESG principles. initiating very strict selection processes for new investments. This is therefore an extremely relevant issue, and above all linked to an extraordinary focus on the part of the company that the operator of private capital, in his fiduciary capacity to support the creation of value, cannot overlook. In this regard, there are essentially two aspects to take into consideration: a formal issue, linked to the need for the company to be competitive and obtain ESG credibility with the financial community, and a substantial issue, linked to the effective implementation of measures. for the preservation of the environment, respect for human rights and good governance rules for the creatio of value. At the end of the paragraph, for its original perspective, the opinion of Micheal Jensen, founder of the Managerial Economics Research Center and of the Journal of Financial Economics, deserves to be cited, who tries to give an answer to what ultimately is the main question. Why is it that private equity investors, normally without specific industrial synergies, are able to make returns on their investments that are often significantly higher than those made by so-called industrial investors? And why such returns do not derive, as some sometimes claim, solely from price arbitrage or the mere use of financial leverage, but are largely linked to the actual and substantial increase in value of the companies in which they have invested, which do they develop at widely higher rates and have levels of efficiency and margins often better than their direct competitors? Jensen argues that the ability of private equity operators to develop and enhance companies in the best possible way is mainly connected to their aptitude to act as active investors in the acquired shareholdings.
These operators, through their deep and active involvement in the strategic activity of the investee companies, allow what he calls “the reemergence of institutional monitoring of management”. In a context where widespread ownership and increasingly stringent rules on the use of confidential information have left management with an almost total, uncontrolled and uncontrollable power, like the US one experienced by Jensen, the presence of investors who return heavily and incisively to carry out a function of control and close monitoring of management, to the point of determining its replacement if deemed inefficient, would seem to be an effective and efficient response to the numerous problems created by what some define as the “excessive power” of management and / or the CEO. The tendency to leave management less and less monitored has in fact allowed, in some cases, a bad management of corporate resources, managing to destroy more than 50% of company value before incurring some kind of reaction from shareholders, often represented by a multitude of passive institutional financial subjects, frequently frightened of being too involved in corporate decisions. In Italy, apart from public companies or some large industrial groups, where such problems could be present, we are probably far from a context such as the represented one. Perhaps we are witnessing a contrary problem: that of the excessive concentration of ownership in the family. But on closer inspection, even family-owned companies could be subject, for other reasons and in different ways, to problems similar to those mentioned by Jensen. Problems due to what we could define as a phase of “immobility” of the property, as well as from an irrational and unreasonable use of company resources, in the continuation of an interest purely focused on ownership and not on the environment that surrounds the company.
Hence, in these cases, the logic set out by Jensen, although developed overseas and in an economic context very different from the European and Italian one, appears less distant and it could be that private equity operators, as long as they are professional and competent, acting with an active ownership approach, may represent a possible and, perhaps in many cases, desirable solution. Over the last few years, numerous research have been carried out having as objective the analysis of the contribution of private equity and venture capital operations to economic growth. Most of these studies are summarized in a document produced in 2013 by Frontier Economics for EVCA (European Venture Capital Association), which focuses on the impact of operations in terms of innovation, productivity, and internationalization. First of all, private equity is able to increase innovation, not just by providing capital for research and development, but also, for example, helping the company to focus on its own strengths. Typically, this impact is measured by the number of patents. The relationship between patents and economic growth is not clear cut, and patent regimes are not a primary determinant of growth. However, the vast majority of new product innovation gets patented, making patents an effective proxy of innovation activity. Popov and Rosenboom, for example, use data on 21 European countries in the period 1991-2004 and show how 12% of private industrial innovation derives from private activity equity, while private equity investment accounts for 8% of aggregate (private equity plus R&D) industrial spending62. This is explained by Popov and Roosenboom’s finding that R&D investment by private equity-backed firms is more effective than R&D investment by non-private equity-backed firms. Their estimates show that €1 of private equity finance can be up to nine times more effective than €1 of non-private equity finance in delivering innovations as measured by patents granted. The magnitude of this impact varies by sector, with biotechnology showing the strongest impact.
The key conclusion of this study is then supported by Mollica and Zingales (2007). They explore the direction of causality using data from 23.565 private equity-backed companies in the US. Their findings confirm that private equity investment (in particular venture capital) results in increased innovation, rather than the other way round (namely the argument that private equity selects more innovative firms). Furthermore, when companies are facing difficulties accessing finance, even if private equity funds select only the most innovative companies, the provision of funds to support this type of investment is still a valid contribution to innovation63. Also, according to a study realized by Gambardella et al. (2008), 116.000 patents are attributable to private equity-backed companies, for a corresponding value of 350 billion euros in the previous 5 years. Other research indicates that innovations delivered by private equity-backed firms are economically more significant. A 2011 analysis provided by Lerner, Sørensen and Strömberg on 495 leveraged buy-outs made on an international level between 1980 and 2005, highlights how operators help companies to focus on the areas that allow them to produce more innovation. They find that on average, the citations for patents increase from an average of 1,99 times before private equity participation to 2,49 after private equity investment65. This is crucial because it means that the initial investment in R&D and innovation by private equity funds is more likely to yield positive outcomes, generate a return and economic value.
Therefore, private equity appears to be associated with a beneficial refocusing of firms’ efforts to deliver increased innovation. Private equity firms also provide corporate governance support and business expertise to improve firms’ innovation efforts, as pointed out by Bloom et al. (2009). In addition to support for innovation, further research show how private equity contributes to making portfolio companies more productive, supporting aggregate economic growth. Productivity is meant as the efficiency with which inputs, such as capital, labor, land, and materials are turned into outputs. Increased productivity helps the target companies to deliver more goods from the same level of inputs. For example, a better practice for realizing a procedure may mean that is performed in a reduced time frame. Among the interventions that can be implemented by private equity investors we find, for example, strategic and managerial improvements, economies of scale, employee incentives, which lead to time saving and to a greater ability to exploit business opportunities. There are several ways to measure company performance. For the purposes of gauging the relationship between company performance and productivity, the most relevant measures relate to the company’s operational performance. As such, the typical measure used in research is the company’s operating profit per employee. The performance of private equity-backed firms has been researched widely. The majority of the research finds a positive relationship between private equity participation and company performance, showing a clear relationship between private equity involvement and company profits, growth, and survival. A study provided by Ernst & Young in 2012, analyzes 473 investments made in Europe in the period 2005-2011 and demonstrates how the target companies are characterized by an average growth in EBITDA per employee of 6,9%. Similar results emerge from a study by Davis et al. (2009) which, using a sample of US companies subject to private equity investment, highlights a differential in terms of productivity increase compared to comparable companies by 5,2%68.
Furthermore, according to the research, target firms experience an intensification of job creation and job destruction activity, establishment entry and exit, and establishment acquisition and divesture (all relative to controls) in the wake of private equity transactions. Moreover, a paper realized by Croce and Martì (2014), studying the reluctance of family firms to accept private equity investors and the impact of private equity on firm’s performance, highlighted how family firms that access private equity investors are mostly growing family firms, where funding and added value provided by the investor lead to a significant improvement in productivity growth. According to Kaserer (2011), about two thirds of the overall performance is attributable to strategic and operational activities, while the use of financial leverage affects only one third of returns. However, the study did not find robust evidence that investment returns are effectively increased by the leverage highlighting that the operating profitability of the target companies of the private equity is, in the first three years after the investment, 4,5% higher than non-participated companies. Another productivity indicator, used in many analyzes, is related to the degree of bankruptcy: some recent academic studies, including that of Tykvovà and Mariela of 2012, state that operator intervention does not increase the chances of default. As evidence of this, Thomas (2010) shows that the failure rate of private equity-backed companies’ is up to 50% lower than a sample of comparable companies. Another topic of great interest is undoubtedly the impact of private equity and venture capital on employment level: the above-mentioned EY study shows an annual growth in the number of employees in the target companies of 2,2%, against a European value that fluctuated during the period 2007-2011 between – 1,8% and + 1,8%. Beyond the increase in the level of employment, employees of investee companies are also more satisfied, as stated in a study of Gospel of 2010.A research provided by Scellato and Ughetto (2013), investigates the effects of buy-out deals on theex-post performance of target companies. The analysis is based on a sample of 241 private-to-privatebuy-outs involving European firms between 1997 and 2004 and a control sample of non-buy-outs.The study explores three different dimensions of the firm performance: size, profitability, andproductivity.
The results indicate a positive impact of buy-outs on the growth of total assets and ofemployment in target firms in the short- and mid-term. However, an equivalent clear pattern couldnot be identified for productivity, while they estimate a lower operating profitability for buy-outcompanies with respect to the control group three years a deal is made. Restricting the analysis to asub-sample of buy-out companies, they found that generalist funds negatively and significantlyimpact the average ex-post operating profitability of private equity-backed companies, whileturnaround specialists are positively associated with operating profitability. The evidence alsohighlights that target companies whose lead investor is located in the same country show relativelyhigher ex-post profitability performance.Regarding the employment contribution enhanced by private equity investments, a 2005 EVCAresearch paper reveals that private equity and venture capital play a vital role in the conservation andcreation of employment at a European level. The larger buy-out-financed companies the majority ofjobs, accounting for close to 5 million or 83% of the total number of people employed (at that time)by private equity and venture capital target companies. In addition to its role in employmentconservation, the study underlines the private equity role in the creation of new jobs. Between 1997and 2004, the buyout-financed firms surveyed in this study experienced an average growth rateemployment of 2,4% per year following the buy-out transaction. This is nearly four times the annualgrowth rate of employment in the EU 25 (0,7%) between the years 2000 and 2004.The third field of analysis on the economic impact of private equity is related to the benefits in termsof competitiveness: in particular, numerous studies demonstrate the contribution to the processes ofinternationalization, often very difficult for smaller or younger companies.
Private equity can play acrucial role in helping investee companies to overcome these hurdles in two key aspects: first of all,there is support in defining the best strategies for entering new markets. In addition, the necessarycapital is provided with the aim to implement such internationalization strategies. Based on data from340 companies, a study by Locket et al., for example, shows that the early-stage companies’ supportis mostly based on creating a propensity to export, while for companies at a later stage it relies inparticular in the monitoring of activities75. Finally, from a study by George et al. on Swedishcompanies (2005), emerges the greater inclination towards internationalization of firms with“external owners”, as in the case of private equity.After combining a review of the studies carried out in recent years at an international level, we can observe that most of them have found a decidedly positive impact of private equity on target companies, supporting them by increasing the level of innovation, productivity, internationalization, and competitiveness. However, in some cases there is also evidence of a non-positive impact on the performance of the companies in the period immediately following the investment.
Giuseppe Incarnato – Chairman & CEO IGI INVESTIMENTI GROUP
