PE boasts resilience to downturns

GPs provided companies with greater capacity for investment and growth during the financial crisis, according to a study from the National Bureau of Economic Research.

With some private equity firms raising mammoth distressed debt vehicles ahead of a potential downturn, academic research from a US institute has provided evidence that private equity-owned companies are likely to perform better in a downturn than non-PE-owned peers.

The National Bureau of Economic Research’s Private Equity and Financial Fragility during the Crisis report, which analysed the performance of more than 500 private equity-backed UK companies during the 2008 financial crisis, found private equity firms experienced a smaller decline in capital deployment during the recession than non-private equity-owned peers.

Private equity-backed companies also increased their assets more rapidly relative to the control group and enhanced their market share.

The resilience stemmed from greater access to capital among private equity-backed companies, the study noted. Private equity sponsors were able to invest dry powder raised prior to the crash and had stronger relationships with banks, making it easier to raise debt for their portfolio companies despite the tough economic conditions.

“Our evidence is not consistent with the overall negative view of the private equity industry,” Shai Bernstein, co-author of the study and a Stanford scholar, said in a September statement.

“We did not find evidence that private equity-backed companies struggled more than their peers because of their high leverage. To the contrary, we found that they managed to invest and grow more rapidly during the crisis.”

Just 2.8 percent of private equity-backed companies defaulted during the 2008-09 financial crisis, less than half the 6.2 percent reported by comparable businesses, according to 2010 data from the American Investment Council.

From an investor perspective, private equity deals made during the immediate pre-crisis years also performed reasonably well.  Deals made between 2006-08 generated an 11.5 percent gross pooled internal rate of return and 6.5 percent mean revenue compound annual growth rate, with a slight drop in IRR attributable to longer holding periods during the crash, data from investment decision platform CEPRES showed.

The research challenges the perception of private equity creating financial instability during a crisis. Bernstein cited Bank of England concerns that buyouts should be monitored for “macro-prudential” reasons.

“The resulting increase in indebtedness makes those companies more susceptible to default, exposing their lenders to potential losses,” David Gregory of the Bank’s markets, sectors and interlinkages division said in a 2013 bulletin.

“This risk is compounded by the need for companies to refinance a cluster of buyout debt maturing over the next few years in an environment of much tighter credit conditions.  From a macro=prudential policy perspective it will be important to monitor the use of debt in acquisitions in future episodes of exuberance.”