George Anson, managing director of one of the world’s largest investors in private equity HarbourVest, has warned managers to “stand up and be counted” or risk constraint by regulators and legislators.
Speaking at Private Equity International’s 2007 European Investor Relations Forum in London this week, Anson said the conditions for financial markets were almost perfect, but for every investor pleased at the industry’s success there was also envy.
He said the debate with the unions in the UK and the US was triggered in part by excessive displays of wealth causing them to flex their muscles on behalf of their workers. Anson said: “The unions have come out publicly in recent months voicing their unease, and questioning the logic of employee pension funds investing in the very same groups that are putting their jobs at risk.”
The industry has to do a better job of explaining itself not only to its investors, but to the public at large, he said, adding: “What needs to happen is that the private equity industry needs to be much more mindful of the impact their decisions will make to the broader community, and the political capital they will lose if they ignore this constituency.”
However, Anson said: “One of the biggest concerns over-arching all this, is that with the massive fund economics and leverage at the disposal of the fund manager, the managers don’t even have to be half-right in their investment decisions to become incredibly wealthy personally.”
As an investor, Anson has concerns that some of today’s deals are being done at “eye-watering multiples, often above public market comparables”.
He said the equity component was continuing to decrease, as credit markets are falling over themselves to lend to these very large transactions. This has increased leverage and anxiety, Anson said.
According to Standard & Poors, the average leverage multiple on larger deals are 9.4 times EBITDA (earnings before interest and tax, depreciation and amortization) up from 7.0 times just three years ago.
Anson said: “Of course the wise old sages in the business will tell you that this is still a long ways off from the days when 6 cents of equity was all that was required, but the trend and risk is still clear. Businesses have less and less room to manoeuvre if their trading suffers a downturn.”
According to Anson this means if there is a private equity disaster, then “there is probably going to be a hell of mess to clear up, and it will require a great deal of effort and explanation to do so”. He said: “We should think about what our response should be.”
Anson is also worried by the proliferation of secondary buyouts, or sponsor-to-sponsor transactions. He said: “It’s been proven that actually these secondary buyouts have been generally successful, with executive company management re-investing heavily in second and third ownership rounds. But it still makes us feel a bit uneasy that we may be on a merry-go-round entitled the ’greater fool theory’.”
These deals in HarbourVest’s portfolio of larger buyout funds account for around 50 percent of the deals being done today.
Anson has a solution: “The rational response and advice to the current exuberant wave of private equity investment has to be to manage your fund sizes, don’t raise too much money and then don’t feel the consequent pressure of too much money bearing down on your decision-making process.”