Private Equity’s Image Problem

Private equity funds are under fire these days. Their very size and success is starting to work to their disadvantage as the great unwashed public becomes increasingly uncomfortable with their concentration of power. Witness the fact that, in the fight to acquire Texas utility TXU, suitors Texas Pacific and KKR made overtures to environmental groups not only to help get the deal done, but one suspects as part of a larger image-burnishing effort.

In Europe, buyout firms are comparative newcomers, and resistance is growing. They are seen and financial manipulators, asset strippers, and enemies of labor (and mind you, those observations aren’t wrong, although they are made in an inflammatory manner). In the US, the concerns are more diffuse, but revolve around lack of transparency and concerns about undue influence, particularly as larger and larger enterprises are taken private. There are also more specific issues coming to light, such as anti-trust (the fad towards club deals appears to have abated as a result) and in a separate post, “Private Equity’s Tax Problem,” possible changes in the tax treatment of the partners’ income.

Sunday’s New York Times ran a story on the joint image/tax problem, “Of Private Equity, Politics, and Income Taxes:”

“What I worry about is really the political stuff that’s going on,” Mr. Schwarzman of the Blackstone Group said two weeks ago in Frankfurt at Super Return, one of the industry’s best-attended and most closely watched conferences. “There are people who are trying to, at a minimum, interfere with what’s going on in private equity business.”

Mr. Schwarzman was referring to the palpable political animosity directed at private equity in Europe, but he might as well have been talking about an undercurrent of ill will toward private equity that is beginning to bubble to the surface in Washington.

Indeed, the political maneuvering in Europe may be a preview of what is to come here. It started two years ago, when a German minister said the private equity industry was filled with “swarms of locusts.”

The environment has only grown more hostile since. In Britain, the European capital of private equity, union heads are calling for government investigations, and the Treasury minister has said he is reviewing the tax treatment of deals that use debt. Denmark has proposed a radical bill that could make taxes on private equity in that country so onerous as to drive out the industry. Late last week, the head of the Australian Treasury, Peter Costello, said he, too, wanted to review the tax treatment of private equity.

Not that these subtleties matter to most readers, but Peter Costello is the second most powerful person in the Liberal Party, which is staunchly pro business.

So the industry could use some good PR. But, based on a Financial Times story, “Private equity slams ‘hostility’,” these efforts appear to be getting off on the wrong foot:

The head of the US’s first private equity lobby group has hit out at the “extremely low” understanding of the industry by policy­makers as the sector launches its first campaign to head off public criticism of its growing role in the economy.

Douglas Lowenstein, a veteran lobbyist recently named by 10 of the largest buy-out groups to head the Private Equity Council, told the Financial Times the body would set out to prove that the industry’s deal-making benefits the whole economy.

Now I am not a lobbyist, but telling your counterparties that they are ignorant at a minimum isn’t very polite, and it comes dangerously close to sounding like you are telling them they are stupid. And you’ve just treated them as opponents, when there might have been a way to find common ground.

Now I don’t know where the industry found this guy, but his previous claim to fame was that he was head lobbyist for the videogames industry. Query how much that has in common with private equity. As I recall, the most contentious issue they had to face was the charge that their games were too violent. That puts them, Hollywood, and the TV industry on the same side of the table against worried mothers and a few shrinks. That isn’t much of a contest.

Plus he is missing how the whole basis of discourse is changing. He says he will “prove” that private equity benefits the economy “as a whole.” It may in the GDP sense, but it is unarguable that many private equity firms cut costs, often by cutting headcount, and they tend to be more aggressive about it than public companies. Now that may in the end lead to more productive businesses, but in the short run, it leads to job losses. No matter how the buyout firms dress it up, there is an element of wealth transfer: cost cuts that hurt the little guy benefit the private equity firm owners, their investors, and the top management team that has an equity stake.

So we the real issue here is efficiency versus equity, meaning fairness. Private equity has one paradigm, which is strongly biased towards efficiency (note there may be other ways of creating greater efficiencies and distributing the results more equitably; Louis Kelso, who believed in employee ownership and was instrumental in the passage of legislation that created employee stock ownership plans, later formed a firms that specialized in ESOP buyouts). That paradigm has benefitted from a cultural shift towards the right and a widespread acceptance in this culture of the benefits of efficiency. But with growing discomfort over rising income inequality, Democratic control of Congress and the likelihood of a Democratic president, it might behoove the industry of thinking about ways to temper its focus on efficiency with greater concern about fairness and impact on communities. The TXU deal illustrated that sort of thinking. Lowenstein’s harangue does not.

His talk will go over particularly poorly in Europe, where market fundamentalism is viewed with a great deal of skepticism. And if you read our related piece, the industry’s efforts to fight off changes in tax treatment of their earnings is not a wise battle. Someone at the IRS has apparently realized that private equity firm partners are managing to get their labor income treated as capital gains. If the public at large comes to understand what the private equity firms are arguing for, and have gotten away with, it will tarnish their image even further. It smacks of preferential treatment.

From the FT:

In his first interview since taking the post, Mr Lowenstein said: “In parts of Europe, there is a lot more overt hostility from certain constituencies. One of the outcomes is to avoid a situation where private equity becomes a political punching bag.”

Politicians and trade unions in Europe have accused private equity firms, which were last year branded “locusts” by Franz Müntefering, Germany’s deputy chancellor, of asset-stripping and savage cost-cutting at the companies they buy….

In the US, opposition has been more muted despite a sharp increase in the size of the funds raised, and deals clinched, by buy-out groups.

However, many in the industry fear that discontent with the large returns reaped by private equity funds and the fortunes amassed by its top executives could prompt politicians and regulators to take action.

Mr Lowenstein said the council, whose members include Kohlberg Kravis Roberts, Blackstone and Texas Pacific Group, would strive to fill the “knowledge gap” of Washington policymakers.

“The level of understanding of private equity in policy circles is extremely low,” he said. “There is both a lack of understanding and a lack of knowledge and either of them is problematic from a public policy standpoint.”

On policy matters, Mr Lowenstein said one of his first tasks would be to fight plans to increase taxes on the industry.

He said the council would lobby specifically against efforts in the Senate Finance Committee to increase the tax rate on the “carried interest” – the gains made by private equity firms on deals. “Yes, there is a proposal . . . obviously we have a stake in that,” he said.

The council is poised to commission research to back the industry’s claim that its deals help make companies leaner and more efficient and add value to the economy as a whole