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This recent article from The Guardian presses the panic button on the private equity industry. It contends that recent failures of prominent PE-backed companies, the changing interest rate environment, rising prices for acquisitions & the inability of firms to dispose of their portfolio companies at attractive prices means that the PE business model is facing an “existential crisis.” This excerpt addresses some of the issues associated with longer holding periods & rising valuations:

Private equity firms promise investors higher returns than the stock market, in exchange for holding on to their money for a longer time period, generally 10 years, a business model that’s been the same for decades.

“What has changed is that the price of buying a target company has gone through the roof,” as the number of private equity funds increased, explains Rosemary Batt, a Cornell University management and labor professor who studies the industry’s impacts on workers and companies. Healthcare companies that once sold at 11 times EBITDA, a measure of enterprise value, are now priced at 18 times or more, for example.

That makes exiting the investment for a profit even more difficult on investors – and on customers and employees.

The higher prices for buyouts are “putting even more pressure on PE firms to squeeze the juice out of their portfolio companies”, Batt said, at a time when there’s almost no regulation governing how they do that.

“They can engage in financial engineering or just slash and burn on the operating side,” Batt said. “And it takes years for anyone to really see it.”

As they hold the company, these investors generally channel free cashflow to “creditors and equityholders, often constraining capital expenditures, worker training, and safety investments”, the University of Chicago’s Business Law Review warns. Tightening macroeconomic conditions can result in forced restructurings “that are costly and value‑destroying for the going concern”.

Not everyone thinks the sky is falling, however. The article quotes Will Dunham, the President & CEO of the American Investment Council, who contends that the PE industry’s pockets are deep enough to weather a crisis:

“Private equity-backed businesses face the same higher interest rates and economic pressures as other companies, but they also have committed investment partners that can provide additional capital and keep investing through difficult periods,”

– John Jenkins