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Private equity is under pressure. Higher interest rates and a still sluggish new listings markets have made it harder to sell holdings and return cash to investors. That in turn has made it more difficult to raise new funds because pension funds, endowments and family offices have less money to allocate and a growing array of other options.
One way to tell that the squeeze is starting to bite is the recent announcement by Blackstone, the biggest and best-known PE firm, that it has launched a “shared ownership initiative” to give workers at its portfolio companies an equity stake. The programme will start at Copeland, which Blackstone bought for $14bn last year. When the climate control group is ultimately sold, its 18,000 employees will receive payouts tied to the PE firm’s profits from the deal.
Blackstone has plenty of company: rival KKR began offering ownership stakes in 2012, and a charity founded by firm executive Pete Stavros has signed up nearly 30 PE firms — but not Blackstone — to do likewise. Ownership Works has helped organise employee share schemes worth nearly $400mn at 88 companies and is targeting $20bn within a decade.
For private equity firms struggling to woo new investors, these plans have multiple attractions. First, they allow PE sponsors to argue that they are helping address social inequality, unlike the private credit and hedge funds with whom they compete for allocations to “alternative investments”.
Such claims are likely to resonate with investors who are concerned about PE’s role in directing most of the profits from productivity gains to investors rather than workers over the past couple of decades. The outgoing investment chief at Calstrs, the second-largest US pension fund, has explicitly called for increased profit-sharing by PE firms, and the head of New York State’s pension fund has advocated for employee ownership more broadly.
However, the growing enthusiasm for shared ownership plans ought to be about more than marketing. Higher interest rates have fundamentally changed the game for private equity firms, forcing a rethink of how they do business. Between 2010 and 2021, borrowing accounted for half of all of PE’s performance, according to consultants StepStone.
But that strategy falters when interest rates are higher. Loading a portfolio company with debt hits its bottom line immediately and damages the PE sponsor’s ability to sell or float it later on. The impact is already starting to show: 2023 buyouts were done with meaningfully less debt relative to company earnings than prior years, according to statistics from McKinsey.
With less leverage, private equity firms must find other ways to deliver strong returns, even as investors demand better results because the comparable risk-free rate is so much higher. “Going forward we have to do things differently,” says McKinsey senior partner Amit Garg. “The question is how.”
The obvious path to lasting profits is through operational changes that increase revenue, cut costs or both. PE firms have always claimed to do this, but leverage has made some of them less diligent than they could be.
The tried and true methods involve better management. Some PE firms focus on new appointments on a newly purchased portfolio company’s board and management team. Others maintain a staff of full-time in-house consultants who provide services to multiple companies. A third way is to recruit a roster of veteran executives to advise company leaders.
At Goldman Sachs’s private equity arm, its “value accelerator” experts offer advice on everything from picking the right headhunters and consultants to upgrading IT platforms and redesigning management processes.
In the past, PE ownership’s main interest in rank-and-file workers has too often been on eliminating them to cut costs. The new focus on employee profit-sharing suggests that is about to change.
Polls show that US employee engagement has stagnated after falling from early 2020 highs, while union organising is on the rise. Profit sharing could help change that and harness positive energy. Who knows better than current workers where money is wasted, sales opportunities squandered or processes need improvement.
Employee ownership cannot guarantee success, as the recent woes of UK retail chain John Lewis demonstrate. But if investors really believe that top executives are motivated by share grants and options, they should reward PE firms who expand that principle beyond the elite few.
