Fundamentals of Private Equity and Venture Capital - PEI Media

mean that they are highly restricted in terms of the
information they can share with their investors.
The problem with governance in this environment
is that it is required to protect a huge array
of interests – from shareholders, through
employees to much more broadly defined interests
such as the environment and the broader
community – and to do so with a universally
applied set of rules and procedures.
By contrast a private equity backed management
team has a tightly defined shareholder group and
a governance structure tailored to a specific and
explicitly agreed set of objectives (explored further
in Module 8). The team can share detailed
information with its investors, discuss and obtain
specific consent for its strategies and plans, and
essentially operates in an unregulated environment
where shareholders are assumed to be
sophisticated, able to look after their own interests
and in need of no further protection than that
afforded by the tenets of corporate law.
Beyond the regulatory and governance issues,
there are broader commercial attractions to the
private equity environment. Foremost among
these is that the pressure to post earnings growth
every quarter is alleviated – replaced, of course
by performance pressures of a different kind (see
Modules 4 and 5) Beyond this, the intense, often
misinformed public scrutiny which often follows
every action, announcement and report from a
major quoted company is removed (although as
private equity backed companies become ever
larger and more economically and politically significant,
the press and public are showing much
greater interest in their activities). The freedom
to make decisions in private, in direct consultation
with shareholders and lenders, with a focus
on medium- to long-term value creation without
worrying about day to day share price performance
has many attractions.
The lure of private equity for corporate managers
is further accentuated by the status issue, which
although a very personal and human driver is
highly relevant. Growing public cynicism about
corporate behaviour – which comes not just from
a series of accounting scandals but from increased
questioning about ethics and social responsibility
– means that being a director of a major quoted
company no longer has the cachet, the status, that
it awarded in earlier decades.
Finally, of course, private equity not only offers
managers the prospect of significant financial
gain, but actively incorporates the generation of
wealth in its fundamental principles. This
approach centres on shared motivation between
shareholder and manager and represents a clear
solution to the perennial corporate management
challenge – the agency issue.
The agency issue
Managers act as agents for their shareholders,
and are required to make decisions in the best
interests of those shareholders. But in the quoted
company environment management may often
have vastly differing motivations from those
shareholders and, more importantly, different
means of achieving rewards.
Options to purchase shares, short-term performance
related bonuses, golden parachutes, handcuffs
and hellos, large salaries, plus access to
corporate jets, properties, entertainment and
various other perks are all designed to attract
and motivate the highest performers to run
major companies. However no matter how carefully
these are designed and how extensively
they are debated, there is the constant risk of a
structural disconnect between these types of
remuneration and shareholders’ long-term interests,
especially now that the tenures of CEOs are
becoming shorter and shorter.
A well structured private equity transaction, by
contrast, ensures that management will gain in
tandem with its investors. Furthermore, because
cash is ultimately the only measure used to gauge
success, it becomes the focus and short-term
methods to manage profit performance or to
influence a share price, so common in quoted
markets, become irrelevant.
Access to emerging markets
The development of stock exchanges, the evolution
of governance and reporting standards, and
the ability to invest in quoted companies tends to
lag behind economic growth in developing
economies. This makes it difficult for investors to
gain exposure to these economies and private
equity, with the ability to bypass public
exchanges offers an alternative route.
Informed decision making and access to
insider information
By definition, investors in quoted stocks are
COPYING WITHOUT PERMISSION IS UNLAWFUL
THE FUNDAMENTALS OF PRIVATE EQUITY 15