In Defense of Private Equity:
Why Our Society Needs Middle Market Investments
The private equity industry is increasingly under scrutiny from policymakers and the public about its negative impact on society. The failed turnaround of Toy ‘R Us, for example, raised questions about whether private equity funds profited on the backs of employees who lost their jobs. Failures and bad apples will exist in any high risk/reward industry, yet the oversimplified narrative about private equity funds using massive amounts of leverage, irrationally cutting jobs, and leading ill-conceived mergers being the only way to turn a profit misses the bigger picture. There are also countless examples of funds helping companies scale business through massive job creation, disruptive innovations, and lower prices. These are positives that are being amplified as intentional impact investors are entering the field.
While venture capital investments are more easily understood as capital to build a new business, private equity funds invest in established companies that need capital to develop new products, expand teams, pursue mergers and acquisitions, and restructure balance sheets. These support a range of outcomes such as revenue growth, improvement of margins or profits, or the turnaround of a distressed business. Companies that nearly failed due to economic recessions, for example, have also successfully been able to save jobs due to private equity investment.
With fewer companies going public, there are approximately 200,000 private middle market companies that, without capital, cannot continue to be the engine that employs approximately 35% of private sector jobs in the U.S. These companies are spread across rural and urban geographies and include every sector from manufacturing to technology and healthcare. Many create goods or sell services that benefit more than just their employees. For example, take Impact Engine’s recent investments: the combined company of Insight Telepsychiatry and Regroup Telehealth provides critical mental health services to the 51% of counties in the U.S. that otherwise lack access due to provider shortages, and Footprint International manufacturers biodegradable packaging that has diverted 60 million pounds of plastic.
None of this means that misalignment of incentives is not a serious issue in the industry that must be addressed. Short time horizons for determining compensation, high management fees on large funds that can create significant wealth without significant returns for investors, and lack of transparency about fund expenses are some of the many reasons investors and the public should continue to demand more from an industry with tremendous power and influence over society. However, I urge policy makers not to throw the baby out with the bathwater. The ability of a large profit incentive to motivate people to fund and partner with businesses that can create high positive impact, and may otherwise not succeed, is a unique differentiator in our economy that must be made better, not taken apart.
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