Two tribes

Private equity has been getting a bad press. In a rare allegiance against what they perceive to be a common enemy, politicians and journalists have seized on private equity and ganged up to suggest that the industry destroys rather than creates value.

It simply asset-strips good companies, they thunder, reducing capable businesses into debt-ridden hulks. Indeed, the vice-chancellor of Germany went so far as to call private equity funds “locusts”.

But is private equity really that bad? Is there any truth behind the accusation that it destroys companies and strips assets? I would argue that the charge is less hard fact than scaremongering and myth. More cynical observers might even say private equity is simplyapoliticalfootballbeingsimply a political football being kicked around to curry public favour.

Private equity is all about keeping public corporations on their toes. These companies must be able to justify their business strategies to shareholders and explain why they are able to deliver greater value than private equity.

In many ways, private equity serves an essential function by taking out, then rebuilding failing companies, generating value in the long run and ensuring the efficient distribution of capital. It should also not be overlooked that much of the profits feed back into all of our pension funds, which invest in private equity.

Regardless of the benefits of private equity, there is a risk that the bad publicity attracted by the industry could tarnish the related venture capital market. It is crucial that this does not happen because venture capital is vital to our ability to develop an innovation-based economy.

Although venture capital can be considered a sub-set of private equity, aside from sharing a basic characteristic – both make equity investments in businesses where the stakes cannot be traded on public markets – there are few similarities between the two. Whereas venture capital invests to drive top--line growth and build the businesses of the future, private equity invests to restructure existing corporates. These are quite different and should be recognised as such.

THE VALUE OF VENTURE

Venture capital is essential because it provides the risk capital that young companies need to fund their product development, marketing and sales. Indeed, one of the big challenges for entrepreneurs is to feel able to exchange part of their ownership in return for a share of a potentially much larger and more valuable company.

It’s helpful to remember that Chad Hurley only had a 20% stake in his company, but when that company is YouTube and it’s acquired for $1.65bn the exact percentage is not terribly relevant.

So the message to entrepreneurs is, don’t mess up the chance to grow your business by steering clear of venture capitalists. They know about building great companies not destroying them.

The scare stories about private equity are wide of the mark. Regardless of the indignation currently being spouted in the media, entrepreneurs should not let the soundbites and spin dampen their enthusiasm for venture capital.

Because venture capital is about far more than the efficient distribution of capital, shareholder value and liquidity. It is also about the fundamentally important task of building and nurturing the stars of the future – and without them the vitality of our innovation-based economy will simply fade away.