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Private equity is under pressure. Higher interest rates and still sluggish markets for new listings have made it harder to sell assets and return cash to investors. This, in turn, has made it more difficult to raise new funds as pension funds, endowments and family offices have less money to allocate and a growing range of other options.
One way to tell that the pressure is starting to take hold is the recent announcement by Blackstone, the largest and best-known PE firm, that it has launched a “shared ownership initiative” to give employees of its portfolio companies an equity stake. The program will begin at Copeland, which Blackstone bought last year for $14 billion. When the climate control group is eventually sold, its 18,000 employees will receive payouts linked to the PE firm’s profits from the deal.
Blackstone has plenty of companies: rival KKR began offering equity stakes in 2012, and a charity founded by the firm’s chief executive Pete Stavros has signed up nearly 30 PE firms — but not Blackstone — to do the same. Ownership Works has helped organize nearly $400 million in employee stock at 88 companies and is targeting $20 billion over ten years.
For private equity firms trying to attract new investors, these plans have a number of attractions. First, they allow PE sponsors to claim that they are helping to address social inequality, unlike the private credit and hedge funds with which they compete for allocations to “alternative investments”.
Such claims are likely to resonate with investors concerned about PE’s role in funneling most of the productivity gains of the past few decades to investors rather than workers. The outgoing chief investment officer of Calstrs, the second-largest US pension fund, has explicitly called for increased profit sharing by PE firms, and the head of a New York state pension fund has advocated for broader employee ownership.
But the growing enthusiasm for shared ownership plans should be more than just marketing. Higher interest rates have fundamentally changed the game for private equity firms, forcing them to rethink the way they do business. Between 2010 and 2021, loans accounted for half of all PE performance, according to consultants StepStone.
But this strategy fails when interest rates are higher. Loading a portfolio company with debt will immediately hit its bottom line and hurt the PE sponsor’s ability to sell or capitalize it later. The impact is already starting to show: according to statistics from McKinsey, buyouts in 2023 were carried out with a significantly lower debt-to-income ratio than in previous years.
With less leverage, private equity firms must find other ways to deliver high returns, even as investors demand better results because the comparable risk-free rate is much higher. “We need to do things differently going forward,” says McKinsey senior partner Amit Garg. “The question is how.
The obvious path to sustainable profits is through operational changes that increase revenue, reduce costs, or both. PE firms have always said they do, but leverage has made some of them less diligent than they could be.
Best practices include better management. Some PE firms focus on new appointments to the board and management team of the newly purchased portfolio company. Others have a team of full-time in-house consultants who provide services to multiple companies. A third way is to get a list of experienced executives to advise company leaders.
At Goldman Sachs’ private equity arm, its “value accelerator” experts offer advice on everything from selecting the right headhunters and consultants to modernizing IT platforms and redesigning management processes.
In the past, the main concern of PE ownership for rank-and-file workers was too often to eliminate them to reduce costs. A new focus on employee profit sharing suggests that will soon change.
Surveys show that employee engagement in the US has stagnated after falling from highs in the early 2020s, while union organizing is on the rise. Profit sharing could help change that and harness the positive energy. Who knows better than current employees where money is being wasted, sales opportunities are being missed or processes need improvement.
Employee ownership cannot guarantee success, as the recent woes of British retailer John Lewis show. But if investors really believe that top executives are motivated by stock grants and options, they should reward PE firms that extend this principle beyond the elite.
brooke.masters@ft.com
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