Bridgepoint | The Point | December 2019 | Issue 36
Viewpoint
It’s private
Almost every company starts off in private hands, and today, more and more are staying that way, as owners take the view that such businesses benefit from increased agility, greater flexibility and the ability to take a long-term perspective. But is this a temporary phenomenon or a more permanent trend?
In business, as in life, growing up is a rather more protracted affair than it used to be. Just as today’s twenty-somethings no longer feel that they have to rush through rites of passage, such as leaving home, getting married and having kids, the equivalent corporate milestone – a listing or flotation on one of the world’s big stock exchanges – is increasingly deferred as well, or even ruled out completely.
Europe saw just 23 initial public offerings (IPOs) in the first quarter of 2019, raising a total of $351 million, 51 per cent down on the previous year. In the US, 20 IPOs raised $3 billion, 57 per cent down on Q1 2018, according to EY’s Global IPO trends: Q1 2019 report. The US has picked up since, but activity across Europe remains extremely subdued.
Supply of private capital soars
By contrast, private equity is enjoying something of a bull run. Since the current economic cycle began in 2009, the supply of private capital has grown at more than twice the rate of public investment, according to management consultancy Bain’s Global Private Equity Report 2019. A staggering $5.8 trillion has been allocated by investors to private equity over the same period.
Compared with life in the spotlight of a public listing, private ownership has intrinsic advantages that appeal to both investors and company management teams
Of course, private ownership is by no means all – or even mostly – about private equity. The vast majority of businesses are private, typically owned by the founder or founding family rather than by external investors.
Successful examples abound. Multinational commodities group Cargill is the largest privately held business in the US, with annual revenues that top $100 billion. Yet it is almost entirely in family hands. IKEA, the world’s best-known furniture firm, is owned by a charitable, Netherlands-based foundation, as its late founder, the Swedish born Ingvar Kamprad, consistently eschewed the public market. And today, Sweden’s capital, Stockholm, has more unicorns – privately owned businesses valued at more than $1 billion – than any other city in the world.
On a smaller but still substantial scale, international design and engineering group Arup is widely renowned, with operations in more than 34 countries. Yet it remains privately owned and is run as a professional members’ organisation, whose staff share in the group’s profits.
Strategic investments
To some observers, this focus on private ownership might seem counter-intuitive, given the profile and widespread access to capital that public markets bring. But Alexander De Mol, a private equity specialist at Bain, says that compared with life in the spotlight of a public listing, private ownership has intrinsic advantages that appeal to both investors and company management teams. “It provides opportunities for companies to create exceptional value, by making strategic investments and transformational shifts that would be much harder to do if the companies were publicly owned,” he says.
Excessive pay, misdeeds and falsified accounts have eroded that bedrock of trust in listed companies. We see people turning more to local, family and privately held companies as potentially more trustworthy alternatives
Some countries seem to have a particular affinity with private ownership. For instance, Germany’s Mittelstand, which is usually equated with the country’s small and medium enterprise (SME) sector, is rightly regarded as the backbone of the country’s economy. According to German trade body the BDI, 99.6 per cent of all German companies are SMEs – more than in any other developed nation. Together, they are responsible for 70 per cent of all jobs and contribute more to economic output than any other sector of the economy.
In no rush to go public, these businesses are often family-run or richly imbued with their own distinctive culture. And while Germany leads the way in this part of the market, it is by no means alone. Around half of all French companies are SMEs, and similar examples can be found across Europe.
Consultant Alastair Dryburgh, who has been CFO at a number of private and public companies, highlights the freedom to manoeuvre that private ownership brings: “You can have a different kind of conversation with investors when a company is privately owned. You can say, ‘Let’s invest now to secure a greater long-term return in the future.’
“If you have a plan to deliver a 300 per cent increase in profits in year five, but that requires taking a hit of 50 per cent of profits in year one, you would struggle to sell that to the management of a listed company, because they would not see past the reduction in year-one profits,” he says.
Dysfunctional behaviour
If the advantages to private ownership are becoming more apparent, does that mean that the appeal of the listed model is also diminishing? Dryburgh believes so. “Barriers to entry are down in many sectors, so there are fewer and fewer businesses that require really large amounts of capital. And the sheer weight of governance for listed companies is becoming more and more extreme,” he says. Scrutiny from analysts, investment managers and the press also creates an environment where steady incremental growth becomes the overriding goal.
“There is an implicit promise to shareholders that things will never go backwards. You can’t make less money this year than you did last, and that leads to all sorts of dysfunctional behaviour, including serious underperformance and reduced growth,” says Dryburgh.
Public-to-private deals reached their highest level since the previous boom years, in terms of both value and count
Notes: Includes add-ons; based on announcement date; includes announced deals that are completed or pending, with data subject to change; geography based on target’s location
Source: Bain & Company, Global Private Equity Report 2019
The increasingly onerous burden of life as a listed company may be one factor in the rise in public-to-private deals – listed companies being acquired and taken private. Globally, $227 billion of such deals were completed in 2018, the highest level since 2006, with those in Europe up from $44.5 billion to $71.2 billion, according to Bain’s report.
But as De Mol points out, the trend is being driven by valuations as much as anything else: “Most funds have their shopping lists – assets they have always wanted to own, but where the valuation has not been right. We are seeing more [public-to-private] activity in 2019 because public market valuations are coming down.”
Pros and cons
So is the writing on the wall for the listed company model? Not quite. Mark Dixon, founder and chief executive of flexible office space provider IWG, has run his business as both a privately held and publicly listed entity. “The benefit of being a public company is that you get the opportunity to meet regularly with some very smart people who have invested in your business,” he says. “They ask questions and they can help you if you listen to them. I would say 20 per cent of my good ideas come from investors asking, ‘Why are you doing it like this?’
“The downsides are that investors can sometimes be short-term, and, of course, everything is public. There is nowhere to hide, so you had better perform. But the advantages outweigh the disadvantages.”
The attention and transparency that comes with listed status has historically also paid reputational dividends, says Sandra MacLeod, CEO of corporate reputation specialist Echo Research. “Being listed means organisations have to withstand close scrutiny with due compliance, processes and rigorous standards – so they benefit from being followed and commented upon, and traditionally enjoy a stronger reputation than those ‘in the shadows’ of less transparency and openness,” she says.
Barriers to entry are down in many sectors, so there are fewer and fewer businesses that require really large amounts of capital. And the sheer weight of governance for listed companies is becoming more and more extreme
Emphasis on values
Echo produces an annual survey, Britain’s Most Admired Companies. Two decades ago, every company involved was publicly owned. Now, about 10 per cent of them are private firms, including McLaren Automotive and Laing O’Rourke, the largest privately-owned construction company in the world.
The survey’s best-performing businesses of the past decade – Diageo and Unilever – are still large listed companies. But McLeod believes that the rise of social media and “radical transparency” is levelling the reputational playing field and eroding the public-versus-private advantage. “Excessive pay, misdeeds and falsified accounts have eroded that bedrock of trust in listed companies. We see people turning more to local, family and privately held companies as potentially more trustworthy alternatives,” she says.
The emphasis on values is significant. Private companies will often highlight their commitment to a broad range of stakeholders, rather than a narrow focus on shareholder interests. Take the words of Arup founder Ove Arup: “If the right kind of people feel at home with us, they will bring in other people of their kind, and this again will attract a good type of client and this will make our work more interesting and rewarding and we will turn out better work, our reputation and influence will grow, and the enthusiasm of our members will grow – it is this enthusiasm which must start the process in the first place.”
The statement was made in 1970, but it seems almost tailor-made for today’s socially conscious world. Perhaps more importantly, the sentiment has been shown, through the decades, to work n