Are New Challenges Ahead for the Booming Private Equity Sector?
Insiders are bullish after a record-breaking 2021, but calls for increased regulation are part of the overall forecast.
- The private equity market has been historically fluid and experienced a record deal boom in 2021, but recent developments may foreshadow issues.
- The private equity sector is growing, with firms emerging in non-traditional fields, notably healthcare and the sports world.
- Many industry leaders have a positive outlook and say COVID has created many new opportunities, but that view is not unanimous.
- Lawmakers, The Justice Department, and the SEC are proposing or enforcing rules that could influence how the private equity industry manages deals.
In 2021, private equity firms were responsible for deals totaling over $944 billion. It was a record year for the sector, which posted numbers double that of the previous peak in 2007.
The timing of that past boom has some industry watchers predicting that another bust is inevitable. Many remember how some of the giants created by pre-financial crisis deals failed. However, others say the industry’s recent deals are far more stable and the economic climate more favorable.
The boom of private equity
The history of private equity, a term used to refer to alternative investment classes consisting of capital not listed on a public exchange, is riddled with booms and busts. And the surplus of unused capital accumulated during the pandemic-caused slowdown throughout 2020 catalyzed the current boom.
For some industry leaders, the pandemic highlighted new avenues of investment. According to Norma Kuntz, CEO/CFO of Global Private Equity at the Carlyle Group, “You can’t underestimate the opportunities being unleashed as digital trends accelerate . . . which is why we are investing in technology to address the speed of change and disruption that’s leading to a new level of productivity.”
The private equity market has traditionally been dominated by investors who directly invest in private companies or engage in buyouts of public companies in a narrow range of industries. The pandemic-fueled boom saw that scope expand into healthcare, a wide range of startups, and even sports teams. Private equity firms and investors also contributed to the rise of the SPAC (special purpose acquisition company) as a funding option.
Taking themselves public is another trend for large private equity firms. Many of the industry’s largest players are now public companies, including Apollo Global Management, Blackstone, the Carlyle Group, KKR, and, in late 2021, Fort Worth-based TPG. All their stocks “skyrocketed” in 2021.
Private equity offers advantages to investors and companies. Some analysts believe that the way private equity functions, using “floating rate structures,” makes the model less vulnerable to changes in monetary policies and inflation. Leaders of companies, particularly founders of startups, use it as an alternative way to access liquidity. Some public companies have found that “going private” with the backing of a skilled private equity firm can save a failing enterprise. And certain forms of private equity, such as venture capital, are the primary funding sources for startups.
Private equity’s image problems and regulatory hurdles
The private equity industry has sometimes suffered from a public relations problem in addition to being the target of legal and regulatory challenges. Many firms are combating a perception of simply being ‘job-slashers’ and putting ‘profit above everything else’ (not ‘drivers of innovation and growth’) by promoting sustainable investing and backing “public good” companies. But possible legislative obstacles could be trickier to navigate.
Some industry analysts believe that private equity firms must evolve to meet heightened public scrutiny and increased regulatory standards. Jeremy Coller, CIO of Coller Capital, which conducts an annual benchmarking survey of the industry, remarked that the days when private equity “flew under the radar” are over. “The industry is now simply too big for society to ignore. Like it or not, private markets are becoming less private–and we need to decide how to respond.”
In a late-2020 announcement, the Justice Department warned private equity investors that they might expose themselves to False Claims Act liability if their companies break the law. The government has used the False Claims Act, a Civil War-era statute originally designed “to stamp out fraud against the government,” to charge private equity companies. The False Claims Act has been applied to private equity firms four times since 2019, primarily those in the medical sector.
The Wall Street Journal reported that Texas-based firm Ancor Holdings LP agreed to pay almost $1.8 million for involvement in “an alleged kickback scheme” in May 2021. Another case against Miami-based buyout firm H.I.G. Capital resulted in the firm agreeing to pay almost $20 million to settle allegations of fraudulent billing practices brought by the state of Massachusetts.
An attorney for the whistleblowers involved in the latter case commented that “The size of the recovery alone may have a ‘blood in the water’ effect in incentivizing future investigations and lawsuits in the PE space.”
An industry in some Congressional crosshairs?
On the legislative front, several reports of companies failing their employees and customers after being taken over by private equity management groups have spurred legislators to propose changes. In October 2021, a group of Senate Democratic leaders introduced the “Stop Looting Wall Street Act.” The bill, as written, proposes “to subject certain private funds to joint and several liability with respect to the liabilities of firms acquired and controlled by those funds, and for other purposes.”
As described by sponsor Senator Elizabeth Warren (D-MA), the purpose of the bill is to “fundamentally reform the private equity industry,” putting into place regulations that will “level the playing field by forcing private equity firms to take responsibility for the outcomes of companies they take over, empowering workers, and protecting investors.”
Businesses depending on an influx of money from private equity or waiting for a buyout should keep abreast of possible legislative and regulatory changes. Private equity remains an immensely popular and viable mechanism, but political pressure and public perceptions could impact the industry.
The attorneys at Johnston Clem Gifford routinely advise companies on issues related to securing capital and regulatory compliance. Our Financial Services team works with the world’s largest institutions as well as smaller and middle-market firms. Contact us online or by calling (214) 974-8000.