September 2020
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AAM Magazine
September 2020
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PE Panorama: UK private equity bailouts are probably a bad idea

Why should state capital bail out businesses ultimately owned by big pools of private capital

According to S&P Global Market Intelligence and Financial Times reports, the UK government has been evaluating ways to extend state-backed loans to private equity investee companies in difficulties, without violating European Union rules on state aid. These rules state that enterprises with losses over 50% of their share capital cannot receive state loans under programmes such as the UK’s Coronavirus Large Business Interruption Loan Scheme. Many private equity-backed firms, with substantial leverage debt on their balance sheets, cannot meet the associated “undertakings in difficulty” qualifications.

The arguments against state aid for private equity-backed businesses have already been rehashed in the US. The fundamental point at issue in both cases is the same: why should state capital bail out businesses ultimately owned by big pools of private capital? Governments may be prepared to do whatever it takes to save jobs during a difficult period like the ongoing coronavirus crisis, but it won’t take long for questions about the allocation of state aid to take front seat.

Pension funds and other institutional backers of private equity aren’t much of a justification for advancing state aid. If an investee company collapses, their returns suffer. If a private equity firm decides to deploy more fund capital to support an ailing investee, that may drive down returns too. And if state loans are made, taxpayers may be the ultimate losers where the money is diverted to keeping portfolio companies afloat.

There’s also the argument that private equity-backed firms take on such large debt burdens partly to lower their tax exposure, which is hardly likely to endear them or their owners to the taxpaying public.

The Financial Times isn’t exactly positive towards these government initiatives. It holds that private equity investment is known to be risky, and also cites the substantial stock of undeployed capital – up to some US$1.5 trillion globally as of July 2020, according to Preqin figures.

Instead of government loans, it urges private equity firms to use their much-vaunted balance sheet restructuring skills to shore up struggling businesses, including potential write-downs of current creditors and shareholders. After all, those are the kind of skills that private equity firms make their investment case on. Plus, if private equity funds really do offer outperformance substantially above other asset classes, shouldn’t they be able to crimp their expected returns while still being able to deliver decent performance to investors?

The UK has never quite embraced private equity to the same extent as the US, and the firms ought to take a hard look at their long-term prospects before turning to the government for help. The UK government is already unpopular for its handling of the coronavirus crisis. Private equity would do well to avoid being caught in any backlash.