Comment: In defence of private equity

Despite the spate of negative comments about private equity and retail recently, it is worth remembering a few points in private equity’s defence.

Private equity is just a form of capital.  Bank lending or listing on the public markets are the only meaningful alternatives available for retailers wanting capital, for example to expand or refurbish stores, grow internationally, invest in increased stock or develop a multi-channel offering. 

For the past ten years, a combination of public market indifference to UK retail and more recently, the banks’ nervousness at lending to consumer-facing businesses, has meant that these sources of finance are limited. Private equity has filled that gap for many successful retailers (Office, Poundland, Wiggle to name just a few).

The retail sector’s current woe’s are predominantly due to first and most obviously, the economic downturn but also secondly, a new era in retail with the advent of the internet.

The sector is having to respond to a huge structural shift away from consumers purchasing in physical stores towards e-commerce fulfillment.  This shift is made worse by the contraction of consumer demand. The vast majority of retail failures to date have been due to those retailers’ inability to cope with this new world and has nothing to do with ownership structures or private equity.

Where private equity ownership arguably has hastened a perhaps inevitable outcome is in two ways:

1. Whilst not constrained to private equity as a strategy, rollout was the principal route to growth in the early 2000’s. Private equity assets bought in this period had the incentive and the capital to grow rapidly through rollout. In hindsight, any retailers who expanded store numbers too aggressively are regretting it and have weakened their financial viability to a greater or lesser extent.
2. Private equity uses debt to help fund its deals.  (To dispel another myth, generally very little debt has been available to private equity backed retailers so the “leveraging up to the eyeballs” argument that is sometimes leveled at private equity, is fundamentally wrong.)  However, having virtually any debt in a retail business that has an extensive rented store portfolio means that, if hard times come, the bank is in serious danger of losing money.  It is this dynamic that has accelerated the downfall of certain private equity backed retailers whose model has not worked and have gone into administration.

Finally, it is worth remembering what has (generally) happened to many retailers who have failed – often the business is sold as a going concern but with fewer stores; some sites are acquired and the staff taken on by other retailers or leisure operators who have a successful format and/or the brand is bought to enhance an online venture. Many of the acquiring entities are themselves private equity backed.

In short, private equity is far more a force for good in retail investing than many would have you believe.

Gareth Whiley, partner & head of retail & leisure investment at European private equity firm, Silverfleet Capital