What does the private equity boom imply for the third sector?

I’ll start this post by freely admitting that I am not an economist…so these thoughts (opinions?) probably won’t stand up to rigorous analysis. As such, I am trying to stimulate debate.

Private equity funding – those investors who are taking companies private by buying the publicly listed shares and then delisting them in the expectation that they can run them more efficiently and therefore profitably – is a global phenomenon that has been boosted by low interest rates (and in turn cheap credit) and the perceived difficulties of maintaining a public stock market listing (e.g. the need for quarterly reporting to shareholders). Examples of companies that have been bought by private equity firms include Boots the Chemist and Debenhams – as such, private equity is controlling an increasing amount of the UK (and world) economy.

The boom in private equity funds in recent years has potentially interesting pointers for the future of the UK third sector. In no particular order, I wonder if they are:

1. The obvious parallels with venture philanthropy. The success of private equity potentially legitimises the venture philanthropy model in particular and the broader shift from ‘funding’ to ‘finance’. (See an article I wrote on this shift for the Charity Performance Guide in December 2006). So, should we expect resources to be increasingly tied to external advice and support? And if so, might there be a point where the incumbent managers are displaced in favour of external ‘experts’? It would also be interesting to see if venture philanthropy encourages the more efficient use of capital that private equity is encouraging (e.g. sale and leaseback of physical assets to free-up working capital)

2. Loan finance (1). Private equity purchases are heavily leveraged – that is, they use borrowed money. Loan finance has been heavily promoted in the third sector as it has many attractions: it brings market disciplines (repayment) and market benefits (it smoothes out the illiquid characteristics of the third sector economy) that the sometimes dysfunctional world of grants and contracts fails to. OK, it’s not possible to undertake a hostile takeover in the third sector, but loan finance might provide the sort of temporary liquidity that could facilitate mergers? Even more contentious – might the venture philanthropists/capitalists start to borrow themselves in order to inject resources into under-capitalised parts of the third sector?

3. Loan finance (2). The sudden drying-up of liquidity in the money markets has increased the cost and availability of capital (the ‘credit crunch’). Although interest rates might fall to avert a crisis in market confidence, is this the wrong time to be promoting loan finance to the third sector?

4. New philanthropists. The private equity industry, with its comparatively favourable tax treatment, is creating some seriously wealthy individuals. These people are prime candidates for my fellow public policy wonks who are talking up the new philanthropy, which is all good. But what sort of practices, attitudes and values will shape their philanthropy given their day jobs?

5. Accountability. An oft-heard complaint in relation to private equity is the lack of accountability of huge entities that, amongst other things, control a significant proportion of the workforce. Will the third sector play an increasing role in holding these institutions to account? On a different track, will the venture philanthropy model change the accountability models of third sector organisations?

6. Dealing with the aftermath? This was one I hadn’t particularly thought of, but this morning’s Observer reports on the role of private equity in social services provision. A private equity firm running 45 children’s homes has collapsed. Now, this of course could happen to any organisation, but there may be something in the private equity model that is more risky – unsurprising, as any innovative practice (e.g. financial innovation) is bound to attract risk. This story suggests two implications for the third sector: more competition for contracts from suppliers with a more innovative, fleet-of-foot financial model; and the increasing need to step in where the model fails.

On balance, this blog feels a bit too negative. I’d be interested in other thoughts though, as perhaps my concluding point is that for service delivery organisations you might argue that the actual service is increasingly being commoditised: in other words, there might be less and less to distinguish between the actual service provided by for-profit and third sector providers. If so, distinctive value and innovation might instead relate to the underlying business model. If so, maybe we need to look more at private equity when thinking about a thriving third sector in the future?

Last updated at 15:08 Mon 18/May/09.
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