[Free Speech] Private Equity Funds: Corporate Rescuers or Raiders?

In Korean society, private equity funds (PEFs) have a strongly negative image. This is because their distinctive method of intervening in corporate control through aggressive equity acquisitions has been perceived by the public as that of “corporate raiders” targeting sound companies solely for investment returns. In addition, although PEFs ostensibly pursue value creation through enhancing corporate value, the fact that several major companies that passed through PEF ownership instead lost competitiveness in the market and faded away has also raised doubts about the effectiveness of PEFs.

The PEF market has not yet fully reached maturity, but over the past 20 years it has grown nearly 200-fold. Among its segments, “buyout PEFs,” which involve management participation, have shown especially notable growth, accounting for more than half of the overall market. However, despite this remarkable growth in the investment market, PEFs have still shown limited effectiveness in strengthening the profitability and growth potential of companies.

Why, then, has the effect of increasing the intrinsic value of portfolio companies—arguably the essence of PEFs—remained so limited, even as investor returns and market size continue to grow? The reason is that the current PEF market is focused not on improving corporate growth potential and profitability, but on securing investment stability through “improved financial performance.” Strategies aimed only at improving a company’s short-term financial soundness have minimal effect on enhancing its actual growth potential, and in that sense can be seen as one of the factors limiting fundamental improvements in intrinsic corporate value.

Rigid market regulations are also one of the obstacles limiting the intrinsic value-enhancing effects of PEFs. Current regulations do not take into account the differing characteristics of investment-type and management-participation-type PEFs, and instead apply uniform rules on required equity holdings and leverage limits. As a result, the cost burden of managing PEFs has increased, and pressure to secure returns has also risen, leading them to take a passive approach toward improving the growth potential and profitability of riskier companies.

To strengthen the essential capability of enhancing corporate value, the PEF market—currently concentrated too heavily in simple buyouts—must first be diversified. Since the investment period is generally limited to five to six years, it is difficult for a buyout-centered PEF market to raise corporate value in a meaningful way. Therefore, the market structure skewed toward buyouts should be diversified by expanding the use of M&A PEFs and minority-equity investment PEFs.

Uniform regulations that restrict the flexibility of investment activity should also be eased. Current regulations impose excessive costs on fund managers, significantly limiting opportunities to generate investment returns. If the cost burden is reduced by expanding borrowing limits and relaxing minimum equity-holding requirements, the effect of PEFs in increasing intrinsic corporate value will naturally be strengthened as well.

Until now, the PEF market has functioned well as an investment vehicle, but it has not fully fulfilled its fundamental role of enhancing corporate value. In that sense, the current PEF market remains limited to the role of a corporate raider pursuing only its own interests and leaving, rather than serving as a rescuer of companies.

The desirable direction is one in which institutional investors earn investment returns while companies simultaneously strengthen their competitiveness through restructuring and debt resolution. As successful investment cases continue to emerge, companies’ trust in PEF capital will grow, and the PEF market itself will also be able to expand. At a time when the presence of the PEF market is becoming more prominent, both the PEF industry’s own efforts to achieve its essential goals and institutional improvements are needed for the sustainable development of both companies and PEFs.

Sungjin Ahn, Intern Researcher, Center for Free Enterprise (CFE)

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Original title: [자유발언대] 사모펀드, 기업의 구원투수인가 기업사냥꾼인가?

Author: Seong-jin An

Date: 2022-04-15

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=free_opinion&pn=8&idx=24674