It’s been a bad week for the image minders in the private equity industry. First, Henry Kravis bemoaned the industry’s awful reputation, and now a tax-reform plan – floated by a Republican (gasp!) – threatens to axe its carried-interest tax goodie. Meanwhile, investors like Carl Icahn that once were reviled as “corporate raiders” have been reborn as “activist investors” and hailed as saviors. There are lessons here for the private equity industry.
Henry Kravis, the co-founder of Kohlberg Kravis Roberts, told a conference in Berlin this week that the private equity industry is still thought of as “locusts” and needs to do a better job of telling its story. At the same time, Carl Icahn, a veteran investor who first made his name as a swashbuckling raider in the 1980s, was lauded in a Financial Times article as an “activist investor,” paving the way for timid institutional shareholders to join in the fight for shareholder value.
How did this happen?
Well, context is certainly one factor. Private equity took a beating during the 2012 election and has not recovered. Its image problem persists, despite an expensive information campaign by the Private Equity Growth Capital Council, the industry’s trade group. Activist investors, on the other hand, have had much better environment. A five-year bull market in equities has helped boost the fortunes of all investors, activists as well as more pedestrian types.
The activists enjoy some other advantages, too. For one thing, they can show a dramatic gain in a short period of time. Build a position, fire off a damning letter to the board, tweet to your followers and – zoom! – watch the stock rocket. By contrast, an investment by a private equity firm can take years to pay off.
Activists also benefit from having the stock market as a widely seen and unambiguous gauge of their impact. When the stock price goes up, activists claim victory and reap benefits for themselves and other shareholders. Private equity firms often invest in non-public companies, so there’s no handy stock-market barometer to help them.
Perhaps the most important difference, though, is that it is much tougher to manage a company than invest in one. Activists put in their cash, and that’s nothing to sneeze at. But private equity firms put in cash and a lot of sweat, as they should since they own much larger stakes than activists. Running a company isn’t easy, and it often involves making difficult decisions, like layoffs, that bring bad headlines. That’s been a heavy burden for private equity.
Ironically, Mr. Icahn and other “corporate raiders” were also maligned as job-killers when they rode to prominence in the 1980s. But that association dissolved in their re-branding as activist investors. How did they do it, and what can they teach the private equity industry?
Names matter. It might sound like a gimmick, but names really do matter when repairing a reputation. Finance offers several examples. “Lesser-developed-country (LDC) loans” became emerging market bonds, “corporate raiders” were renamed as activist investors and “junk bonds” were transformed into high-yield securities. Private equity might consider something new, too. Warren Buffet, who has been a private equity investor all his life, never uses that term. There’s a lesson in there.
Find a villian. Activists know exactly who the bad guys are, and they’ve learned to be very effective at attacking them. Carl Icahn is on message all the time, railing about inept CEOs, entrenched directors and the tools they use to resist change, like poison pills and staggered boards. Private equity needs to find its bad guys. Maybe they’re the activists. Hmm.
Get away from Washington. Investors like Mr. Icahn benefit from the tax code, too, but he’s not leading the charge to preserve it. The private equity industry on the other hand has made it their defining cause and has built a fortress in Washington to defend it. Just blocks from the Capitol and staffed by Beltway insiders, the Private Equity Growth Capital Council embodies the two things that Americans trust the least – finance and lobbying. If it wanted to be seen as a driver of economic growth and renewal, rather than a defender of a tax privilege, the group should move its center of gravity away from Washington. A move to, say, Detroit would help shift the conversation.
Changing minds takes time. It took the better part of twenty years for activist investors to shed the raider label. It might take just as long for private equity to win public support. Like investing, it is a long-term process.