Private equity: at the start of the journey?

A recent conference for private equity firms in emerging markets left me wondering, is private equity about to repeat the same sustainability journey corporations have had over the last 5 years? They have the opportunity to transfer best practice and have a profoundly positive impact.

The gilded ballroom of the Sheraton Park Lane was the slightly incongruous location of ‘Capital Impact’, Financial Times Business and the Emerging Markets Private Equity Association (EMPEA)’s first-ever conference on potential positive impact of private equity on development. As I listened to the presentations and networking chatter, I reflected that I could have been at a ‘business sustainability’ conference from 2006.

First, there was the baggage of a ‘responsibility’ mindset. For many of the attendees, Impact was about the effect of a business on society – the jobs created, the tax revenues paid, modelling good corporate governance, deepening management talent and providing linkages to external markets. One speaker told us that Russia had many wealthy people, but banks hadn’t yet figured out how to connect that wealth to Russian firms. Certainly private equity has a crucial role to play where countries have lack either the financial capital or the institutional vehicles to invest in private enterprise.

But a responsibility mindset also means that people see having a positive impact as an add-on to running the business, and thus assume that it must cost money. It just simply must! For instance, one exchange went like this. A presenter said that making an Indian company compliant with global health and safety standards had paid off in the final sales price. A questioner from the floor asked: but there must be a conflict between social good and financial performance. Speaker: no, it improved our returns. Questioner: surely not. Speaker: yes, yes it did!

There were people and institutions on the cusp of what you might call a ‘sustainability mindset’: what is the impact of society on our business? What are the sustainability trends and issues that will set the business context for our assets? What must our strategic response be, including industries should we be in and what business strategies our investments should have?

The best speaker I saw for this was Paul Fletcher, senior partner at Actis. (Full disclosure: we’ve just been working with Actis on a way of measuring the impacts – positive and negative – of their investments in energy infrastructure. More to come on that soon.) He was the speaker who gave the win-win case above. He also gave the example of a recent energy fund. Actis put a cap on the carbon emissions for the totality of the fund. Quite naturally, the fund managers started investing in renewables as well as coal. Adequate returns, and building an infrastructure for the future. I’d call that a positive impact.

This is the sort of Pioneering Practice that indicates a sector is at the start of the journey. (For more on Forum’s Six Steps to Significant Change see here or here.) The other weak signal came from how leaders were engaging with investors. A number of stallholders told me that conventional investors used positive impact as a differentiator, as long as the funds had reasonable returns. This is exactly the same as mainstream consumers using fair trade or organic as a differentiator, once they know the quality and price are about right.

Private equity has a pretty ropey reputation for using financial engineering and downsizing to improve the financial performance of a company, but at the expense of local communities and the business’ own long-term future. That well might have been true in mature markets, especially when there was cheap debt around. But I think the circumstances are different for emerging markets.

Private equity can bring ‘patient capital’ that isn’t buffeted by short-term storms. It has to look several years out, because it has to think about the sales value of the asset. It can bring things into emerging markets that are not locally available, from financial capital through expertise to relationships – and make sure the country has more of these by the end of the investment. At the moment, the conventional story in private equity circles is that they have positive impact, regardless of what they invest in. I don’t think so; how a company makes profit is important. Therefore, what a private equity firm invests in, and how it shapes the business strategies of its assets, is important.

Let’s hope that private equity is at the start of the journey to a sustainability mindset. There is a large body of practice in the corporate world which they could adopt, on embedding in key decision processes, on building the capability of people and more. The next thing to do is probably bring in the relevant bits of corporate practice, create some exemplars and prepare for scaling up. If the private equity industry take the right steps they can burnish their reputation by having a profoundly positive impact.