Is the economic impact of private equity measurable?

There is no commonly accepted methodology for this manner of study as will be seen as we take a closer look at two recently produced reports: The British Private Equity Venture Capital Association's (BVCA) The Economic Impact of Private Equity in the UK, conducted by ourselves at IE Consulting, and the Spanish Venture Capital and Private Equity Association's (ASCRI) Economic and Social Impact of Venture Capital & Private Equity in Spain, conducted by the Universidad Complutense De Madrid and Webcapitalriesgo.

In general, the results published in the ASCRI report suggest that Spanish private equity-backed firms have a greater impact on their local economy than their British equivalents. Is this really true? Does it follow that in a market such as the UK, where competition for the very best deals is so strong, one might expect that private businesses with slightly less potential would also receive investment, thus flattening growth and lowering average performance? Are investors in Spain simply doing a better job? Looking at the methodology, there are clear differences in the way these reports are compiled and, hence, the stories they tell.

Both reports contain an analysis of employment and revenue figures which make them the best variables for this comparison. The summary of the findings can be found in Figure 1.

As can be seen, the BVCA report shows that private equity-backed firms have increased employment by 4% per annum in the past five years. On the other hand, the Spanish report shows an average of 13.7% employment growth in private equity business per annum.

Whereas the ASCRI report measures growth from years 0-3, year 0 being the year of the first private equity/venture capital investment, the report IE Consulting conducted measured the growth over a fixed five-year period to 2006/07. Thus, the Spanish sample is measuring the impact on growth over a relatively short period and directly following significant capital injection. In contrast, the BVCA project measures the longer term effects of private equity investment and over a longer period; the horizon in the British study is five years and only 11% of the UK sample had received private equity investment three years prior to the data of measurement. Naturally, the effect of this is to lower the average growth rate as investments in staff and infrastructure typically follow capital investment (from whatever source) very closely.

More significantly still, there is a strong bias towards immature businesses in the ASCRI report: buyouts of mature businesses only constituted 12% of the sample in Spain, compared with 49% of the sample in the UK. According to the data in the ASCRI report, mature, private equity-backed businesses in Spain only very slightly outperformed their peers, with employment growth pegged at 2.7% per annum and revenue rising by 7.3%.

Looking deeper into the results, it seems that the contribution to employment and revenue generated by private equity-backed firms in Spain dwarfs that generated by non-private equity firms. In the case of the BVCA report this difference is not as pronounced. Why? (Figures 2a and 2b.)

The answer to this question may be found in the methodology. The BVCA report compares private equity-backed firms to those in the FTSE index measuring performance regardless of the characteristics of the company. On the other hand, the ASCRI report compares the growth of both private equity-backed businesses and other companies with similar characteristics (sector, size, product portfolio etc) over the same three-year period. This may seem a sensible approach, providing as similar a benchmark as possible for private equity-backed businesses. In fact, what this actually does is compare, for example, a small Catalan printing press that was considered a good prospect for growth by a professional investor (private equity firm) with one that was not. In other words, it could be argued that the ASCRI report is actually measuring businesses with relatively good prospects for growth against those with relatively poor prospects for growth.

And herein lies the problem with purely quantitative studies of this topic: No study can provide a 100% reliable and fair appreciation of the economic and social impact of private equity; survivor bias alone makes this impossible. This does not mean that no attempt should be made to capture this data as accurately as possible. Rather it suggests that the value of such a report can be greatly enhanced by the inclusion of a qualitative element, such as the report we produced for the BVCA, which captures the additional, non-financial benefits of private equity (see figure 3, right).

Matthew Craig-Greene is principal and Karenine Loayza is a junior analyst at IE Consulting.

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• Performance
• Southern Europe