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By Richard Hunter, Hargreaves Lansdown

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It seems that private equity firms are fast taking their place in the public eye somewhere between traffic wardens and estate agents.

Private equity companies have an ever increasing line of interested parties queuing up to question their business ethics, operations and strategies. Having been variously described as "locusts" and "amoral asset strippers" concerns have been voiced about whether the number of deals being done in this way is potentially damaging, both to the target companies themselves and, from a wider perspective, whether a bubble is developing which is currently being sustained by the fact that money is cheap. Many of these deals involve a high level of "leverage" - debt - being piled on the newly-acquired company, which is less of an issue for stable, cash generative machines but can inevitably come with the emotional cost of staff losing jobs and the company itself losing its corporate identity.

The general idea is that the private equity company will be looking at a timeframe between three and seven years, during which time they look to generate returns of 20% or more. Not surprisingly, this can involve the sale of assets and/or cuts in the workforce, which is part of the reason for the current perception held by some. Of further concern is that the acquired company is left hollow.

In theory, rather than practice, the issue should not be cause for concern. It is often the case that private equity houses opt for ailing companies and have had some success in turning that company's fortunes around, to the benefit of all concerned. Even for companies who are already enjoying some success, the arrival of an independent set of eyes can give the business a jolt and force the company to look at itself and ensure that it is not being held back by the inevitable corporate complacency which can creep in.

However, this is not the entire story and some of the worries that are being debated go far beyond the theory.

Firstly, there is some unease that private equity houses are opaque. They do not have the City to answer to, their management style is often one of anonymity, and the questions surrounding corporate social responsibility, employment practices and general corporate governance are issues which can be much more simply avoided.

In addition to this, the levels of debt being loaded on to the target company can initially cause the balance sheet to creak. If all goes well and after say, 5 years, the business is leaner and then re-floated on the market with everyone having turned in a tidy profit, the initial acquisition will have been vindicated. However, the fear is that the current market environment, where general Merger and Acquisition/bid speculation has been rife, has resulted in many potential target companies rising to a level where their valuations are looking pretty full. If this is the case, they do not have much equity left in them and, as such, (usually) the biggest cost of staff will be the first one to be reduced in order to make the deal viable. This in itself can have damaging effects, from overloading the remaining staff all the way through to the impact on morale which can easily follow.

Another concern is that given the timeframes which private equity houses tend to load on themselves for an acceptable return, they run the risk of bringing a company back to the market before it is properly ready. Debenhams came back to the market last May and has struggled to adapt in the hugely competitive marketplace in which they operate - the float price was 200p and at the time of writing the share price is currently nearly 30% south of that level.

In all, this is a high profile issue. A meeting in March of trade union leaders from some 40 countries in Paris discussed how private equity houses could be made to be more accountable. At the same time there were calls that they should not be allowed to destabilise markets, and that they should ensure corporate governance whilst allowing workers' rights to collective bargaining.

It is early days yet, but this marked a definite watershed moment - it is estimated that at the current time in the UK, nearly 20% of the UK workforce in the private sector are employed by companies in private equity control.

For its part, the EU recently argued that private equity deals generate strong returns for investors and "keep company bosses on their toes". As ever, there are compelling arguments for and against the rise in this particular form of financing, and the debate will rumble on for some time to come.

In the meantime, private investors are looking to make hay while the sun shines. Persistent bid speculation has been a major factor in the strength of the UK market over the last couple of years and, whilst it persists, so will general equity returns.


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