Research Finds PE-backed Companies More Resilient Than Others During Economic Contractions

Although states and businesses are beginning to reopen amid progress in the fight against COVID-19, the economic fallout has been devastating. Over the past nine weeks, almost 40 million Americans have filed for unemployment while the unemployment rate reached almost 15 percent in April – a number that has steadily increased since then. The private equity industry plays a substantial role in the U.S. Economy.  This raises the question: How is the PE industry equipped to support an economic recovery after such a massive shock?

One way to answer this question is to take a look at how PE-backed companies performed during the global recession in the late 2000s. A 2017 paper published by the National Bureau of Economic Research found that PE-backed companies were more resilient and rebounded more quickly than their non-PE-backed peers during the crisis, which offers hope for our economy today. Here are the top takeaways from that report:

1. During the last Great Recession, private equity backed companies were able to make greater investments supporting their recovery than non-PE-backed companies. Their average quarterly business investment volume was between 5 and 6 percent greater, an effect that’s “not only statistically significant, but also large in economic magnitude.” PE-backed companies maintained this higher level of investment after the crisis.
2. PE-backed companies had access to more debt and equity capital than their non-backed peers, by 4 and 2 percentage points, respectively. Meanwhile, the “cost of debt, measured by interest expense over total debt, was relatively lower for PE-backed companies during the crisis.” The researchers partly attribute these observations to the fact that private equity firms have strong relationships with lending institutions, which gives them more access to credit. PE investment also “did not lead to a low quality or excessively risky projects.”
3. PE-backed companies that were more likely to face financial constraints during the recession (as indicated by factors such as their dependence on outside financing and their “pre-crisis leverage”) were especially likely to benefit from PE investment. Overall, the researchers write, “Private equity firms alleviated financing constraints of portfolio companies during the financial crisis, allowing them to invest more when credit markets were frozen and economic uncertainty high.”
4. PE-backed companies saw “greater growth in their stock of assets in the years after the crisis” and actually increased market share during the recession: “In the crisis period,” the researchers write, “PE-backed companies experienced an 8 percent increase in market share relative to the control group.”
5. PE-backed companies were comparatively seen as more attractive businesses by would be suitors after the recession.  The study found PE-backed companies were 30 percent more likely to be successfully acquired in the post-crisis period. Moreover,

At BluWave, we are already starting to see history repeat itself.  Our clients are moving at a rapid pace in support of the resurgence of their portfolio companies.  We are witnessing each of the elements of the above occurring in real time once again.  Moreover, we are seeing innovative applications of technology and business processes that we’ve never observed before.

While no two recessions are the same, the report suggests that PE-backed companies have several advantages as we navigate another severe economic downturn.  Private equity backed companies will have greater access to capital (at a lower cost) which will allow them to strategically invest more than their non-PE-backed peers and in turn support a faster economic recovery in the United States.