Guest Contributor: How Private Equity Can Rebuild Trust Following Toys R Us
If you work in the finance industry, you likely had mixed feelings about the fall of Toys R Us and the ensuing complaints about greed in America’s private equity funds. On one hand, we can all empathize with the demise of one of our country’s most favorite brands.
By: Jess Stonefield
If you work in the finance industry, you likely had mixed feelings about the fall of Toys R Us and the ensuing complaints about greed in America’s private equity funds. On one hand, we can all empathize with the demise of one of our country’s most favorite brands. Those of us who have kids—or grew up with Toys R Us—hurt to see it go. We empathize with employees who received no severance. We feel for their families. We wish there was something we could have done to keep the company afloat. We like to think that, if we had taken on that investment, we could have done it better.
On the other hand: business is business. No matter how much we care about the companies in which we invest, our ultimate responsibility is to our investors.
So, how can we make everyone—investors, investees, and potential public detractors—happy? In my view, every private equity fund today must find a positive and ethical balance between the deals it makes and its commitment to building wealth for its investors. The following are a few recommendations for implementing this practice within your own private equity company:
- Promote transparency among investors and investees. In any given deal, make it clear to both groups exactly what steps will be taken to protect the investment. Which assets will be leveraged? If employees are laid off, how will severance be impacted? Will fund managers receive bonuses even if the deal goes south? If so, how will those bonuses be paid? Disclose this information so investors can make a value judgment on whether they want to take part in such an investment. And repeat it—numerous times if necessary—to help investees truly understand the consequences of their equity deal.
- Limit the amount any single investor can invest into the fund. As a fund manager, it’s your responsibility to limit risk—but leveraging the assets of the investee is just one of the ways you can do it. The most committed fund managers will naturally feel a strong need to protect their investors from loss. One of the best ways to limit that potential loss is to limit the total amount any single investor can invest in the fund (as a percent of their available capital).
For instance, refuse to accept more than a certain percentage of an investor’s capital, depending on the person and their stage in life (young, retired, etc.). Further still, require that they diversify that investment by placing it in at least two different funds if possible. Diversification is always key to mitigating risk, and it’s our responsibility to help investors understand that.
- Use good old-fashioned judgment. Long story short: if you know you’re taking advantage of someone, don’t do it. You have the power to decline investments from people who want to invest too much into a single deal or simply don’t seem to understand the risk behind the opportunity. At the same time, you have the power to decline a deal in which you know a company would be hard-pressed to walk away profitably—even if your investors could benefit.
As reported by The Washington Post, Toys R Us was saddled with paying back $400 million a year in debt, often at the expense of making a profit. That kind of debt is simply not sustainable. At the very least, we need to believe that our investment will help both the investors and investees. If not, we should find another business.
Working in private equity funds, we will not likely ever eliminate the issue of failed investments, layoffs, business closures, or any number of other issues we may experience in recouping the assets leveraged in a failed investment. But that doesn’t mean we should willingly pursue those investments where our gains seem far more likely than our investee’s loss.
Jess Stonefield is a contributing writer on aging, technology, mental health and the greater longevity economy for publications such as Changing Aging, The Mighty, and Next Avenue.
The views and opinions expressed in the article are those of the author and do not necessarily reflect the views of The DI Wire.
