Rising interest rates and a sluggish market for new listings are reshaping the landscape of Private Equity (PE). These changes have made it increasingly difficult for firms to sell their holdings and return cash to investors. As a result, raising new funds has become more challenging as pension funds, endowments, and family offices face tighter budgets and a broader array of investment options.
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The Emergence of Shared Ownership
In response to these pressures, industry leaders like Blackstone are adopting innovative strategies. Blackstone has introduced a “shared ownership initiative” that aims to give employees at its portfolio companies an equity stake. This initiative will commence with Copeland, a climate control company Blackstone purchased for $14 billion. When Copeland is eventually sold, its 18,000 employees will receive payouts tied to the firm’s profits from the sale.
Blackstone is not alone in this approach. KKR has been offering ownership stakes to employees since 2012. Additionally, Ownership Works, a charity founded by KKR executive Pete Stavros, has collaborated with nearly 30 PE firms to implement similar schemes. These initiatives have facilitated employee share schemes worth nearly $400 million across 88 companies to reach $20 billion within a decade.
Attracting Investors Through Social Responsibility
These shared ownership plans offer significant advantages for private equity firms striving to attract new investors. They allow PE sponsors to demonstrate a commitment to social responsibility, which can differentiate them from private credit and hedge funds that compete for the same “alternative investments” allocations but do not offer similar social benefits.
These claims appeal to investors who are concerned about the historical trend of PE firms directing most productivity gains to investors rather than workers. Notable figures, such as the outgoing investment chief at CalSTRS—the second-largest US pension fund—and the head of New York State’s pension fund, have called for increased profit-sharing by PE firms and broader employee ownership.
Navigating a New Financial Environment
The growing interest in shared ownership goes beyond marketing. Rising interest rates have fundamentally altered the private equity landscape, necessitating a reevaluation of business strategies. Between 2010 and 2021, borrowing accounted for half of all PE performance. However, this leverage-driven strategy is less effective in a high-interest-rate environment.
Loading a portfolio company with debt has an immediate negative impact on its bottom line. It complicates the PE sponsor’s ability to sell or list the company later. The effects of this shift are already apparent: According to McKinsey, 2023 buyouts involved significantly less debt relative to company earnings compared to previous years.
With reduced leverage, private equity firms must find alternative ways to deliver strong returns. Investors are now demanding better results as the comparable risk-free rate has increased. “Going forward, we have to do things differently,” says McKinsey senior partner Amit Garg. “The question is how.”
Focusing on Operational Excellence
Private equity firms are turning to operational improvements that increase revenue and reduce costs to achieve sustainable profits. While PE firms have always claimed to focus on operational enhancements, the reliance on leverage often led to a lack of diligence in this area.
With less financial engineering available, PE firms are intensifying their focus on operational excellence. This involves better management, strategic appointments to a portfolio company’s board and management team and employing full-time in-house consultants to provide services across multiple companies. Recruiting veteran executives to advise company leaders is also a common strategy.
Goldman Sachs’s private equity arm exemplifies this approach with its “value accelerator” experts, who guide everything from selecting headhunters and consultants to upgrading IT platforms and redesigning management processes.
Empowering Employees: A New Approach
Historically, PE ownership’s primary interest in rank-and-file workers has been in cost cutting measures, often leading to layoffs. The new emphasis on employee profit-sharing marks a significant shift. Polls indicate that US employee engagement has stagnated since early 2020, while union organizing is rising. Profit-sharing initiatives could help reverse these trends by leveraging employees’ insights and energy.
Current workers are well positioned to identify areas where money is wasted, sales opportunities are missed, or processes need improvement. Engaging employees through ownership stakes could unlock untapped potential and drive performance improvements.
Learning from Past Experiences
However, employee ownership is not a guaranteed solution. The recent struggles of the UK retail chain John Lewis illustrate that success is not assured simply by distributing ownership stakes. Effective implementation and a supportive corporate culture are essential for realizing the benefits of employee ownership.
Extending this principle to all employees could yield significant returns if investors believe that top executives are motivated by share grants and options. Rewarding PE firms that adopt broad-based employee ownership could set a new standard for socially responsible and effective investment strategies.
The Future of Private Equity
The private equity industry is at a critical juncture. Rising interest rates have disrupted traditional leverage-based strategies, compelling firms to innovate and adapt. Shared ownership initiatives and a renewed focus on operational excellence represent a promising path forward.
By empowering employees and engaging them in the success of their companies, private equity firms can foster a culture of collaboration and continuous improvement. This approach addresses social inequality and positions firms to deliver robust returns in a challenging economic environment.
As the industry evolves, the success of these new strategies will depend on effective implementation and a genuine commitment to shared value creation. Private equity firms that embrace this new playbook may find themselves better equipped to navigate the complexities of the modern investment landscape, delivering sustainable growth and lasting impact for all stakeholders.