The lobby of BlackRock, an American private equity company, is pictured in Frankfurt, Germany, on Feb. 12.Michael Probst/The Associated Press
Sean Stevens, Gesta Abols and Caitlin Rose are lawyers at Fasken. The views expressed herein are those of the authors.
Private equity builds businesses for the wider benefit, and has done so for decades. But recently, a contrary opinion has developed that asserts private equity is sometimes value-destructive or anti-competitive. This misleading narrative – arguably politically motivated – began in the United States, but has since migrated north of the border. For numerous reasons, including the Bank of Canada’s warning that Canada faces a productivity “emergency,” we believe a counterpoint is appropriate.
In its most classic form, private equity acquires companies that are either underperforming or otherwise present significant growth opportunities through efficient capital deployment and the better alignment of management’s interests with company performance. Through the private equity fund’s experience, sector-specific expertise, greater access to financing and often the purchase of complementary businesses, value is created or unlocked and the improved company is later resold at a profit. The cycle is repeated and, with each turn, the economy gains on multiple levels, including through stronger companies, increased employment, a more productive allocation of resources and healthy returns to investors.
This has been well understood since private equity’s inception, and no doubt has been a key driver of the unrelenting growth of the U.S. economy. Nowhere else is the private equity industry larger, more diversified or more sophisticated. Nowhere else does it have deeper roots.
Indeed, in its 2020 Merger Remedies Manual, the U.S. Department of Justice stated that in some cases a private equity bidder may be preferred over an established industry player, i.e. a “strategic” bidder, in a divestiture of assets mandated by regulators during a merger approval process. In doing so, the Justice Department cited a U.S. Federal Trade Commission study indicating that a private equity buyer “had flexibility in investment strategy, was committed to the divestiture, and was willing to invest more when necessary.”
The emergence of a conflicting characterization by the DOJ and FTC in 2022 was therefore notable. Both agencies began questioning private equity’s incentives, and cautioning that private equity investment strategies and governance structures would be subject to enhanced scrutiny for concerns regarding perceived negative effects on competition. Last month, the FTC and DOJ announced they are launching a cross-government public inquiry into private equity and other private investment in the U.S. health care industry.
This recent regulatory scrutiny into private equity in the U.S. has started to migrate north of the border. For example, when speaking to the Canadian Bar Association’s Competition Law Conference in October, 2023, Canada’s Commissioner of Competition stated: “On the emerging issues front, we see clearly what’s happening in terms of evolving business practices. We are wise to the risks of creeping acquisitions – including private equity roll-up strategies – and the harm they may pose to competition.” The strategy he referred to is the practice of acquiring and merging several small companies to achieve efficiencies through the economy of scale.
Where Canada has not followed the U.S. is in productivity gains. As reported by The Globe and Mail last month, in 1984 Canada’s productivity – its economic production per hour worked – was 88 per cent of that of the United States. By 2022, this has fallen to 71 per cent. Moreover, over the same time period, Canada also fell behind its Group of Seven peers, with only Italy seeing a larger decline in productivity relative to the United States.
In a candid speech, the Bank of Canada’s senior deputy governor Carolyn Rogers deemed the situation an emergency. Ms. Rogers explained that low productivity growth makes it harder to control inflation and could erode living standards if left unaddressed. Reasons she cited for Canada’s lagging productivity included weak business investment, meagre competition and a risk-adverse business culture.
Private equity is primed to combat each of these issues. Private equity can provide badly needed liquidity and is proficient at the efficient allocation of capital, assets and other resources. Private equity is typically engaged, forward-thinking, dynamic, agile and innovative. Their portfolio companies tend to operate more efficiently as the fund instills industry best practices and offers more substantial incentives to management. Unlike in public companies, ownership and control are closely integrated. The entry of a private equity investor into an industry sector can also create positive disruption, immediately causing otherwise complacent competitors to double down on business investment, employee training and other performance-enhancement initiatives. Over all, private equity is capable of stimulating significant increases in productivity, and can often achieve these results relatively quickly.
This is imperative to appreciate as we confront Canada’s productivity crisis. While private equity is not a magic bullet, it is certainly undeserving of any adverse presumption or other disadvantage before regulators. What has essentially been an abrupt ideological shift in the U.S. should not unduly influence Canadian public policy, particularly given private equity’s much longer history of overwhelmingly positive contribution to economic growth, productivity and prosperity.