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Today core business model must be shown to work, says CBI boss; PRIVATE EQUITY.

The private equity industry must prove its core business model works now the economic conditions have changed compared to a year ago, the directorgeneral of the CBI has said.

Last year PE firms took advantage of highly leveraged debt and rising asset prices to do deals and deliver returns, but the credit crunch and global economic slowdown had brought this to an end, temporarily at least, Richard Lambert said yesterday.

Now firms need to show their core business model works without the easy access to credit and rising prices of assets.

Mr Lambert, speaking at the British Venture Capital Association's 25th Anniversary Summit, said the PE model was very different to that of banks and financial institutions, many of which have got into severe difficulties during the credit crunch.

Some investment banks, the CBI director-general said, had overlooked basic risk management in their desire to make money and allowed some staff to take decisions which private equity firms, with their own equity at risk, would not have countenanced.

"The spectacular returns generated by some private equity houses over the past half dozen years have been derived from three sources: high leverage, rising asset prices and a business model that cuts out the agency problem inherent in listed companies, by aligning exactly the interests of owners and managers," said Mr Lambert.

"It's never been entire lyclear which of these three elements was the most important . Now in today's changed financial climate, the first two are going to be much less powerful.

" Producing above average returns in the next few years is going to be more challenging and will have to rely much more heavily on private equity's business model."

The BVCA is currently pulling together data to identify how portfolio companies create value and this, Mr Lambert said, will be "very important in demonstrating the contribution made by management activity as opposed to financial engineering to private equity performance".

Mr Lambert said it was clear that a number of investment banks had overlooked basic risk controls in their drive to increase profits.

This pattern of behaviour, said the director general, had been exacerbated by a remuneration structure which encouraged some employees to take spectacular short-term risks, confident that if things worked out well they would reap huge rewards, while if they didn't, then they wouldn't be around to worry.

A year ago, Mr Lambert said, PE was treated as a social pariah but since then it had woken up to the need to engage with the wider world and this was going to remain a priority for some time. "The challenge is to show that private equity ownership is absolutely compatible with a sense of corporate responsibility, in precisely the way that also applies to listed companies," he added.

He said businesses, many backed by private equity were likely to fail in the next couple of years and this would be a strong test of the levels of responsibility.

However, Mr Lambert said that PE firms would continue to play a significant role in the economy as they still had lots of capital to invest.


Richard Lambert
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Title Annotation:Business
Publication:The Birmingham Post (England)
Date:Apr 24, 2008
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