Compliance and Private Equity: An Oxymoron?
We all enjoy an oxymoron, e.g., army intelligence, compassionate conservative. Some words go together and some do not. When it comes to compliance and private equity companies, you can predict with usual success that private equity and compliance do not fit.
Sometimes simple statements turn out to be good explanations for a trend. When a private equity firm acquires a company, the focus is on the bottom line: making money. A private equity firm has little to no interest in building a company committed to sustainable and long-term growth. To the contrary the private equity company likes to earn cash, build a strong profit and loss statement, and then “flip” or sell the company at a great profit.
The private equity model usually leads to a series of “tragedies” for employees, managers and others who may be committed to the company. Senior leadership is not dedicated to the employees as a long-term investment. They are only seeking to reduce costs and increase revenues. If an employee is consistent with this approach, the employee keeps his or her job. If the employee is not helpful to this immediate cause, the employee will be let go. It is a harsh world that a company enters when a private equity company takes over.
A frequent casualty in this process is support functions, meaning the non-revenue earning functions such as compliance. I have seen too many private equity owned companies that manage a target company with little to no attention to ethics and compliance, after all there is no bottom line benefit to a compliance program in a short-term financial strategy.
We all know the theoretical benefits from a market-driven economy. Consumer welfare is maximized and assets are used in the most productive manner. But there has to be some accounting for employee welfare and sustainability as an economic goal. Employees who experience private equity ownership are likely to turn cynical and suffer from poor morale. Such an attitude inevitable will hurt the company’s bottom line.
For private equity companies that own and manage a portfolio of companies, they are playing with real risks. Portfolio companies often have immature compliance programs that suffer from lack of basic compliance program structures, policies and procedures and resources. In today’s enforcement world, private equity companies will cross the line and get caught. It is inevitable.
If private equity companies were “smart,” they would attend to a compliance model that fits the situation, meaning a three to five year window for building a corporate compliance program that makes the company more attractive as an acquisition target.
A company that has a streamlined and operational program is much more likely to pass the due diligence process without creating unnecessary red flags and risks for a potential acquiring company. We all know the dangers of successor liability in anti-corruption, sanctions, export controls, anti-money laundering areas, and there is no need for a company to slow the acquisition process by failing to address compliance and enforcement risks.
Private equity companies often rely on homegrown management teams to take over and operate an acquired company. There is no reason why the management team cannot include a compliance professional who is ready to address existing risks and build mitigation strategies for the acquired company. An effective compliance program is a bottom line contributor and an essential requirement in the world of mergers and acquisitions.
Private equity companies have to recognize this new reality and pay attention to compliance. If they fail to do so, they are only demonstrating their inflexible ignorance to today’s reality – compliance is an essential currency in the marketplace, and companies that fail to address compliance do so at their peril.