3 reasons why private equity will enable the post-pandemic economy

For three-quarters of a century, small and medium-sized enterprises (SMEs) have been the growth engine of the global economy. In recent years, they have created 62% of net new jobs in the US, and even more in developing economies. There is little doubt that as we emerge from the COVID-19 pandemic, any meaningful and sustainable economic recovery will again be driven by SMEs.

However, this crisis has been like nothing in recent history – the whipsawing of real US GDP from a negative 36% in the second quarter of 2020 to a positive 30% in the third quarter has no parallel in modern economic history. Given the magnitude of the disruption, it is testimony to how resilient our economic systems are. However, three trends stand out in affecting SMEs disproportionately, and therefore threatening their role as economic growth engines.

The first has become a frequent headline topic – the inflation of materials and goods, driven by geopolitics and fragile global supply chains. According to a recent World Economic Forum article, US supply chain disruptions are back to their peak 2020 levels, and continue to remain a big concern particularly for SMEs that have a smaller and more concentrated supplier base than large corporates.

Adding to the difficulties that SMEs face is the “Great Resignation”, a complex phenomenon that has been exacerbated by the pandemic, as workers have had to deal with personal tragedies, an uncertain and complex work environment, and issues of burnout and mental health. SMEs are affected in two ways. First, front-line workers, minority and lower level employees are more likely to quit their jobs according to recent research by Mercer, a profile that is more prevalent in SMEs. Second, SMEs with a smaller footprint and recruiting network struggle to attract scarce talent when compared to larger firms.

Finally, SMEs are facing a once-in-a-generation need for investment. To keep up with the Fourth Industrial Revolution, businesses will need to make an estimated $6.8 trillion in digital transformation investments by 2023. At the same time, the decarbonization of the economy will affect all businesses, requiring investments even by those who are not directly engaged in high-carbon sectors.

Together, those three trends create substantial headwinds for SMEs, just when we need them to power the world economy. How can they overcome those obstacles? The answer might come from an unexpected source – private capital.

Private equity firms have already been active investors in the “middle market”, companies with revenues between $10 million and $1 billion in revenues – increasing their deal volume by over 2.6x over the last decade. While those transactions almost never make frontpage headlines, they account for over 60% of private equity activity. And it is this activity that matters most for SMEs.

Through partnership with a private equity firm, SMEs can overcome the structural headwinds and level the playing field in three ways.

Being part of a private equity firm’s network unlocks access to supplier networks as well as procurement best practice – which can improve profitability by as much as 10-20%, and introduce more strategic and resilient supply chain partnerships. At my own firm, we partnered with a manufacturer of neutraceuticals and managed to dramatically improve their supply chain – not by transactional cost cutting, but by building long-term supplier relationships that allowed us to double production capacity throughout the pandemic.

Private equity firms can also offer improved access to talent at all levels of the organization. It is well known that senior executives have great alignment with private equity owners. What is less talked about is that private equity firms can help by leveraging their network of recruiters and change the positioning of the company to attract more talent. At one of our portfolio companies, we are changing the deployment model of technicians from being alone on the job to working in pairs – improving resilience, but also offering camaraderie that makes the role more attractive to talented workers. It helped us close a gap of several hundred vacancies, and allows us to continue to grow the business in line with the demand for its services.

Finally, and almost by definition, private equity can help with the investment challenge SMEs face today. Good private equity partners offer access to patient private capital that can fund the necessary transformations for the Fourth Industrial Revolution and decarbonization. They can also help to structure the balance sheet effectively – a key differentiator as rising inflation increasingly erodes the value of cash sitting idle on balance sheets.

This is a more lasting and collaborative approach than what private equity has historically been known for. But in the middle market, it is the natural approach – in this segment, many businesses are led by founders, families or entrepreneurs. They look for sustainable value creation and legacy, rather than quick financial gain.

According to the latest analysis, private equity firms globally hold nearly $1.2 trillion in ‘dry powder’ capital waiting to be deployed. While this number is often cited as an indicator of market excess, I think of it differently. It is an indicator of private equity standing ready to make a positive difference – powering the historic growth engine of the economy through the headwinds that the COVID-19 pandemic has created.