THERE IS ONLY ONE WAY TO BE A SUCCESS / THE FINANCIAL TIMES ( A MUST READ )

August 9, 2011 10:30 pm

There is only one way to be a success

By Luke Johnson


An obvious truth dawned on me recently: all the really successful investments I’ve ever made have achieved great returns because the underlying companies enjoyed high growth.


Such an elementary insight should have occurred to me long before now. Yet I had always believed that private equity made money in four separate ways: buying low, selling high, companies generating cash and companies growing. But the reality is that the first three mechanisms are pretty irrelevant in the long run – growth is what matters.


Traditionally, leveraged buy-outs supported mature, cash-generative companies using debt. They cut costs and incentivised management, hence boosting profits. For many such deals the top line doesn’t increase much. I have always preferred development capital, where new funding is injected to help a company enlarge organically.


In general, growth comes either from taking share from rivals or from participating in markets that are growing. The latter path tends to be a much easier one to follow. But growth is rare in states that have negligible economic expansion.


And right now underlying growth in the west is very scarce indeed. Output in most countries is stagnant, with heavy public debt burdens, crushing welfare costs and deteriorating demographics all extracting a toll. The results of these circumstances are falling living standards and structural unemployment.


Growth matters not just because it leads to rising prosperity. Growing countries tend to be more optimistic and happier. Material improvement leads to general satisfaction; decline leads to misery.


Growth is also the only realistic way to generate the necessary tax revenues to pay back public debts and fund the obligations of ageing societies. I just do not buy the argument that we can enjoy a zero-growth future. Such a tendency runs against human nature, and is simply too pessimistic a forecast to contemplate.


But growth is never easy. For a start, it consumes resources, which are likely to be finite. It is cyclical and can have environmental impacts. Growth is spurred by innovation, most of which is based on technological advances. While overall these developments are welcome – better products, more efficient processes – rises in productivity usually rely on automation, thus leading to fewer jobs. So while growth engenders new jobs, it also kills old ones. It is about reinvention, which itself triggers “creative destruction”, and the requirement for retraining. Thus companies must constantly adapt, or die. Citizens must re-skill, or risk becoming redundant. This turmoil has accelerated in the digital age across our global economy.


Unfortunately growth markets can often be profitless. Typically they require plenty of investment up front, frequently for negligible returns. I am involved with an electric car charging business. At first glance it is hard to think of a sector offering more potential. Governments and automotive manufacturers are pumping tens of billions into the development of electric cars. Yet in Britain, out of 28m cars, just 2,500 are pure electric vehicles. Sadly, it is going to be some time before this is an industry of real scale and opportunity, despite the endless excitement.


Furthermore, growth can be risky, and even an illusion. I used to part-own a chain of fitness clubs which provided purpose-made exercise equipment for women over the age of 50. Everything was designed to appeal to the market segment. Those members who used it regularly showed remarkable improvements in health and weight – it should have been a roaring success. But the business never took off. Despite there being many unfit and overweight older women in our society, it seems too few of them really want to apply much effort and investment getting into shape.


My conclusion is that growth is a necessity both for business and a fulfilled society. To drive it we need more patient capital, better technical education, deregulation of commerce and lower tax on private enterprise. This is a shortlist of requirements: but a fantastically difficult series of actions to implement.

The writer runs Risk Capital Partners, a private equity firm, and is chairman of the Royal Society of Arts



Copyright The Financial Times Limited 2011.