NHS organisations can learn a lot from the ways private equity operators turn tight cash control to effect, says Jon Allen

Having just come to the end of an executive MBA at Said Business School, I have found myself reflecting on some of the key areas of learning and how it transfers to my practice as an executive director in the NHS.

While I have increased my financial and strategic skills and knowledge, I think some more important areas of learning and understanding were also transmitted.

One of the final courses was on private equity and my group had the good fortune to have some lectures by Damon Buffini, senior partner of Permira, the highly successful private equity fund.

Several things are interesting about how private equity works. But first it is important to dispel a myth: private equity funds, which mainly raise large sums of money from pension funds, endowments and large-scale private investors, do not just look to buy companies cheaply and strip them of all their assets to make a quick buck. In fact, funds look for companies that are struggling to achieve their potential and improve their performance and value.

Private equity typically adds value in four ways.

  • With publicly listed companies, it takes them out of the stock market. Instead of a complex array of shareholders, all with their own ideas of how the chief executive should run the company, the private equity company has the controlling share and sets the performance and improvement agenda.

  • The private equity firm develops a clear strategy for reducing costs and improving performance.

  • Managers are given strong incentives and powers to get on and improve performance in the agreed areas. Where necessary, managers are replaced and the best managerial talent in the industry is sourced to complete the transformation.

  • Where the company may be complacent because it has excess cash on the balance sheet, the private equity house purchases the company with a large amount of borrowed money, putting significant debt on the balance sheet. This adds additional managerial discipline as they work hard to ensure they have enough free cash to meet the interest payments.

Let's compare this business model with the NHS, where our governance structures in foundation trusts (said to be more comparable to commercial businesses) are becoming increasingly democratic, giving managers a greater burden of consultation and negotiation when making changes.

In NHS organisations, managers and staff incentives are not aligned with improved performance. Improvement, rather than being driven from within, as a matter of achieving our business goals, has to be driven and developed by external organisations such as the NHS Institute for Innovation and Improvement.

All NHS organisations I have come across strive to have a healthy cash position and very few would want a significant amount of debt on their balance sheets. Increasingly, foundation trusts are moving towards positive cash positions but few appear to have clear ideas about how to invest that cash to make positive returns, whether that is judged in net present value or in public benefit. In this situation, a private equity house would argue there is a real risk managers will become complacent and use the excess cash unwisely.

Good private equity firms turn failing companies around and deliver substantially superior results, compared with the stock market. Can the NHS learn lessons from private equity and find ways to lighten the load of excessive governance, through which managers are stymied from acting effectively? Can we free up pay arrangements adequately to get the best talent and align their incentives to achieving world-class performance? And can we stop organisations from becoming too cash rich, leading to inappropriate use of those resources?

As the NHS moves towards commercial approaches to doing business, models that deliver superior results need to be carefully considered.