Until recently, private equity (PE) firms' reputational standing with limited partners (LPs) — the pensions, endowments, and other investors whose capital fuels PE — turned almost entirely on the returns they delivered. These times are coming to an end.

In a shift — like one that Edelman has documented in surveys of public-stock investment managers in recent years — many LPs said they are giving weight to private equity firms' environmental, social and governance (ESG) practices in making investment decisions.

That finding stood out in Edelman's 2021 survey, released today, of more than 400 LPs in the U.S., Canada, the UK and Germany that probed LPs’ views of the PE industry's reputational components. The LPs' verdicts, while positive on balance, underscored that today, stellar financial returns aren't always enough for PE firms to win LP allegiance.

Private equity's reputation in Washington is another concern for the industry. Led by Senator Elizabeth Warren, Congressional Democrats recently reintroduced the "Stop Wall Street Looting Act" that Warren initially proposed in 2019. The bill would upend industry economics, putting firms on the hook for portfolio company debt and pension obligations, curtail debt-funded dividend recaps, and tax firms' carried interest earnings as regular income. Three-quarters of the global LPs Edelman surveyed favor increased regulation of the industry, with half saying they support some or all of Warren's proposal, despite its possible negative impact on financial returns.

With higher standards for transparency and ESG factors along with increased scrutiny from politicians, private equity firms must do more to defend and build their brands. Facing pressures like those that public companies do from large investors, GPs can no longer expect to coast on their IRRs to achieve LP support. The investor community's standards for what it seeks in private equity partners have evolved, and PE firms must evolve accordingly.

Based on our survey, here are some specific actions PE firms need to take:

Establish a robust ESG program. Making a positive impact on society and the environment is important. LPs want to see their capital used to drive economic growth, create jobs and improve the communities where PE firms and their portfolio companies operate.

Take employee welfare, corporate culture, and DE&I seriously. These have emerged as front-burner issues for investors since the onset of the pandemic. PE firms need to address employees' health and welfare and promote diversity and inclusion in the workplace. Recognize that a loyal and vocal employee base serves as a key reputation influencer.

Work with, not against, the political agenda. Most LPs favor increased regulation of PE, and momentum for it has built in Congress. Now is the time to show you are aware of the trend and prepare for some changes.

By all measures, private equity is booming, and overall LP trust in the industry remains high. In addition to our data, we see evidence of this with record high fundraising and deal making. But for private equity firms to thrive going forward, they must take a strategic approach to reputation management. PE firms must mount strong communications programs to update lawmakers, LPs, employees, and other external stakeholders on their actions. Those that do will continue to attract LP capital, grow deal flow, and find it easier to hire and retain talented employees. Those that do not risk falling behind.

Renee Calabro is US Head of Private Equity and David Carey is a Senior Content Advisor.