Ludovic Phalippou, professor of financial economics at Oxford University’s Saïd Business School, has conducted research on private equity’s “billionaire factory”. He pointed out their wealth had grown rapidly. In 2005, he said, there were three multi-billionaire private equity bosses in the US — including Henry Kravis and George Roberts, who lent their names to the buyout house KKR, which features in the 1989 book Barbarians at the Gate. By his estimation, the Forbes list in 2020 included 22 private equity bosses.
Private equity secures funds from banks, pension funds, insurance companies and wealthy individuals.
It then invests in asset-rich companies often through complex corporate structures, with secretive partnerships at the apex. Money is often routed through offshore havens to secure tax advantages.
The dash for high short-term returns is frequently accompanied by low investment, low wages and low staff morale.
Typically, private equity acquires control of a company and loads it with secured debt. The debt often comes from related parties – that is, from another entity under the control of the private equity owners.
They then are high up the queue to be repaid if things go wrong, and in the meantime can charge high rates of interest.
These lenders may be located in tax havens which levy little or no tax on profits and income from outside those jurisdictions.
The debt loading has consequences. Firstly, the interest qualifies for relief which lowers the tax liability and increases the return to shareholders. Secondly, if it has become a secured creditor, private equity drastically cuts the risks of losing money if a firm they have bought goes bust.
Normally, shareholders are the last to be paid from the assets of a bankrupt business and receive little or nothing. But with secured creditor status, private equity is at the head of the queue and is paid first.
So in these cases the risks are almost entirely transferred to suppliers, employees, pension schemes, taxpayers and local councils, all of whom are behind private equity in the line.
It then invests in asset-rich companies often through complex corporate structures, with secretive partnerships at the apex. Money is often routed through offshore havens to secure tax advantages.
The dash for high short-term returns is frequently accompanied by low investment, low wages and low staff morale.
Typically, private equity acquires control of a company and loads it with secured debt. The debt often comes from related parties – that is, from another entity under the control of the private equity owners.
They then are high up the queue to be repaid if things go wrong, and in the meantime can charge high rates of interest.
These lenders may be located in tax havens which levy little or no tax on profits and income from outside those jurisdictions.
The debt loading has consequences. Firstly, the interest qualifies for relief which lowers the tax liability and increases the return to shareholders. Secondly, if it has become a secured creditor, private equity drastically cuts the risks of losing money if a firm they have bought goes bust.
Normally, shareholders are the last to be paid from the assets of a bankrupt business and receive little or nothing. But with secured creditor status, private equity is at the head of the queue and is paid first.
So in these cases the risks are almost entirely transferred to suppliers, employees, pension schemes, taxpayers and local councils, all of whom are behind private equity in the line.
The Strategic Secret of Private Equity
https://hbr.org/2007/09/the-strategic-secret-of-private-equity
https://hbr.org/2007/09/the-strategic-secret-of-private-equity
Harvard Business Review
The Strategic Secret of Private Equity
The huge sums that private equity firms make on their investments evoke admiration and envy. Typically, these returns are attributed to the firms’ aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and…
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Zombie funds
A manager whose portfolio in its current fund is too weak to get the fundover the preferred return and into the carry, or where the current fund’sperformance is too weak to allow for a successor fund to be raised, isunaffectionately referred to as a ‘zombie’. The problem of zombie fundslooks set to continue as the fundraising market remains challenging.
The effectiveness of carried interest and the preferred return in thisscenario as a tool for alignment is all but redundant as the GP’s revenuestream is only from the management fee. This provides a perverseincentive to continue to hold assets in the portfolio even where exitconditions are favourable.
A manager whose portfolio in its current fund is too weak to get the fundover the preferred return and into the carry, or where the current fund’sperformance is too weak to allow for a successor fund to be raised, isunaffectionately referred to as a ‘zombie’. The problem of zombie fundslooks set to continue as the fundraising market remains challenging.
The effectiveness of carried interest and the preferred return in thisscenario as a tool for alignment is all but redundant as the GP’s revenuestream is only from the management fee. This provides a perverseincentive to continue to hold assets in the portfolio even where exitconditions are favourable.
As the 50-year-old private equity industry matures, investment returns are falling. Traditional tools of value creation such as financial engineering are outdated. The next frontier of value creation is to design and manage PE portfolios as a business ecosystem. With portfolio companies linked together, synergies can be realized. Value is primarily created through revenue enhancements, procurement advantages, other cost efficiencies, higher valuation ratings, and some downside protection. What’s more, value-creating relationships that cut across the portfolio can often be maintained after portfolio businesses have been sold, so they can increase the sale price. To take advantage of an ecosystem approach private equity firms will need to embrace new organizational structures, a harmonization of systems, new skills, changes to remuneration arrangements, and a culture of cross-business coordination
The Private Equity industry makes money in two main ways. Firms typically charge their investors a management fee of 2 percent of their assets. And they keep 20 percent of future profits that their investments generate.
That slice of future profits is known as “carried interest”.The term dates at least to the Renaissance. Italian ship captains were compensated in part with an interest in whatever profits were realized on the cargo they carried.
That slice of future profits is known as “carried interest”.The term dates at least to the Renaissance. Italian ship captains were compensated in part with an interest in whatever profits were realized on the cargo they carried.
10 observations on private equity and venture capital
Scott Becker - Tuesday, June 22nd, 2021
1. Over the last two decades, the private equity news and business has often been dominated by the largest funds: Blackstone, Apollo, Carlyle, Madison Dearborn, etc.
2. In the last decade, there has been an explosion of smaller funds, ranging from $50 million to several billion dollars.
3. Many of these smaller to midsize funds, $50 million to $10 billion, have performed incredibly well, many over a sustained period of time. Examples of these funds are Frontenac, LLR Partners, CP Founders, Vistria, Gauge Capital, Silver Oak and a lot more.
4. This next size level of funds has provided tremendous opportunity for private equity professionals, advisory firms, middle market firms and companies seeking investments.
5. The funds with the biggest dollars often make the most money for their firms. It is a simple law of larger numbers: 2 + 20 percent of $50 billion to $200 billion is more than 2 + 20 percent of $100 million to $10 billion.
6. However, a lot of small to midsize funds and venture capital funds have performed extremely well.
7. There has also been an explosion of venture capital funds. The venture capital funds are often smaller than the mega funds. We often see venture capital funds that have $50 million to $1 billion. Venture capital can have higher risk, but in periods where things go well can outperform the private equity funds investing in more mature growth companies. See: 7Wire Ventures, Andreessen Horowitz, LiveOak, Flare Capital and more.
8. When investing in venture capital, the investment sizes can be small at the seed stage but grow as one moves through the Series A and B and so forth. One needs to be prepared to back up the initial investments.
9. There has also been great growth in seed and venture capital funds that make a lot of relatively small investments. For example, we just interviewed a fund that has made nearly 200 investments over 5 years at small dollar amounts.
10. There is increasing growth in women-owned and women-led venture capital funds and slower growth in women-led private equity funds.
Scott Becker - Tuesday, June 22nd, 2021
1. Over the last two decades, the private equity news and business has often been dominated by the largest funds: Blackstone, Apollo, Carlyle, Madison Dearborn, etc.
2. In the last decade, there has been an explosion of smaller funds, ranging from $50 million to several billion dollars.
3. Many of these smaller to midsize funds, $50 million to $10 billion, have performed incredibly well, many over a sustained period of time. Examples of these funds are Frontenac, LLR Partners, CP Founders, Vistria, Gauge Capital, Silver Oak and a lot more.
4. This next size level of funds has provided tremendous opportunity for private equity professionals, advisory firms, middle market firms and companies seeking investments.
5. The funds with the biggest dollars often make the most money for their firms. It is a simple law of larger numbers: 2 + 20 percent of $50 billion to $200 billion is more than 2 + 20 percent of $100 million to $10 billion.
6. However, a lot of small to midsize funds and venture capital funds have performed extremely well.
7. There has also been an explosion of venture capital funds. The venture capital funds are often smaller than the mega funds. We often see venture capital funds that have $50 million to $1 billion. Venture capital can have higher risk, but in periods where things go well can outperform the private equity funds investing in more mature growth companies. See: 7Wire Ventures, Andreessen Horowitz, LiveOak, Flare Capital and more.
8. When investing in venture capital, the investment sizes can be small at the seed stage but grow as one moves through the Series A and B and so forth. One needs to be prepared to back up the initial investments.
9. There has also been great growth in seed and venture capital funds that make a lot of relatively small investments. For example, we just interviewed a fund that has made nearly 200 investments over 5 years at small dollar amounts.
10. There is increasing growth in women-owned and women-led venture capital funds and slower growth in women-led private equity funds.
Private Equity
As a business owner interested in selling for maximum return, you should consider a Private Equity (PE) transaction.
A few reasons you should consider PE deals:
1. Higher valuation multiples than strategic buyers
2. PE partners assess and close transactions more quickly than a traditional buyer
3. They have deep pockets and invest in growing your Company via organic and acquisitive means
4. You can close on much larger acquisitions allowing scale to be more readily achieved
5. PE firms prefer your team to continue to operate the business on a day-to-day basis
6. You will have a sophisticated strategic partner with skill sets not typically found internally
7. Company name and culture will be maintained
As a business owner interested in selling for maximum return, you should consider a Private Equity (PE) transaction.
A few reasons you should consider PE deals:
1. Higher valuation multiples than strategic buyers
2. PE partners assess and close transactions more quickly than a traditional buyer
3. They have deep pockets and invest in growing your Company via organic and acquisitive means
4. You can close on much larger acquisitions allowing scale to be more readily achieved
5. PE firms prefer your team to continue to operate the business on a day-to-day basis
6. You will have a sophisticated strategic partner with skill sets not typically found internally
7. Company name and culture will be maintained