Question

This assignment concerns the idea of "private equity," a notion that is very important to the financial strategy of firms. We had a brief discussion on Blackrock, which is a private equity firm. Many companies have recently been bought by private equity, including Dell. Private equity firms argue that they can re-engineer the firm without shareholders breathing down their neck.

But private equity can be a very dangerous thing. Private operators buy companies by borrowing money, then load the debt on the companies books, strip it of all value, and leave it to go bankrupt. A particularly egregious case involved the Simmons mattress company, and the same might be unfolding at Toys R Us.

In his 2014 letter to investors, Warren Buffet had warned about the ethics of this phenomenon:

Families that own successful businesses have multiple options when they contemplate sale. Frequently, the best decision is to do nothing. There are worse things in life than having a prosperous business that one understands well. But sitting tight is seldom recommended by Wall Street. (Don’t ask the barber whether you need a haircut.)

When one part of a family wishes to sell while others wish to continue, a public offering often makes sense. But, when owners wish to cash out entirely, they usually consider one of two paths.

The first is sale to a competitor who is salivating at the possibility of wringing “synergies” from the combining of the two companies. This buyer invariably contemplates getting rid of large numbers of the seller’s associates, the very people who have helped the owner build his business. A caring owner, however – and there are plenty of them – usually does not want to leave his long-time associates sadly singing the old country song: “She got the goldmine, I got the shaft.”

The second choice for sellers is the Wall Street buyer. For some years, these purchasers accurately called themselves “leveraged buyout firms.” When that term got a bad name in the early 1990s – remember RJR and Barbarians at the Gate? – these buyers hastily relabeled themselves “private-equity.”

The name may have changed but that was all: Equity is dramatically reduced and debt is piled on in virtually all private-equity purchases. Indeed, the amount that a private-equity purchaser offers to the seller is in part determined by the buyer assessing the maximum amount of debt that can be placed on the acquired company.

Later, if things go well and equity begins to build, leveraged buy-out shops will often seek to re-leverage with new borrowings. They then typically use part of the proceeds to pay a huge dividend that drives equity sharply downward, sometimes even to a negative figure.

In truth, “equity” is a dirty word for many private-equity buyers; what they love is debt. And, because debt is currently so inexpensive, these buyers can frequently pay top dollar. Later, the business will be resold, often to another leveraged buyer. In effect, the business becomes a piece of merchandise.

So workers and customers suffer, while financiers make money.

***In this assignment, please write a 500-word analysis of private equity. Give your essay an original title. You can be pro-private equity or anti. I want you demonstrate how well you understand this concept. would you please elaborate and elucidate it thanks.

Answer 1

LBO model still remains the model of choice for most of the private equity players. That part remains true. However, who are really sitting behind private equity are their general partners who demand much higher returns on their investments than are available in the market. This means, that the fund managers or the limited partners have to take additional risk. They do this by combining that equity with a lot of debt. Debt while being dangerous also bring financial discipline. The excellent returns which some of the PE owned firms generate when they get listed are a testimony to that. An example is AZ electronic materials owned by Carlye group before it listed in London in 2012.

Private equity also helps many of these firms which do not have access to stock markets get finance quickly and a customized financing structure. In fact, many PE players are interested in taking a sizeable minority stake based only on equity. In exchange, they take a seat on the management and help turnaround the company.

Warren Buffett's contention is right for some cases, but there are numerous examples which run counter to his assertion.