The perception about private equity firms ranges from vultures, barbarians and flippers to job-creators and increasing a company’s net worth. Private equity firms typically invest in U.S. companies that are underperforming their industry peers. Investors in private equity only make money if they improve the performance of the companies invested in; private equity companies are last in line to be paid in case of insolvency. Private equity companies tend to use more incentive-based pay than other firms.
Private equity firms specialize in leverage buyouts or deals funded by debt that is loaded onto the target company’s balance sheet. The acquired companies are often restructured to reduce costs, improve efficiency and repay the debt, before being sold or listed on the public markets.
The preferred “exit strategy” of a private equity firm is to take the company it has acquired public, thereby raising even more money that may help the company become even stronger. By law, a company cannot pay a dividend unless it is solvent. It is illegal for a director to authorize a dividend that would render the company insolvent. Board members can be personally liable for agreeing to a dividend of an insolvent corporation.
Private Equity Firms
The Good | The Bad |
6.6% annualized returns over 5 years vs. -0.9% annual returns for stocks held by pension plans (Sept. 2011) | 2% annual fees + 20% of any profits |
Industry employs 8.1 million worldwide | Borrowed money = 49% of buyout value |
In 2010, Apollo Global invested $1.5 billion in LyondellBassell; Apollo was worth $6.6 billion in early 2012 | Annualized rates have fallen to single digits |
At the height of the 2008 financial crisis, the GAO’s private equity report wrote, “academic research suggests recent equity LBOs have had a positive impact on the financial performance of the acquired companies.” The same reported noted that in the 2004-2008 period it studied, none of the 500 complaints received by the SEC’s Division of Investment Management involved private equity fund investors.
The 2008 GAO report shows companies that the private equity firms invested in had low growth relative to their peers and that employment growth grew after they were acquired by a private equity firm. In 2009, Ford sold Hertz to a private equity firm for $14 billion. A year later, the private equity firm took Hertz public at a $17 billion valuation.
Bain Capital
In a January 2012 article, The Wall Street Journal reported about their assessment of 77 businesses Bain invested in while Mitt Romney led the firm from its 1984 start until early 1999. Among the findings:
[a] 22% filed for bankruptcy reorganization or went out of business by the end of eight years after Bain first invested (note: the figure drops down to 12% if the period is five years). Another 8% resulted in Bain losing its entire investment money.
[b] A different study, covering the 1985-1999 period, found bankruptcy rates among target companies globally was 5-8%.
[c] The stellar returns for its investors was largely concentrated in a small number of deals; 10 deals produced > 70% of the dollar gains. Of these 10 companies, four later landed in bankruptcy.
[d] Many of the Bain acquisitions that went into bankruptcy emerged far healthier after the reorganization (similar to GM several years ago).
[e] Bain generally invested in smaller companies that carried greater risk.
[f] A 1995 Bain investment of $6.4 million in eye-wear company Wesley Jessen Vision-Care resulted in a gain of > $300 million, a 46-fold return.
[g] Research shows that buyout companies, on average, add value to their targets.
Bain Capital: 10 Deals That Resulted in its Largest Profits [1984-1998]
Investment Date and Amont Bain Invested [in millions] | Estimated Bain Gain | What Happened | Chap. 11 B/K |
Steel Dynamics [1994] $18m | $85m | Public in 1996 | no |
American Paper & Pad [1992] $5m | $102m | Public in 1996 | 2003 |
DDi Corp. [1996] $41m | $117m | Public in 2000 | 2003 |
Experian Corp. [1996] $88m | $164m | Sold in 1996 | no |
Physio Control [1994] $10m | $168m | Public in 1995 | 2000 |
Stage Stores [1988] $10m | $175m | Public in 1996 | no |
Waters [1994] $27m | $178m | Public in 1995 | no |
Dade [1994] $30m | $186m | Dividend | 2002 |
Wesley Jessen [1995] $6m | $302m | Public in 1997 | no |
Italian Yellow Pages [1997] $17m | $373m | Sold in 2000 | no |
Unlike other investments that trade in debt and derivatives, private equity firms make money by investing in businesses making things and providing services.
