Private Equity also needs a host of tools to gather and analyse Business Intelligence. These include public records searches, news archives, legal proceedings, patent awards & applications and employees. It seems that PE Governance relies strongly on elaborate processes and ruthlessness. The discipline imposed by debt means that they are pretty conservative in their attitude. It also means that it can be extremely difficult for an entrepreneur working with a PE firm to find breathing space. PE firms simply have too much money on stake and hence need strong internal controls, auditing and monitoring. An entrepreneur, on the other hand, lives to be free. PE firms provide an effective alternative to governance by boards. Nevertheless, it may prove to be more effective for mature firms rather than start-ups. Moreover, since PE firms must focus on returns, I wonder what stops them from milking a company dry in 10 years and leave the rotting corpse for anyone who wants it. I am, therefore, a bit sceptical about PE model being the best one, especially for start-ups. Or perhaps I am missing details about operations of firms that specialize in start-ups. Either way, there is much to learn.
Showing posts with label private equity. Show all posts
Showing posts with label private equity. Show all posts
Wednesday, June 2, 2010
Friday, May 7, 2010
The PE Governance Model and its Implications
PE promises a new governance model that is more ruthless, hard-nosed and realistic when compared to traditional governance models (family-owned, professional managers controlled by a Board of Directors - public or private). Although I have to take it with a pinch of salt as I believe that too much pressure can destroy team fabric, there is some truth to what is being said here.
PE firms are anything if not efficient. The pressure brought on by debt forces them to a discipline not seen in other private or public firms as it forces them to monitor their dealings closely. In absence of the sword of debt hanging on their heads, as will be the case with PE firms going public, it will be interesting to see if the PE model holds. Further, ignoring the human element of business can be a dangerous mistake, especially because humans can vote in elections and can influence. Hence, I am not surprised why PE firms seem to be the favourite punching bag in the current financial crisis. Step on a few feet, make some enemies and wait for them to get even. Personally, I think it is an excellent model capable of delivering value due to its meritocratic and impersonal approach. But it is likely to make them more enemies, something that may be responsible for that talks about PE firms being punished for a crime they never did. PE firms need a strategy to re-package (but not change) their governance style, I say.
PE firms are anything if not efficient. The pressure brought on by debt forces them to a discipline not seen in other private or public firms as it forces them to monitor their dealings closely. In absence of the sword of debt hanging on their heads, as will be the case with PE firms going public, it will be interesting to see if the PE model holds. Further, ignoring the human element of business can be a dangerous mistake, especially because humans can vote in elections and can influence. Hence, I am not surprised why PE firms seem to be the favourite punching bag in the current financial crisis. Step on a few feet, make some enemies and wait for them to get even. Personally, I think it is an excellent model capable of delivering value due to its meritocratic and impersonal approach. But it is likely to make them more enemies, something that may be responsible for that talks about PE firms being punished for a crime they never did. PE firms need a strategy to re-package (but not change) their governance style, I say.
Thursday, May 6, 2010
Legal Obligations for PE and its Implications
Merger and Acquisition activities are bread and butter to Private Equity, and M&A activities are directly affected by Antitrust Regulations in the US. Hence, PE firms need to be aware about them. This is what I learned about the main Antitrust regulations in USA:
The Sherman Antitrust Act of 1890 prevents companies from horizontal/vertical price fixing, boycotts, bid rigging or forming cartels/market allocation. This focussed on limiting monopolies. It, however, did not outlaw any attempts to reduce competition. This was addressed by Clayton Antitrust Act of 1914 that further prevents interlocking directorates, price discrimination, acquisitions with the view to reduce competition and tie-in sales agreements (unless needed to maintain selling company's goodwill). The Federal Trade Commission Act (FTC) of 1914 further prohibits using market share to strong-arm the suppliers and using misleading/false advertisements. Robinson-Patman Act of 1936 was brought in to "save" small retailers from chain stores by prohibiting price-discrimination that is not cost justified or that is not done in response to a competitor's price- an odd-man (according to me) that stands out for its populist undertone. An anti-merger loophole in the Clayton Antitrust Act was closed by the Celler-Kefauver Act of 1950, which prevented acquisition/merger by buying of assets (earlier act outlawed acquisition by buying of stocks only). Hart-Scot-Rodino Antitrust Improvement Act of 1976 further tightened the regulation by making it mandatory for companies to go through at least a 30-days waiting notice period for a merger or acquisition. In principal, this allows the authorities to investigate the case thoroughly, ask for more information and decide if it violates the anti-trust laws.
Overall, the Antitrust laws in US seem robust and well developed. These laws are further supplemented by a long and inclusive list of more than 40 laws to protect consumer rights, indicating a well developed consumer protection system as well. PE firms need to take them into account, depending on the industry vertical they are operating in. In addition to Antitrust laws, PE firms are also affected by laws governing the Capital Markets. This includes 8 different acts, including the recent Sarbanes-Oxley Act of 2002. It seems the PE firms rely on the exceptions stated in the laws governing the Capital Markets to prevent or reduce the overhead associated with it: offering the securities to a limited number of accredited investors (499) with a pre-existing relationship with the firm. All the same, the bottom line that I gather is that private equity functions can get impossibly out of hand in the law-maze without the presence of an able lawyer in the team. After reading "World's Newest Profession" by Dr. McKenna, I also gather that Management Consultants may to be involved to keep clear of legal issues. I am not sure about this as PE firms have their elaborate processes to impose internal control and check fraud, which if sufficiently developed or recognized may obviate such a need. No matter which way it turns, it makes my head reel to think of the amount of bureaucracy and paper-pushing inherent to businesses at larger scale.
The Sherman Antitrust Act of 1890 prevents companies from horizontal/vertical price fixing, boycotts, bid rigging or forming cartels/market allocation. This focussed on limiting monopolies. It, however, did not outlaw any attempts to reduce competition. This was addressed by Clayton Antitrust Act of 1914 that further prevents interlocking directorates, price discrimination, acquisitions with the view to reduce competition and tie-in sales agreements (unless needed to maintain selling company's goodwill). The Federal Trade Commission Act (FTC) of 1914 further prohibits using market share to strong-arm the suppliers and using misleading/false advertisements. Robinson-Patman Act of 1936 was brought in to "save" small retailers from chain stores by prohibiting price-discrimination that is not cost justified or that is not done in response to a competitor's price- an odd-man (according to me) that stands out for its populist undertone. An anti-merger loophole in the Clayton Antitrust Act was closed by the Celler-Kefauver Act of 1950, which prevented acquisition/merger by buying of assets (earlier act outlawed acquisition by buying of stocks only). Hart-Scot-Rodino Antitrust Improvement Act of 1976 further tightened the regulation by making it mandatory for companies to go through at least a 30-days waiting notice period for a merger or acquisition. In principal, this allows the authorities to investigate the case thoroughly, ask for more information and decide if it violates the anti-trust laws.
Overall, the Antitrust laws in US seem robust and well developed. These laws are further supplemented by a long and inclusive list of more than 40 laws to protect consumer rights, indicating a well developed consumer protection system as well. PE firms need to take them into account, depending on the industry vertical they are operating in. In addition to Antitrust laws, PE firms are also affected by laws governing the Capital Markets. This includes 8 different acts, including the recent Sarbanes-Oxley Act of 2002. It seems the PE firms rely on the exceptions stated in the laws governing the Capital Markets to prevent or reduce the overhead associated with it: offering the securities to a limited number of accredited investors (499) with a pre-existing relationship with the firm. All the same, the bottom line that I gather is that private equity functions can get impossibly out of hand in the law-maze without the presence of an able lawyer in the team. After reading "World's Newest Profession" by Dr. McKenna, I also gather that Management Consultants may to be involved to keep clear of legal issues. I am not sure about this as PE firms have their elaborate processes to impose internal control and check fraud, which if sufficiently developed or recognized may obviate such a need. No matter which way it turns, it makes my head reel to think of the amount of bureaucracy and paper-pushing inherent to businesses at larger scale.
Monday, March 8, 2010
Understanding Private Equity Fundamentals
In parallel to reading about pharmaceuticals, I have also started reading "Private Equity: History, Governance and Operations" by Cendrowski et al. I just wish to understand the place and importance of Private Equity (PE) from point of view of a future entrepreneur. The books consists of four modules: history, governance, operations and special considerations. I will simply record my main observations for future reference.
Reading about history, I understand that PE is a relatively recent phenomenon with its roots in the USA. In fact, the book is primarily written with US in mind. Nevertheless, I hope the basic working and attitude would not differ significantly across borders due to a close-knit PE community. It explains the structure of PE firms and general terms used in the industry (e.g. describing what is a general partner or a limited partner, the fee structure, legal agreements and other legal aspects). The books focuses primarily on two type of PE investments: venture capital (VC) financing and buyout transactions. It is interesting to learn that VC funding is further classified as Angel Investing, Seed Funding and Later Stage VC depending upon the maturity of the product portfolio. PE has developed as a distinctive alternative investment vehicle whose profitability is highly dependent on the overall performance of the economy and government policies (especially wrt Capital Gains Tax Rate).
Due to comparatively higher rate of returns many institutions and high-net worth individuals wish to invest with a PE firm. However, it is a very tightly knit circle that works on "knowing" the right people and by being successful. While the top quartile funds are plush with funds, others struggle to raise basic amounts. It is a highly competitive arena where success breeds more success. In the last decade buyout funds have apparently performed better than VC funds. Consequently they find it easier to raise money.
There are primarily two ways in which the PE firms "harvest" their investments: Initial Public Offerings (IPO) and Mergers & Acquisitions (M&A).
The book notes that IPO can be an expensive, lengthy and cumbersome procedure. It not only depends on the prevalent market condition but also it enforces more complexity and regulation on the organization. Nevertheless, it can be seen as an important step in the life of a company signifying a strong historical growth. It also allows the entrepreneur to possibly maintain the control over his company, something that he may loose in some M&A transaction.
Takeovers are defined as horizontal (same industry), vertical (supporting industry) or conglomerate (unrelated). The can be further seen as strategic, defensive, growth or financial. Reverse Takeover is mentioned as a credible and more efficient alternative to IPO. The company can be acquired either in an auction (can turn-away strategic buyers but attract financial buyers - the company's financial advisor may favour this as it may lead to more fee. Overall useful if there are not many keen buyers) or an exclusive offering (attracts strategic buyers, can be attractive for the entrepreneur. Advisable when there exists many strategic buyers with a high level of interest). It is important for the entrepreneur to realize that he may loose control of the company in this harvesting strategy. The popularity of M&A has increased significantly since 1999, something that has further bolstered buyout funds.
Reading about history, I understand that PE is a relatively recent phenomenon with its roots in the USA. In fact, the book is primarily written with US in mind. Nevertheless, I hope the basic working and attitude would not differ significantly across borders due to a close-knit PE community. It explains the structure of PE firms and general terms used in the industry (e.g. describing what is a general partner or a limited partner, the fee structure, legal agreements and other legal aspects). The books focuses primarily on two type of PE investments: venture capital (VC) financing and buyout transactions. It is interesting to learn that VC funding is further classified as Angel Investing, Seed Funding and Later Stage VC depending upon the maturity of the product portfolio. PE has developed as a distinctive alternative investment vehicle whose profitability is highly dependent on the overall performance of the economy and government policies (especially wrt Capital Gains Tax Rate).
Due to comparatively higher rate of returns many institutions and high-net worth individuals wish to invest with a PE firm. However, it is a very tightly knit circle that works on "knowing" the right people and by being successful. While the top quartile funds are plush with funds, others struggle to raise basic amounts. It is a highly competitive arena where success breeds more success. In the last decade buyout funds have apparently performed better than VC funds. Consequently they find it easier to raise money.
There are primarily two ways in which the PE firms "harvest" their investments: Initial Public Offerings (IPO) and Mergers & Acquisitions (M&A).
The book notes that IPO can be an expensive, lengthy and cumbersome procedure. It not only depends on the prevalent market condition but also it enforces more complexity and regulation on the organization. Nevertheless, it can be seen as an important step in the life of a company signifying a strong historical growth. It also allows the entrepreneur to possibly maintain the control over his company, something that he may loose in some M&A transaction.
Takeovers are defined as horizontal (same industry), vertical (supporting industry) or conglomerate (unrelated). The can be further seen as strategic, defensive, growth or financial. Reverse Takeover is mentioned as a credible and more efficient alternative to IPO. The company can be acquired either in an auction (can turn-away strategic buyers but attract financial buyers - the company's financial advisor may favour this as it may lead to more fee. Overall useful if there are not many keen buyers) or an exclusive offering (attracts strategic buyers, can be attractive for the entrepreneur. Advisable when there exists many strategic buyers with a high level of interest). It is important for the entrepreneur to realize that he may loose control of the company in this harvesting strategy. The popularity of M&A has increased significantly since 1999, something that has further bolstered buyout funds.
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