Private Equity Firms Face Justified Scrutiny

by: Daniel Moser

Recently, private equity firms have come under the sharp stick of scrutiny. Many of these companies are very poorly run firms that add little, if any, value to society or their shareholders as it turns out. I am confident there are excellent private equity companies of all shapes and sizes that actually improve the businesses with which they invest. However, the debt boom of the previous decade led to a massive amount of poor investments on the part of private equity. These investments were not just poor from the Private Equity standpoint of paying too much for target companies. Moreover, many of these private equity companies made purchases that have led to the financial ruin of very fine young and growing businesses.

In an article by The Economist titled “Return to earth” on Feb 12th, 2009, the author quotes a person from the Boston Consulting Group who estimates that as many as half of the companies owned by private-equity firms may default on their debt within the next three years, leading to a wave of insolvencies, and losses of as much as $300 billion washing through the financial system.”

The article goes on to suggest that “a large number of profitable companies that are still paying down their loans may go bust through no fault of their own.” Furthermore,

“Simon Walker of the BVCA, an industry group, frets that British banks in particular are forcing sound firms into early liquidation over minor breaches of their loan agreements in order to reduce the size of their loan books.”

Upon the shakeout of the private equity industry, one may hope that the remaining players learn their lesson and as such redesign their business models to be oriented around adding value rather than drowning their investment companies in debt. Furthermore, the old private equity business model of loading up a company with debt and stripping the company of assets i.e. employees in an effort to save enough costs to barely squeak by debt payments, rather than increase sales or make new capital investments, is hopefully dead and gone.

Don’t get me wrong, I think private equity is a cool business. But, in my opinion, private equity companies should be run by upstanding classic businessmen with integrity and optimism rather than scoundrels out to make a buck without regard to unintentionally destroying otherwise excellent enterprises.