Private equity groups that buy companies they own
ft.com
ft.com
In reality, LPs and GPs would have been better off reliably holding the same growing asset for 15-20 years as the company went from $10M in EBITDA to $250M. Why take a 3x in 5 years when you can get a 25x in 15 years? The annual compounding works out to be roughly the same. The only issue is your fund structure so you trade it amongst yourself every 3-5 years at a 3-4x mark that makes you look good to your investors. The growth is usually there so it is not a lie though liberty may be taken with multiples which expanded rapidly over the last decade.
This phenomenon has been used aggressively, perhaps too aggressively, in software and particularly software roll-ups where you can comfortably compound 20-30% EBITDA growth annually between 10-15% organic growth (half or more of which is just price increases) and an aggressive M&A strategy that drives higher margins.
That said, this article is raising an early and important alarm bell to the broader public, who have a vested interest because their pensions are invested in these firms, that certain firms may be using it too aggressively. When I scan the broader PE landscape, the firm that has used it to the most success is Clearlake Capital. I don't have insight into their whole portfolio but have heard criticisms that they overuse it. Or that their is incestuous trading of assets between them, TA Associates, Hg, Insight Partners, FP, Thoma, and a handful of others.
The problem is that it's not possible to actually say that. Because the valuation never gets tested against the market you're just marking your own homework. It's a strong protection of these closed end funds that at some point you do actually have to provide the return on investment.
To put it another way - who needs to engage in this, well performing funds that are beating their expectations and making big returns, or poor performing funds who need to come up with creative ways to disguise their bad investment decisions.
3x in 5 years is equivalent to 27x in 15 years.
Obviously it's not that simple in practice but it's not like it's easy to predict growth over a 15 year period.
After some amount invested that likely most people will never see one has a hard time finding suitable places to reinvest -- that is experienced by eg the renessaince fund, Warren buffet etc. Or of course you can inflate the public or private market
A 15-year period is 3 times longer than a 5-year period.
5x3 = 15
Compounding the 3x return, for 3 times:
3^3 = 27
They are exactly, mathematically equivalent.
But of course there's no way to predict that the growth rate will stay the same. Logistic functions look like exponentials, until they suddenly don't (market saturation).
The NPV is not equivalent (unless you happen to have a cost of capital = 25%... like about 10 people). The cash on cash is not equivalent. Every person on planet earth will take the 15 year compounding (again except the 10 or so..).... hence they are not equivalent. When returns are high, investors are not indifferent to time horizon. Longer is better. To make it extremely clear - would you prefer IRR of 50% for 1 minute or 10 years?
The only statement which is precise enough is "the IRR is equivalent". Anyone can be pedantic, it rarely helps.
Less companies held over a longer time would mean less acquisition costs, while more companies held over a shorter time would mean more acquisition costs.
How do you do that? What's the source for getting to know what's going on with PE firms and their funds?
If only we had some mechanism whereby companies' shares could be listed somewhere public, and people could buy and sell them to determine what a fair price for these companies would be! Oh, better yet - we could have a regulatory body that could prevent companies from selling the same asset back and forth to themselves to inflate the price. Crazy, right?
PE LPs are all accredited and know what they're doing, they're betting on a greater fool buying for a higher multiple later bc it worked for the past years, multiples kept rising. Blame the fed, blame congress, blame stupid people who somehow got money. Now people complain bc there's a downturn. I don't know how people are unironically painting them as victims.
If you’ve reached the size of being a public company, lawsuits are a Tuesday. If the flavor of the frivolous is driving executives and investors decision making, then it’s a cultural choice.
> Oh come on, a lot of good companies stay private bc the SEC makes it a pain in the ass (and expensive) to be public. And it's making it worse with stupid shit like ESG reporting or SOX compliance they just keep adding.
It does make it a pain but it also increases the trust investment has in your company to not do things like trade assets between two vehicles you control with no proof that it’s not to your benefit
Generally agree that these aren’t victims though. To borrow a term from Eve, it seems like they decide to venture into null sec space and are surprised they could get hurt
Also these deals arent suffering from a "lack of transparency". The LPs know exactly what they're doing, they're literally marketed as continuation funds. You really can't complain about high net worth individuals or institutional investors getting "taken advantage of" like you can with some random guy investing his 401k in the public markets. Smh.
In particular, rules that require code reviews, auditing around production deployments, regular patching and exercising backup/recovery mechanisms have all made the systems Ive worked on operationally resilient.
It does depend on what kind of expertise your compliance team has (or the 3rd party tool you might use). But followed in spirit, SOX regulations have probably been a net benefit.
https://www.logicgate.com/blog/a-comparison-of-soc-and-sox-c...
Lol. Who’s accrediting them? 9/10 can’t make a 3-statement that foots.
You need to be an accredited investor to invest, as an individual, in hedge funds, private equity, and some other similar things.
Kim Kardashian is an accredited investor.
Kim Kardashian is an accredited investor
The size of these markets are different, their demands on returns and time horizons are different. This provides a much better variety of capital choices for companies searching for capital. If only the public equity market existed, the capital market would be very inefficient. This is microeconomics 101, increase choice/variety to most efficiently meet demand without creating deadweight loss.
Ultimately, the kind of wash sale you're talking about only applies when sophisticated accredited investors pump the price and dump to unaccredited unsophisticated investors. Institutional investors must know better, or (to the benefit of other institutions), they don't remain fit enough to be an accredited institutional investor for very long.
Regulators lie downstream from, and are often directly captured by this sort of jockeying for power between large institutional investors and their turf wars (SEC/CFTC -> private sector financial services/banking pipeline). So regulation isn't always an effective answer for these kinds of incentive problems.
Being private can make the companies much more nimble -- especially if they actually have rigor & profits rather than requiring perpetual shareholder subsidization of "growth."
TLDR: Being public (even absent Sarbanes Oxley) isn't a panacea.
1. The GP arranges for one of its funds to buy from another fund. These funds likely have a different mix of LPs. Because both funds are represented by the same GP, there's no competitive negotiation, and the valuation chosen may benefit one group of LPs (and possibly the GP) at the expense of the other.
2. Such a transaction can increase the total fees earned by the GP, even without additional effort or additional value being created or realized.
PE isn't like a stock brokerage. No transaction fees.
Depending on fee structure it may push future fees up since it rebases cost though. Less relevant if commit based
Yeah I wasn't clear. I meant that the fund could continue getting fees for longer, on the same investment. Collegeburner's sibling comment explains it better, and explains why my point probably doesn't apply in most cases.
It's a nightmare from a valuation standpoint, because while many LPs may well be invested in both funds, making it a wash, some are not. The LPs that invest in both funds sign a check to fund the investment in the new fund, and then get the money back as the older vintage is winding down. The investment just essentially gets rolled forward. The investors who are only in the new fund are cashing out the previous investors, so this is much more of a concern. But they are new and still usually riding the feeling of wow, they let me invest in this awesome fund. PE firms are really good at creating an aura of exclusivity and luxury.
A rolling loan gathers no loss. So long as the music keeps playing, valuations can be whatever number you can get your auditor to agree to. Nice dinners and event tickets for your audit partner can help with that.
And tbh there would be some other LPs cashing out the previous investors if the company was sold normally. The only LPs who take this risk are the ones who buy into the new fund. And if they're worried they should just check the GP commit, if it's thin then obv they're just pulling fees so don't invest. Some of the continuation funds the GPs actually believe they have a really good investment and they increase their commit as a %.
And the increasing valuations you describe are literally the same as the public markets the past few years. No bribing audit partners required.
Their ability to withdraw/redemption is often heavily constricted too.
(I’m not making an opinion on GP behavior yet)
More importantly literally all LPs have to do is not invest in the continuation fund. It costs them 0 money extra to close out their position in the old fund and leave. Continuation funds are 100% optional.
Also IMHO continuation funds can be useful if a PE firm thinks it has a real winner. It's harder than you think to find good places to place a lot of money so it will grow so I can understand why LPs might go for it in some cases.
And of course that doesn't even start to consider the fact that by doing this the PE companies get to mark their own homework, fraudulently pumping valuations by self-dealing safe in the knowledge their valuations don't need to be tested against the public markets.
This just seems like the exact same sort of absurd regulatory loophole that saw SPACS explode and then implode over 18 months. The fact that these firms have been forced to start chasing this style of innovation is not a good sign for the core business.
Access were full of lies. They bought up many category leaders for hospitality software, and tried to sell a single solution that then didn't really work together.
Their sales teams were aggressive, but their solution "made sense" to other decision makers even though Access couldn't really deliver.
A Roth IRA is a just a bucket with rules about how money can go in and out.
There is no reason they are mutually exclusive. Additionally, Roth IRAs can be self-directed which means they can use whatever exotic investment they choose, including private equity.
Exhibit A:
https://www.propublica.org/article/lord-of-the-roths-how-tec...
For funding, people with self-directed Roth accounts can pump $50,000-$60,000 into them via the annual 401k contributions
(this is the slightly obscure higher annual limit when you can make employer contributions on your own behalf)
and then get a couple 3,800% gains in some private equity investments tax free (a percentage from the article), and go from there
Any retirement account can just be a distinct limited partner in the family office or fund
The "financial engineering" trope with PE is largely in the large cap space ($1B+ EV). Most middle market PE is all about value creation.
Note - there are some notorious "death sentence" firms in the middle market...I won't name names but if you dig deep enough you'll see some PE shops (there's only 2 I can actually name off hand) that buy small tech cos and send all of the dev overseas.