The Epicurean Dealmaker

In order to understand why, we should address the framework of the private collateral industry first. Because a PE firm normally acts as the general partner of each of the funds it raises, financial sponsors tend to be known as General Partners or GPs in the trade. The material point concerning traditional financial sponsors, however, is that as the professionals who do the ongoing work have a home in those entities, the companies themselves have very little assets or money of their own. The amount of money, and the investments it enables, reside legally in the private equity funds which the general partners manage for their limited partners.

1 billion finance), and 20% “carried interest,” which portions to a 20% stake in the gains earned by the investments in the fund, after the management charge and certain preferred returns are paid to the LPs. 10 billion, can in fact make very good money just from management fees only. In fact, PE funds themselves really only become accounting entities for the assortment of portfolio investments within them. Therefore, you can see that notwithstanding the often substantial debt private equity companies take on in their investments, this leverage resides in carefully walled-off buckets at the amount of each individual investment.

If things go wrong with one company, it craters, but its cratering does not result in a domino impact within any particular PE fund’s portfolio, nor will it cause stress and financial contagion at the sponsor level. In almost all instances, neither PE firms nor PE funds take on debt of any kind for themselves. Therefore, they neither suffer financial distress nor have a mechanism to transmit such stress to the outside world.

  • Detailed accounting of environmental costs can help support the development and
  • Capitalization (Take a look at Statement of Shareholder Equity)
  • Very liquid, able to draw out your cash anytime
  • Road Show Investor Meetings

Sure, lenders to specific profile companies which go belly up are going to take it in the shorts, but that’s where it ends. You will find practically no pathways of systemic financial contagion in the original private equity firm or its business. This is accentuated by the known reality that by participating in a PE account, LPs consent to meet their financing commitments over the (normally 10-year) life of the finance and cannot contractually get their money back prior to its expiration. That is a material difference between your investment an institutional buyer makes in traditional private equity and one it creates in a hedge finance.

While hedge funds are gated, and also have all sorts of mechanisms to hold off investors from withdrawing their money at will, by the end of the day hedge fund traders normally have the capability to withdraw their money with limited notice. Investors in private collateral do not. This makes significant amounts of sense, of course, because hedge funds trade in relatively liquid assets normally, whereas private collateral investments are almost this is of long-term, illiquid investment. Let’s review. PE firms do not borrow funds, and they have virtually no assets of their own.

PE money do not borrow either, and they call upon the irrevocable, unwithdrawable equity commitments of limited companions to fund investments in specific companies. PE investments (companies) are funded individually on a non-recourse basis to the finance and the financial sponsor. Lenders to PE company investments cannot result in a “operate on the lender” at financial sponsors, and collateral investors in PE money cannot result in a run on the lender, either. Traditional PE PE and firms funds do not lend money to other entities, nor do they operate liquid securities, derivatives, or other financial devices in any markets. Their investments in company buyouts are long-term, illiquid, and safe. At least from the financial system’s point of view.

Therefore, what do we value the potential risks private equity firms take in their investments? What do we care and attention that other investors lend them a significant amount of money at much too low interest rates with few or no covenants to invest in their leveraged buyouts of companies? What do we care and attention that large institutional investors like CALPERS and Yale University give them hundreds of billions of dollars of collateral to purchase dangerous buyouts?

The answer is we shouldn’t. And since traditional private equity poses no materials threat of financial contagion through highly liquid, interlinked personal debt and equity exposures which can be called at a moment’s notice, why should we care how its professionals are paid? Why should we care that they can get paid billions if their investments succeed? Why should we caution if they make highly levered, risky investments in shaky businesses in order to make themselves and their limited companions rich? From the point of view of systemic financial risk, we shouldn’t. Period. End of tale.

Saying private equity payment should not lead to another potential financial meltdown doesn’t quite end the conversation, for me. Not absolutely all the financial regulatory issues we address in the current environment should be restricted to the execution of Dodd-Frank. UPDATE June 11, 2011: Fixed mention of carried interest and added connect to previous dialogue.

10 billion in cash up front off their limited partner investors which they choose bank checking account until they spend it. Rather, they obtain contractual commitments off their LPs to react in a timely fashion with their capital phone calls when they make an investment. The LPs do pay the 2% management fee on their whole commitment from the beginning, however, if the funds are spent or not. 2 What causes bank runs? Liquid deposits. In other words, deposits (or loans) that can be withdrawn immediately by the depositor (lender). Illiquidity is a wonderful mechanism to avoid works on the bank-whatever form a “bank or investment company” might take-if only because you can’t withdraw it in times of stress.