Next Phase for Private Equity
To start off, Mr. Buchanan feels the boom is coming for PE due to the fact that weakened companies will need new equity infusions and that private equity (PE) management principles simply work (backed up by quoted research). While it would be difficult to argue the above two points, I am not sure they correlate to a boom since a boom would imply a very active and expanding market. The key here is that while buyout activity may increase, there is simply too much PE money to lift deal activity for the entire industry. Mr. Buchanan notes that Bain Capital started with a $37M fund back in 1984 and with mega funds now exceeding $10B, it will be hard to put all that capital to work considering that that deal sizes will surely decrease in this next wave due to tighter lending restrictions and mega deal returns sometimes lagging. I would classify this as helping some and hurting may others since the effective market size shrinks. While some funds can still be successful going back to original private equity roots of smaller deals, they will consume less total capital and have a negative effect on growth. This point is briefly touched on in Mr. Buchanan’s commentary regarding over capacity, but I would have liked to see it expanded.
Mr. Buchanan’s recommendation that PE should review its need for a highly leveraged debt structures by better utilizing all deal levers more effectively (purchase price, leverage, value add and sales price) was spot on. He is coming from a position of specific knowledge and does a great job laying out his approach. I especially like him taking a harder position on “transaction focused” funds that manipulate debt instruments instead of creating sustainable value for their portfolio companies. To some extent you can find some version of these points scattered across numerous writing on the PE industry, but what I found interesting was his final point of establishing a “license to operate” with society. This goes beyond the calls for accounting transparency and more to bring PE into the societal fold as another aspect of regular business. Maybe that is just some European sensibility, but it really resonated with me. PE should not be demonized in some circles, but embraced as a useful value creation tool. Maybe with expanded calls to PE by our own Government in the US to help simulate this moribund economy, we will take the first steps in this closer integration.
