& the GII
This note considers private equity funds.
It covers -
page - the shape of private equity funds and fund management
- comments on where private equity comes from
- information about fund managers such as KKR, Cinven,
Apax, Candover, Bain Capital, Oaktree, Macquarie and
- the nation as an exporter and consumer of private
- salient works on particular private equity funds,
the economics and regulation of LBOs, and fund managers
as a target for cultural criticism
- highlights of private equity fund deals since the
1980s, with an emphasis on the media sector
supplements discussion elsewhere on this site regarding
Capital, the digital
Economy and Hedge
As the e-capital and investment guide elsewhere on this
site comments, private equity funds (aka acquisition funds)
consist of pools of capital - from a range of sources,
including banks, wealthy individuals, insurance companies
and pension funds - that are deployed by specialist managers
in the acquisition of assets.
Those assets may be an entire enterprise (typically a
company that is listed on a stock exchange), a component
of such an enterprise (a division, a regional operation
or a production facility) or infrastructure (eg an airport,
a highway, a collection of broadcast towers or even a
waste disposal site).
The expectation is that the fund will generate substantial
returns for investors by disposing of the acquisition,
whether through piecemeal sale of units, through sale
to another fund or a competing enterprise, or through
listing on an exchange. That process may involve enhancement
of the acquired entity's efficiency through changed work
practices; critics sometimes note that 'enhancement' is
often cosmetic, centred on slashing product development,
facilities maintenance and the workforce.
Most private equity acquisition appears to be opportunistic.
Generation of the desired return is dependant on factors
such as whether -
the fund can extract substantial monies through dividends
(reflecting the enterprise's normal revenue or its assumption
of debt) during the period of ownership
it can unload assets at a premium
market perceptions have changed and it can accordingly
float the enterprise, sell it to another fund or sell
it to a competitor at a premium.
lifecycle from acquisition to disposal, discussed below,
is typically medium term. Most private equity funds have
exited from their investments within five to seven years.
Some are out within 12 to 18 months (often at a substantial
profit), derided by critics as 'flipping' or 'burn &
In some instances funds have been left 'holding the baby',
with enterprises that are over-burdened with debt and
are unattractive to competitors or the stock market.
The shape of funds varies from jurisdiction to jurisdiction,
regulatory regimes (with for example anecdotal evidence
that increased corporate compliance costs in the US
after Sarbanes-Oxley are encouraging some enterprises
to "go dark" through termination of reporting
under the Securities Exchange Act once they have fewer
than 300 shareholders)
size and sophistication of the investment community
in different nations (eg greater acceptance in the US
than in France)
by institutions and
are typically incorporated as 'limited partnerships' (LLP
or LLC), with the fund managers as general partners and
investors as limited partners. (The following page considers
participation by investors, noting the recent trend for
managers to align their interests with those of investors
by contributing capital to the fund.) Managers are often
responsible for multiple consecutive and/or concurrent
Relationships reflect the status of the managers (in particular
their track record operating previous funds) and perceptions
by potential investors of risk, reward and opportunity.
Early subscribers, large scale subscribers or prestigious
subscribers may for example get more generous terms than
latecomers or smaller peers. That is consistent with traditional
bond selling and loan syndication practice.
Typically, ordinary investors as limited partners do not
have an active role in management of a fund throughout
that fund's life. That potentially raises governance concerns,
how many funds, how much money?
Statistics regarding PE funds are uncertain.
That uncertainty reflects the private nature of the funds,
some of which are not publicly reported and indeed (in
the tradition of private banking) emphasise discretion
and avoid media coverage.
It also reflects disagreement regarding definitions, with
some figures in official, industry association and academic
reports for example conflating data about different categories
of investment (eg venture
finance of high-tech startups, with a hedge
fund and with with funding for an LBO of an enterprise
that has operated for 30 or 100 years).
One report suggests that in 2002 there were around 3,000
private equity funds in the US, with some US$150 billion
capital, up from US$5.2 billion in 1979. That figure was
contrasted with claims of US$1 trillion under management
by some 9,000 hedge funds (ie entities where the capital
is more liquid and trading more frenetic). Caution is
desirable, as a closer examination suggests that the picture
Much of the private equity participation is occurring
across borders (eg European insurance companies putting
money into funds that are managed in the US and that invest
globally). The fifty largest funds appear to account for
around 70% of aggregate investment and for the highest
profile deals, particularly acquisition of major publicly-listed
Typically private equity fund management has three basic
raising (and new fund raising)
Fund raising, as the term suggests, involves
soliciting investment from several participants.
Where the manager has a succession of funds that solicitation
is often undertaken during the exit stage of a current
Fund raising may take a year or more, although most commitments
appear to be made within six months. The process reflects
traditional large scale loan syndication and bond marketing:
a mix of informal contact between peers, formal one on
one presentations and 'road shows' to collections of potential
participants (eg a meeting of invited representatives
of major financial institutions in a particular jurisdiction).
In most instances solicitation is for an unallocated pool
of money rather than for a specific acquisition. Major
funds typically seek enough capital to fund several acquisitions.
Returns from asset sales may be redeployed for further
acquisitions, rather than being immediately distributed
Fund raising reflects perceptions of likely outcomes and
the balance of power between participants and PE fund
Managers for example may choose to cancel the fund raising
if circumstances become adverse (eg macroeconomic forecasts
are bad or regulatory regimes change) or solicitation
does not secure sufficient commitments. Investors similarly
may choose not to participate, or not to participate on
a particular scale, if there are concerns about past performance
by managers, assessment that the fund is overly dependent
on debt rather than equity (some major acquisitions in
2005 and 2006 involved up to 80% debt), perceptions that
the managers have been overly generous to themselves at
the expense of the limited partners, or even disquiet
about community criticism of asset stripping and job destruction.
Investment involves acquisition of one
or more assets. Those assets could range from a multinational
enterprise to an individual facility or item of infrastructure,
such as an airport or highway. Some funds have aggregated
several acquisitions in the same industry, whether in
an attempt to achieve economies of scale or merely because
the managers have expertise and contacts in a particular
sector. Acquisition may be frustrated by regulators, for
example on the basis of competition policy when a fund
or consortium gains dominance in a sector, even though
the new owners will presumably shed the asset within a
Investment activity has attracted the interest of academic
observers and some of the more independent financial analysts
and journalists, who have suggested that there is an innate
tendency for managers to optimise their rewards as managers
rather than as owners. That is consistent with laments
about conflicts between the interests of managers (and
directors) and shareholders in ordinary corporations.
It is a concern because the fund participants have committed
their resources and can only intervene in management of
the fund with difficulty.
In some instances the fund will inject capital into an
enterprise (or spend money on infrastructure) after acquisition.
There are few coherent statistics on such support and
overall it appears that most funds either forgo dividends
or take money out of the acquisition during the period
of ownership rather than strengthening that acquisition
with new resources. Some of the more egregious instances
of abuse have seen an enterprise starved of investment,
loaded with debt and then flicked to a gullible public
... only to expire shortly thereafter or surrender to
a takeover by a competitor.
Ultimately, private equity funds are about the successful
(ie speedy, trouble-free and lucrative) exit.
They do not purport to be long-term owners, although some
will retain minority stakes beyond the exit stage.
Exits take a variety of forms -
of specific units or facilities from an acquisition
sale of the overall acquisition to a competitor
listing of the enterprise on a stock exchange through
an IPO (ie mums, dads and
institutional investors take the acquisition off the
private equity fund's hands) and even
a fund on a stock exchange, a mechanism used by Macquarie
deals can be deliciously profitable. CVC Asia Pacific
and Catalyst Investment Management appear to have made
a profit of 73% on a four year investment in Australia's
Pacific Brands group; peers have made profits of 80% or
more after flipping an acquisition onto the market within
two years, having recouped their initial investment through
a special dividend in the first year.
US private equity executive Robert Pozen, in the November
2007 Harvard Business Review, chanted the mantra
by claiming that private equity has five maxims for "value
idle cash to a minimum - once buyout portfolio companies
have enough cash on hand to cover emergencies, they
return as much of the rest as possible to shareholders
through dividends or stock buybacks.
the capital structure, increasing the ratio of debt
to equity, lowering tax exposure and the cost of capital.
Public companies remain "overly cautious"
about taking on debt
the operating plan to shareholder value, eg controlling
costs and focusing operations squarely on profit growth
managers stakes in the outcome, with top executives
receiving rewards equivalent to 15 to 20% of the company's
smaller boards of more involved directors
can use role-playing exercises that let 'risk-averse middle
managers recast themselves as swashbuckling buyout buccaneers'.
Val Livada of the Sloan School of Management offered a
caution, commenting that much of the "magic"
of PE managers is attributable to the fact that they are
focused on buying and selling companies in the short term,
without the challenges of day-to-day managing.
The private equity world is a much simpler world than
the operating world. When a company gets purchased by
the private equity guys, the knife comes out of the
closet and they slash and burn. One of the reasons why
it's easier is because they come in and they don't know
Joe and they say Joe's got to go. They cut the fat and
they don't have to worry about what happens 10 years
The 1980s LBO boom saw major fund managers, such as Kohlberg
Kravis Roberts (KKR), seek sole ownership of their acquisitions.
That remains the case with many small and medium scale
The past decade has seen a shift to alliances, with funds
joining together to take over large enterprises or fund
the acquisition of major infrastructure. The following
pages thus refer to consortia that have devoured groups
such as BertelsmannSpringer (purchased by Candover and
Use of consortia reflects the size of acquisitions (often
too big for a single fund to absorb without difficulty)
and reluctance to place too many eggs in a single acquisition
basket. It has however provoked criticisms that a handful
of major funds have colluded to bring down the price paid
for particular acquisitions.
Managers get paid for managing funds: garnering the capital
from participants, identifying potential acquisitions,
buying the enterprise or infrastructure, choosing and
supervising executives to run the enterprise, handling
Their interests are aligned with but not necessarily identical
to those of participants in the funds.
Typically equity fund managers are rewarded for all stages
of the lifecycle, with a service fee attributable to each
stage and a success fee on exit. The scale of fees varies
but it is common to encounter managers charging 2% of
the fund capital per year plus a percentage of the premium
at exit (ie between acquisition cost and sale price or
That premium varies from between 2% to 20% or more. SEC
filings in the 2006 private equity acquisition of US health
giant HCA revealed that fund managers KKR, Bain Capital
and Merrill Lynch received a US$175 million transaction
fee, to be followed by an annual US$15 million management
fee (with an additional termination fee if the management
agreement is cancelled prior to 2016 plus a fee equal
to 1% of the gross transaction value of a future IPO or
sale of HCA. Blackstone received a US$200 million fee
for its acquisition of Equity Office in 2007.
Critics unsurprisingly comment that the manager is the
only entity certain to win. Some discipline is provided
where managers seek new capital or conduct consecutive
funds, with existing investors or potential new investors
who identified the manager's past performance having scope
to avoid investing at that time.
In some instances that has been little consolation for
fund participants, who were unable to fully exit during
an IPO and experienced a decline in the price of the enterprise
after listing but found that the manager was rewarded
for getting the asset onto the market.
The manager's associates may also be handsomely rewarded.
Freeman & Co, using data from Thomson Financial, estimated
that investment banksreceived US$8.4 billion of fees in
the first half of 2007 from arranging leveraged buyouts
for firms led by Blackstone Group and Apollo Management,
compared with US$12.8 billion during all of 2006.
governance and regulation
The partnership agreement is central to governance of
a private equity fund. Australia's corporations legislation
differentiates between ordinary investors in public companies
(with for example obligations for disclosure by promoters)
and institutions or individuals taken to have expertise
and a capacity for handling risk through private investment.
Participants in equity funds thus rely on features of
the specific agreement and how it is described rather
than on standard securities law aimed at 'mums and dads'.
The expectation is that the agreement will embody the
relationship between managers and participants, including
articulation of constraints on the power of the fund manager,
disclosure and reporting requirements, and compensation.
Managers are however subject to common law and statute
law regarding fraud. In the US for example the SEC has
used anti-fraud provisions of the Advisers Act
in relation to the thoroughness and accuracy of disclosure
of performance reporting in a private placement memorandum.
Funds are not exempt from competition policy law and foreign
investment law or from money
laundering (MLR or AML). In takeovers or property
purchases they thus receive the same treatment from regulators
(such as Australia's FIRB and the European Commission)
as is received by corporations.
As the following page notes, some entities in particular
jurisdictions face restrictions regarding participation
(ie cannot participate per se or are only permitted
to invest a certain percentage of their assets in private
Traditional distinctions between private equity, venture
capital and hedge funds
(ie entities that generate revenue for investors through
a large number of short term transactions) have blurred
That blurring reflects perceptions of opportunity, the
availability of capital and increased competition in the
three sectors. Some hedge funds for example have expanded
into private equity to achieve better returns. A handful
are active in the US$1bn+ end of the buyout market, unsurprising
given the resources available to the largest funds.
Private equity managers have also set up VC arms or participated
in venture capital deals and established hedge funds (eg
Blackstone, Texas Pacific, KKR, Carlyle and Bain).
A concise glossary of some venture capital and private
equity terminology is here.
next page (participants)