Wednesday, August 8, 2012

Bain, Private Equity and All That

What is the economic role of private equity?  Private equity firms buy or invest in businesses, mostly private businesses, sometimes public companies.  The usual pattern is that a private equity investment helps a fledgling company expand by providing funding and often management expertise.  For public companies, private equity is often the source of turning a poorly run company into an efficiently run business.  With rare exceptions, private equity enhances shareholder value.

Absent private equity, private and public businesses alike are less valuable.  Why?  Because private equity funds are a source of equity capital, a liquidity provider (through the sale of a company to a private equity fund), and an enhancer of value (by providing management and consulting expertise).  Because of the existence of private equity funds, business large and small are more valuable.  More valuable businesses hire people and are the engine of economic growth in a free enterprise economy.

Politicians who have nothing else to brag about have been attacking private equity as if there is something evil about the industry.  If you despise free enterprise and prefer government control of business, then you probably will not like private equity.  But, if you like free enterprise, job creation and a health economy, then you will love private equity.  President Obama has made his views clear.  He is no fan of private enterprise, job creation, or free markets.  It is hardly a surprise that Obama does not like private equity.


Natasha Gural-Maiello said...

How silly. For public companies, private equity provides nothing more than a takeover bid -- an alternative valuation to market prices that includes a takeover premium that management and the board will either accept, or not. For private companies, it is a source of liquidity for founders, but just one in competition with other sources in the capital markets.

As for management expertise... a company could also just hire a consultant. At least a consultant would work for the company rather than have the company work for it.

And that's the thing... incentives. In a private equity transaction, the target company is run for the benefit of the private equity fund's investors. The interests of the company (especially its employees, customers and minority shareholders) might not match the interests of the private equity buyer.

Is private equity evil? Of course not. Is it good? Of course not. This is not an issue of good and evil. It's about outcomes. Private equity results in good and bad outcomes. We have to act to limit the bad outcomes.

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