8 ms·

Judge’s Ruling Offers Peek into Private Equity’s Secret World

48 points by Ankaios 11y ago

dade_ 11y ago
Reminds me of the Silver Lake buyout of Avaya. The debt from the acquisition has pretty much destroyed the company, but it limps on. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7VU34fMLHns&refer=home http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7VU3...
- iwwr 11y ago
  The moral being that, in these kinds of dealings, you are allowed to cripple a company, but not outright destroy it.
thinkcomp 11y ago
Case docket here: http://www.plainsite.org/dockets/2lf62q01i/new-york-southern-bankruptcy-court/hellas-telecommunications-luxembourg-ii-sca-and-tpg-capital-management-lp-adversary-proceeding/ http://www.plainsite.org/dockets/2lf62q01i/new-york-southern... Related case: http://www.plainsite.org/dockets/2lf6dcjz7/new-york-southern-district-court/in-re-hellas-telecommunications-luxembourg-ii-sca/ http://www.plainsite.org/dockets/2lf6dcjz7/new-york-southern... I'm pretty sure the court order discussed in the article (which is never specified) is this one, Document 188 from the first link: http://www.plainsite.org/dockets/download.html?id=215714507&z=327e9d74 http://www.plainsite.org/dockets/download.html?id=215714507&...
edoloughlin 11y ago
Can someone explain how, if I borrow to buy a company, the company carries the debt after the sale? This seems to me what happened here, am I correct?
- ubernostrum 11y ago
  You have the company (which you now own) pay you money, which pays off your debt, but puts the company into debt.
  - edoloughlin 11y ago
    That would seem like bad corporate governance. Why is this allowed in the case of a limited liability company? It seems like a mechanism to offload liability.
    - charlesdm 11y ago
      Only if the company goes under. Each business has a different level of acceptable debt. Some entrepreneurs are great at controlling a balance sheet, and can run businesses with a ton of debt (e.g. John Malone) For example: a real estate business needs to use a lot more debt than a software company.
- caseyf7 11y ago
  Because you borrow money as a new company called NewCo formed offshore and then you buy the old company with a loan tied to the assets and performance of old company. This loan is also contingent on NewCo completing the acquisition of old company. Ideally you give no personal guarantees so the bank only collects assets of old company if it fails and you walk away with your fees and dividends that you've received since then.
  - psykovsky 11y ago
    Doesn't seem like a good deal for the banks. And bankers aren't the ones to let themselves be fooled like that. Something's fishy.
    - charlesdm 11y ago
      This depends. There are certain types of debt with different risk levels. The debt with the lowest levels of interest tends to be traditional bank debt. If the company goes under, they are first in line to recover any losses. The more debt involved in a deal, the riskier it gets. If you fund a $100m deal with $40m in debt, and $60m in equity, that's fine. That's usually low risk if it's a healthy company. Now imagine the same deal, $80m debt and $20m in equity. Traditional banks might only give you a loan for $50m. The remaining $30m you will need to get from other investors, who will be further in line to recover any losses (meaning they will charge a higher rate of interest). Why do banks love big deals? Easy: these deals generate a lot of profit. On a $100m loan, they'll be making $4-6m a year. Usually the risk level is acceptable for them, since they're first in line when the company gets liquidated.
lordnacho 11y ago
I wonder if history will judge the PE business model as being illegitimate. For the moment, it sounds legal, (IANAL) but it also sounds like the corporate system was not meant to be run this way. In short, what is generally done (and also in this case) is that when you buy a company, you can have the company borrow money, and transfer that money to the PE owner. You can do this because you have good bank connections, and the company is a large going concern that is used to borrowing some money from its lenders. I couldn't just open a company tomorrow and fleece the bank by paying it all to myself. Our corporate system grew out of the industrial revolution. There was a need to finance large undertakings in a way that wouldn't be ruinous if it went wrong. Gathering a bunch of money from investors wasn't a new idea (various "Indian" trading companies) but limited liability was seen as a necessity for risk taking. During the 1800s a bunch of western countries created the modern forms of the law (https://en.wikipedia.org/wiki/Limited_liability https://en.wikipedia.org/wiki/Limited_liability). With the PE type model, you can take over a company, load it with debt, and transfer risk-free money to a parent fund. The company doesn't necessarily go bankrupt, but it's more likely if you take a lot of debt. If the company does well, great. You can take that account statement to your bank and... pile more debt on. Most people who run a company will not behave like this. The idea is not to have a company that is constantly on the brink, but to pay out some dividends when it's safe to do so.
- walterbell 11y ago
  There are also tax benefits, http://dealbook.nytimes.com/2013/04/15/the-top-10-private-equity-loopholes/?_r=0 http://dealbook.nytimes.com/2013/04/15/the-top-10-private-eq... "Right at the core of the private equity business model is taking a company private, loading it up with debt that was used to finance the acquisition and using the interest deductions to shield the portfolio company from tax liability."
- bobcostas55 11y ago
  >Most people who run a company will not behave like this. No, but companies that are taken over by PE firms are fairly special. In any case, since the fund is forced to sell the company after a few years, they're still interested in LT value maximization. Also, high debt levels aren't just a way of taking back some of the money the fund put in. Debt helps to fix the companies. The PE business model essentially focuses on fixing principal-agent issues (i.e. management working against the best interests of shareholders). Improved governance, high equity ownership by management, and high debt loads are how they do it. "Debt disciplines management" because it forces them to eliminate -NPV projects and increase cash flows.
jane_is_here 11y ago
You almost always want to sell the portfolio firm after three to five years. It is therefore in the PE firm's interests to have the firm healthy and thriving. The idea is very definitely not to cripple or harm the portfolio firm. For an excellent example of best practice look at what Blackstone have done with the Hilton Group, Wolfskin, Merlin Entertainments ( owner of Legoland, Madame Tussaud's, London Eye ), the Bujagali Hydropower Project in Uganda or the Moser Baer Projects in India.
- dunkelheit 11y ago
  Well it seems that in this case PE firms have managed to cripple the firm and then sell it. Strangely the details of that sale are not discussed in the article.
acjohnson55 11y ago
I remember doing a lot of research about PE when it was a hot topic during the Romney days. It's hard to put your finger on what makes it feel unsavory. After all, there are a bunch of players who have different interests who all have to agree on the deal for it to go through. Presumably, if it were a rigged game, these deals wouldn't get closed. The whole "fool me twice" thing, and all. Yet, these big PE firms seem to come out ahead. Certainly their principles do. On the other hand, when big companies falter, there are the bystanders: the working people, clients of the business, the community, and other non-equity-holding stakeholders. None of these people seem to stand to gain much no matter who wins the game of thrones in the boardroom. And it's not as though these people will just frictionlessly proceed on to some alternative in the market.
- digi_owl 11y ago
  When accounting tricks can hide national debt (for a time), using it to hide corporate debt is likely to be relatively simple in comparison.

48 points by Ankaios 11y ago

dade_ 11y ago

Reminds me of the Silver Lake buyout of Avaya. The debt from the acquisition has pretty much destroyed the company, but it limps on. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7VU34fMLHns&refer=home http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7VU3...

iwwr 11y ago
The moral being that, in these kinds of dealings, you are allowed to cripple a company, but not outright destroy it.

thinkcomp 11y ago

Case docket here: http://www.plainsite.org/dockets/2lf62q01i/new-york-southern-bankruptcy-court/hellas-telecommunications-luxembourg-ii-sca-and-tpg-capital-management-lp-adversary-proceeding/ http://www.plainsite.org/dockets/2lf62q01i/new-york-southern... Related case: http://www.plainsite.org/dockets/2lf6dcjz7/new-york-southern-district-court/in-re-hellas-telecommunications-luxembourg-ii-sca/ http://www.plainsite.org/dockets/2lf6dcjz7/new-york-southern... I'm pretty sure the court order discussed in the article (which is never specified) is this one, Document 188 from the first link: http://www.plainsite.org/dockets/download.html?id=215714507&z=327e9d74 http://www.plainsite.org/dockets/download.html?id=215714507&...

edoloughlin 11y ago

Can someone explain how, if I borrow to buy a company, the company carries the debt after the sale? This seems to me what happened here, am I correct?

ubernostrum 11y ago
You have the company (which you now own) pay you money, which pays off your debt, but puts the company into debt.
- edoloughlin 11y ago
  That would seem like bad corporate governance. Why is this allowed in the case of a limited liability company? It seems like a mechanism to offload liability.
  - charlesdm 11y ago
    Only if the company goes under. Each business has a different level of acceptable debt. Some entrepreneurs are great at controlling a balance sheet, and can run businesses with a ton of debt (e.g. John Malone) For example: a real estate business needs to use a lot more debt than a software company.
caseyf7 11y ago
Because you borrow money as a new company called NewCo formed offshore and then you buy the old company with a loan tied to the assets and performance of old company. This loan is also contingent on NewCo completing the acquisition of old company. Ideally you give no personal guarantees so the bank only collects assets of old company if it fails and you walk away with your fees and dividends that you've received since then.
- psykovsky 11y ago
  Doesn't seem like a good deal for the banks. And bankers aren't the ones to let themselves be fooled like that. Something's fishy.
  - charlesdm 11y ago
    This depends. There are certain types of debt with different risk levels. The debt with the lowest levels of interest tends to be traditional bank debt. If the company goes under, they are first in line to recover any losses. The more debt involved in a deal, the riskier it gets. If you fund a $100m deal with $40m in debt, and $60m in equity, that's fine. That's usually low risk if it's a healthy company. Now imagine the same deal, $80m debt and $20m in equity. Traditional banks might only give you a loan for $50m. The remaining $30m you will need to get from other investors, who will be further in line to recover any losses (meaning they will charge a higher rate of interest). Why do banks love big deals? Easy: these deals generate a lot of profit. On a $100m loan, they'll be making $4-6m a year. Usually the risk level is acceptable for them, since they're first in line when the company gets liquidated.

lordnacho 11y ago

I wonder if history will judge the PE business model as being illegitimate. For the moment, it sounds legal, (IANAL) but it also sounds like the corporate system was not meant to be run this way. In short, what is generally done (and also in this case) is that when you buy a company, you can have the company borrow money, and transfer that money to the PE owner. You can do this because you have good bank connections, and the company is a large going concern that is used to borrowing some money from its lenders. I couldn't just open a company tomorrow and fleece the bank by paying it all to myself. Our corporate system grew out of the industrial revolution. There was a need to finance large undertakings in a way that wouldn't be ruinous if it went wrong. Gathering a bunch of money from investors wasn't a new idea (various "Indian" trading companies) but limited liability was seen as a necessity for risk taking. During the 1800s a bunch of western countries created the modern forms of the law (https://en.wikipedia.org/wiki/Limited_liability https://en.wikipedia.org/wiki/Limited_liability). With the PE type model, you can take over a company, load it with debt, and transfer risk-free money to a parent fund. The company doesn't necessarily go bankrupt, but it's more likely if you take a lot of debt. If the company does well, great. You can take that account statement to your bank and... pile more debt on. Most people who run a company will not behave like this. The idea is not to have a company that is constantly on the brink, but to pay out some dividends when it's safe to do so.

walterbell 11y ago
There are also tax benefits, http://dealbook.nytimes.com/2013/04/15/the-top-10-private-equity-loopholes/?_r=0 http://dealbook.nytimes.com/2013/04/15/the-top-10-private-eq... "Right at the core of the private equity business model is taking a company private, loading it up with debt that was used to finance the acquisition and using the interest deductions to shield the portfolio company from tax liability."
bobcostas55 11y ago
>Most people who run a company will not behave like this. No, but companies that are taken over by PE firms are fairly special. In any case, since the fund is forced to sell the company after a few years, they're still interested in LT value maximization. Also, high debt levels aren't just a way of taking back some of the money the fund put in. Debt helps to fix the companies. The PE business model essentially focuses on fixing principal-agent issues (i.e. management working against the best interests of shareholders). Improved governance, high equity ownership by management, and high debt loads are how they do it. "Debt disciplines management" because it forces them to eliminate -NPV projects and increase cash flows.

jane_is_here 11y ago

You almost always want to sell the portfolio firm after three to five years. It is therefore in the PE firm's interests to have the firm healthy and thriving. The idea is very definitely not to cripple or harm the portfolio firm. For an excellent example of best practice look at what Blackstone have done with the Hilton Group, Wolfskin, Merlin Entertainments ( owner of Legoland, Madame Tussaud's, London Eye ), the Bujagali Hydropower Project in Uganda or the Moser Baer Projects in India.

dunkelheit 11y ago
Well it seems that in this case PE firms have managed to cripple the firm and then sell it. Strangely the details of that sale are not discussed in the article.

acjohnson55 11y ago

I remember doing a lot of research about PE when it was a hot topic during the Romney days. It's hard to put your finger on what makes it feel unsavory. After all, there are a bunch of players who have different interests who all have to agree on the deal for it to go through. Presumably, if it were a rigged game, these deals wouldn't get closed. The whole "fool me twice" thing, and all. Yet, these big PE firms seem to come out ahead. Certainly their principles do. On the other hand, when big companies falter, there are the bystanders: the working people, clients of the business, the community, and other non-equity-holding stakeholders. None of these people seem to stand to gain much no matter who wins the game of thrones in the boardroom. And it's not as though these people will just frictionlessly proceed on to some alternative in the market.

digi_owl 11y ago
When accounting tricks can hide national debt (for a time), using it to hide corporate debt is likely to be relatively simple in comparison.