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If a PE shop buys your competitor, you should rejoice. PE firms primarily generate returns through (1) debt repayment from free cash flow, (2) multiple expansio

If a PE shop buys your competitor, you should rejoice. PE firms primarily generate returns through (1) debt repayment from free cash flow, (2) multiple expansion, and (3) operating improvements. Because of #1, PE firms like annuity-like businesses with predictable cash flow. A ventured-backed startup doesn't need to worry about #1, and therefore can focus all their internal efforts on #3. (If multiples expand, then that's even better.) Here's an analogy. Venture-backed companies are busy building rockets, and rockets either take off or blow up. When PE takes over, your competitor has decided..."F this, let's go build a train instead."

dmix 10y ago
Why is "(1) debt repayment from free cash flow" appealing vs VC growth? I'm not familiar with that term. A quick search only gave me pages filled with even more finance jargon.
- jldugger 10y ago
  Leveraged buyouts: you borrow a bunch of money, buy the company with it, use any stored cash to pay that down, and saddle the company with the debt you used to buy the company in the first place. Then you repeat this a couple of times to buy up portfolio of related companies that might be better together than competing, reshape them and put them back on the public market at a profit. Debt repayment from free cash flow is appealing because it's comparatively less risky. Startups building products have no free cash flow to speak of and require regular VC cash infusions to balance the books.
- jessaustin 10y ago
  Before the buyout, the firm didn't have that debt! This scenario is a way of converting equity (which costs the firm nothing) to debt (which must be repaid). Of course VC deals can have debt too, but their goal is some sort of equity event, whereas this is almost the opposite of an IPO. The theory is that a PE will buy a firm with the revenue to support such debt payments, or that will have that revenue once the PE partners give it their special kind of love. Anecdotally, I must disagree with TFA's "...they rarely lose capital..." since the only company I ever worked for that got bought by PE ended up a giant loss.
- FireBeyond 10y ago
  Did you ever watch The Sopranos? It's a more legal, slightly less unethical version of what Tony and his crew does to the sports store. They bleed it, leech it dry oil it's a shriveled corpse, ready for Chapter 11, at which point (or ideally before) they walk away.
- bigbossman 10y ago
  Here's an example that helps explain how this works. When people talk about financing engineering, a lot of the nuance is figuring out how to manipulate the "capital structure" like this. A) Imagine buying a $100,000 house and borrowing $80,000 from the bank to finance it. Then you rent out the house for a bit more than the total cost of the mortgage, taxes, and other expenses. Eventually the value of your $20,000 investment will grow based on a combination of (1) more ownership from the house and (2) potential market appreciation on the total value of the house. B) Compare this to buying a $100,000 house but getting someone to co-invest $80,000. In this case, your equity is fixed at 20% (vs 80% for the co-investor). The value of your investment will depend on your share of any intermittent cash flows from rent and market appreciation of the house. Debt (A) is attractive if there is certainty you can finance the debt payments, but that's obviously not the case for many startups.

dmix 10y ago

Why is "(1) debt repayment from free cash flow" appealing vs VC growth? I'm not familiar with that term. A quick search only gave me pages filled with even more finance jargon.

jldugger 10y ago
Leveraged buyouts: you borrow a bunch of money, buy the company with it, use any stored cash to pay that down, and saddle the company with the debt you used to buy the company in the first place. Then you repeat this a couple of times to buy up portfolio of related companies that might be better together than competing, reshape them and put them back on the public market at a profit. Debt repayment from free cash flow is appealing because it's comparatively less risky. Startups building products have no free cash flow to speak of and require regular VC cash infusions to balance the books.
jessaustin 10y ago
Before the buyout, the firm didn't have that debt! This scenario is a way of converting equity (which costs the firm nothing) to debt (which must be repaid). Of course VC deals can have debt too, but their goal is some sort of equity event, whereas this is almost the opposite of an IPO. The theory is that a PE will buy a firm with the revenue to support such debt payments, or that will have that revenue once the PE partners give it their special kind of love. Anecdotally, I must disagree with TFA's "...they rarely lose capital..." since the only company I ever worked for that got bought by PE ended up a giant loss.
FireBeyond 10y ago
Did you ever watch The Sopranos? It's a more legal, slightly less unethical version of what Tony and his crew does to the sports store. They bleed it, leech it dry oil it's a shriveled corpse, ready for Chapter 11, at which point (or ideally before) they walk away.
bigbossman 10y ago
Here's an example that helps explain how this works. When people talk about financing engineering, a lot of the nuance is figuring out how to manipulate the "capital structure" like this. A) Imagine buying a $100,000 house and borrowing $80,000 from the bank to finance it. Then you rent out the house for a bit more than the total cost of the mortgage, taxes, and other expenses. Eventually the value of your $20,000 investment will grow based on a combination of (1) more ownership from the house and (2) potential market appreciation on the total value of the house. B) Compare this to buying a $100,000 house but getting someone to co-invest $80,000. In this case, your equity is fixed at 20% (vs 80% for the co-investor). The value of your investment will depend on your share of any intermittent cash flows from rent and market appreciation of the house. Debt (A) is attractive if there is certainty you can finance the debt payments, but that's obviously not the case for many startups.