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So, the author claims that PE is a scam where PE firms profit at the expense of lenders. If this was true, you could easily check to see how well lenders have d

by Lazare 7y ago

So, the author claims that PE is a scam where PE firms profit at the expense of lenders. If this was true, you could easily check to see how well lenders have done, on average, lending to PE firms. The author has not done this. You could also look at lawsuits between lenders and PE firms (there have been a few interesting ones, I believe), and see how they've ended up. You could also look at the terms of loan covenants (agreements between lenders and borrowers intended to stop this precise sort of thing), and how their wording has changed during the rise of PE firms, or after high profile PE failures. The author hasn't done this either. You could also look at what sort of rates PE firms pay, or what difficulty they have raising loans, or if PE firms which have failed to repay loans have faced any consequences compared to ones which have not, but...well, you can probably guess. In short, the author has identified a somewhat interesting topic (is there something systematically wrong with the loans PE firms take out with large lenders, and if so, why is the legal system and/or financial system not dealing with it as you would expect?), but failed to provide any information about any part of it, presumably because research is hard, and writing tweets is easy. If you know so little about your topic, you're not really going to be able to provide any value when you try and explain it to others.

zzleeper 7y ago
It's not just lending to PE firms but to the original businesses before they get bought. Say Basecamp gets a ~ small 100m loan from syndicate. Basecamp is quite healthy, well managed, low leveraged, so they secure 4% rate for 5yrs, without many covenants. Then PE buys Basecamp, leverages it to the sky and beyond, Basecamp sells, and suddenly the original 100m loan is now junk-grade. The original lenders never interacted with the PE firm, but they still got screwed. Could they have prevented it? Sure, with lots of covenants, but they have lots of added costs for all parties and often have ways around them. Which means every possible firm that might get bought by PE is now a) having to deal with lots of covenants, and b) paying 6-7% instead of the 5% they would get if the likelihood of PE acquisitions was lower.
- travisoneill1 7y ago
  When a company is recapitalized in a PE buy the existing lenders need to either be paid back in full or explicitly approve of having their debt rolled over into the new structure. They can't be forced.
  - zzleeper 7y ago
    You don't need to change the structure. Change management, new management raises all the new debt. Unless there is a bullet proof leverage covenant, then the existing lenders can't do zip about that. Thus, their only option is to go to the table and "accept" the new structure.
    - travisoneill1 7y ago
      This is not a leverage covenant. This is a change in control provision, which there always is for any type of senior debt.
    - valuearb 7y ago
      You are exactly like the author. You don't understand enough to make the conclusions you make. Lenders aren't stupid in general. They have covenants to protect themselves. In the case of Basecamp, which likely has almost zero physical assets, any loan is going to be very contingent on protecting the levels of profitability necessary to repay it. Whoever owns Basecamp won't be able to get a credit card in it's name without lender approval. Source: I spent the last year working for a firm that is funded by venture capital loans. Every other loan & credit line had to be made subordinate to theirs, and we could not borrow anything new without their approval. It wouldn't matter who we sold the business to, they'd have to agree to the same restrictions or no sale.
  - LatteLazy 7y ago
    Is that true of creditors? I didnt think creditors had a right to object to a change in ownership...
    - valuearb 7y ago
- Lazare 7y ago
  That's a good story. Does it actually happen? Nothing in the tweet thread talked about this scenario, and I'm not aware offhand of examples of this, and I rather suspect it wouldn't work in practice. You say "not a lot of covenants", but change in control covenants are pretty standard, and would be triggered in the simple form of your example. As you note, there's often a way around these things but without examples, this feels awfully tenuous.
JamesBarney 7y ago
Anytime an argument relies on assuming "companies that lend money to PE for leveraged buy outs are unsophisticated dummies" sets off my BS detector. And the rest of his links and article confirm this guy has no idea what he's talking about.
- devnonymous 7y ago
  >...this guy has no idea what he's talking about. This guy is Cory Doctorow. I wouldn't say he has no idea what he's talking about.
  - JamesBarney 7y ago
    https://en.wikipedia.org/wiki/Cory_Doctorow https://en.wikipedia.org/wiki/Cory_Doctorow I hadn't never heard of him but going through his wikipedia I don't see any reason to believe his understanding of business, economics, or finance is any more advanced than the impression I get from his tweets. The people who loan money to private equity are very smart individuals who have backgrounds in finance business and economics. They tend to be very sophisticated entities. If you're going to make an argument they are being repeatedly screwed it needs to be more sophisticated than "look at this company owned by a PE that failed " or "look at this company owned by a PE that did a dickish thing to maximize profits".
    - raverbashing 7y ago
      > The people who loan money to private equity are very smart individuals who have backgrounds in finance business and economics Oh you mean like the guys that ran Enron? Like the guys that "invested" with Bernie Madoff? The author's main argument is not in relation to lenders, but the bankrupting of viable business by offloading debt to them.
      - JamesBarney 7y ago
        But if you are a PE and you're constantly buying companies for a 100 million by borrowing 80 million then driving the company into bankruptcy. How are the lenders getting paid their 80 million and how are you getting back your 20 million? And if the lender is getting screwed out of 80 million dollars why do they keep lending to private equity? It's not his main argument but it's an assumption that has to be true for his main argument to be true.
cryptica 7y ago
>> If this was true, you could easily check to see how well lenders have done If the lenders are banks, they will do well no matter what because the money which they loan is printed out of thin air and they have 0% reserve requirement so it doesn't affect their business if the PE borrower doesn't pay back. The banks' liabilities just keep going up with no consequence; just like government debt keeps increasing without consequence. Banks would like it if they could just constantly keep making direct loans to themselves to pay off their own old debt, that would be a simplified version of what is happening now. Unfortunately for banks, they need intermediaries to funnel the money back to them; any make-believe business such as PE firms will do. Bigger PE firms provide more throughput. Moreover, even if the Fed decides to increase the reserve requirement % some day and the bank is suddenly forced out of business, the managers/executives of the bank still walk away with the huge salaries and bonuses from the time they were making the loans and collecting free interest - There is 0 risk for them... They will probably get even better paid jobs at some of the PE firms that they helped. The reality of the current system is that everyone who holds or earns cash ends up paying through inflation; most inflation these days does not show up in the CPI; because rich people can only buy so many bags of potatoes; there are other factors beyond price which limit demand for consumer products (this is what CPI ignores)... Inflation among the rich will not show up in CPI; instead it goes straight to the stock market and speculative investments.
- valuearb 7y ago
  Is this Doctorow himself, because none of what you said is accurate in reality. Banks don't create money out of thin air, the fed does. Banks can get loans from the fed, and the vast majority must be paid back, or the bank will go bankrupt itself. A bank can't survive loaning itself money, that's ridiculous. Every day it's burning cash paying salaries, rent, marketing costs, it has to earn significantly higher returns on money it loans out than it pays depositors and interest to the fed, or it burns through it's capital and dies.
smitty1e 7y ago
Valid criticisms of the specific tweet thread. But the general point that "complexity is a subsidy" stands. If one does not understand an investment well enough to explain it, then it might not be worth the risk.

by Lazare 7y ago

zzleeper 7y ago

It's not just lending to PE firms but to the original businesses before they get bought. Say Basecamp gets a ~ small 100m loan from syndicate. Basecamp is quite healthy, well managed, low leveraged, so they secure 4% rate for 5yrs, without many covenants. Then PE buys Basecamp, leverages it to the sky and beyond, Basecamp sells, and suddenly the original 100m loan is now junk-grade. The original lenders never interacted with the PE firm, but they still got screwed. Could they have prevented it? Sure, with lots of covenants, but they have lots of added costs for all parties and often have ways around them. Which means every possible firm that might get bought by PE is now a) having to deal with lots of covenants, and b) paying 6-7% instead of the 5% they would get if the likelihood of PE acquisitions was lower.

travisoneill1 7y ago
When a company is recapitalized in a PE buy the existing lenders need to either be paid back in full or explicitly approve of having their debt rolled over into the new structure. They can't be forced.
- zzleeper 7y ago
  You don't need to change the structure. Change management, new management raises all the new debt. Unless there is a bullet proof leverage covenant, then the existing lenders can't do zip about that. Thus, their only option is to go to the table and "accept" the new structure.
  - travisoneill1 7y ago
    This is not a leverage covenant. This is a change in control provision, which there always is for any type of senior debt.
  - valuearb 7y ago
    You are exactly like the author. You don't understand enough to make the conclusions you make. Lenders aren't stupid in general. They have covenants to protect themselves. In the case of Basecamp, which likely has almost zero physical assets, any loan is going to be very contingent on protecting the levels of profitability necessary to repay it. Whoever owns Basecamp won't be able to get a credit card in it's name without lender approval. Source: I spent the last year working for a firm that is funded by venture capital loans. Every other loan & credit line had to be made subordinate to theirs, and we could not borrow anything new without their approval. It wouldn't matter who we sold the business to, they'd have to agree to the same restrictions or no sale.
- LatteLazy 7y ago
  Is that true of creditors? I didnt think creditors had a right to object to a change in ownership...
  - valuearb 7y ago
Lazare 7y ago
That's a good story. Does it actually happen? Nothing in the tweet thread talked about this scenario, and I'm not aware offhand of examples of this, and I rather suspect it wouldn't work in practice. You say "not a lot of covenants", but change in control covenants are pretty standard, and would be triggered in the simple form of your example. As you note, there's often a way around these things but without examples, this feels awfully tenuous.

JamesBarney 7y ago

Anytime an argument relies on assuming "companies that lend money to PE for leveraged buy outs are unsophisticated dummies" sets off my BS detector. And the rest of his links and article confirm this guy has no idea what he's talking about.

devnonymous 7y ago
>...this guy has no idea what he's talking about. This guy is Cory Doctorow. I wouldn't say he has no idea what he's talking about.
- JamesBarney 7y ago
  https://en.wikipedia.org/wiki/Cory_Doctorow https://en.wikipedia.org/wiki/Cory_Doctorow I hadn't never heard of him but going through his wikipedia I don't see any reason to believe his understanding of business, economics, or finance is any more advanced than the impression I get from his tweets. The people who loan money to private equity are very smart individuals who have backgrounds in finance business and economics. They tend to be very sophisticated entities. If you're going to make an argument they are being repeatedly screwed it needs to be more sophisticated than "look at this company owned by a PE that failed " or "look at this company owned by a PE that did a dickish thing to maximize profits".
  - raverbashing 7y ago
    > The people who loan money to private equity are very smart individuals who have backgrounds in finance business and economics Oh you mean like the guys that ran Enron? Like the guys that "invested" with Bernie Madoff? The author's main argument is not in relation to lenders, but the bankrupting of viable business by offloading debt to them.
    - JamesBarney 7y ago
      But if you are a PE and you're constantly buying companies for a 100 million by borrowing 80 million then driving the company into bankruptcy. How are the lenders getting paid their 80 million and how are you getting back your 20 million? And if the lender is getting screwed out of 80 million dollars why do they keep lending to private equity? It's not his main argument but it's an assumption that has to be true for his main argument to be true.

cryptica 7y ago

>> If this was true, you could easily check to see how well lenders have done If the lenders are banks, they will do well no matter what because the money which they loan is printed out of thin air and they have 0% reserve requirement so it doesn't affect their business if the PE borrower doesn't pay back. The banks' liabilities just keep going up with no consequence; just like government debt keeps increasing without consequence. Banks would like it if they could just constantly keep making direct loans to themselves to pay off their own old debt, that would be a simplified version of what is happening now. Unfortunately for banks, they need intermediaries to funnel the money back to them; any make-believe business such as PE firms will do. Bigger PE firms provide more throughput. Moreover, even if the Fed decides to increase the reserve requirement % some day and the bank is suddenly forced out of business, the managers/executives of the bank still walk away with the huge salaries and bonuses from the time they were making the loans and collecting free interest - There is 0 risk for them... They will probably get even better paid jobs at some of the PE firms that they helped. The reality of the current system is that everyone who holds or earns cash ends up paying through inflation; most inflation these days does not show up in the CPI; because rich people can only buy so many bags of potatoes; there are other factors beyond price which limit demand for consumer products (this is what CPI ignores)... Inflation among the rich will not show up in CPI; instead it goes straight to the stock market and speculative investments.

valuearb 7y ago
Is this Doctorow himself, because none of what you said is accurate in reality. Banks don't create money out of thin air, the fed does. Banks can get loans from the fed, and the vast majority must be paid back, or the bank will go bankrupt itself. A bank can't survive loaning itself money, that's ridiculous. Every day it's burning cash paying salaries, rent, marketing costs, it has to earn significantly higher returns on money it loans out than it pays depositors and interest to the fed, or it burns through it's capital and dies.

smitty1e 7y ago

Valid criticisms of the specific tweet thread. But the general point that "complexity is a subsidy" stands. If one does not understand an investment well enough to explain it, then it might not be worth the risk.