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Could someone explain for the… ahh… more financially naïve among us why private equity is the important signifier here? It seems like what rscale is talking abo

by notJim 14y ago

Could someone explain for the… ahh… more financially naïve among us why private equity is the important signifier here? It seems like what rscale is talking about are markets which are opaque due to companies that have enough clout to force that inefficiency (e.g., by restricting information or making product comparisons impossible.) Why or how is that coordinated with private equity?

marklabedz 14y ago
At the risk of putting words in rscale's mouth, its not that PE creates these conditions or that PE is even necessary for these conditions. Instead, PE tends to find and play in highly attractive industries (See Porter's 5 Forces for a classic view of "attractiveness"). PE involvement in an industry can be a good signal...
- notJim 14y ago
  Ahh, very cool. That makes a lot of sense to me. Basically you're using PE as a proxy for a measurement of attractiveness.
  - marklabedz 14y ago
    Yes, that's a good way to look at it. Its really important to recognize the crux of rscale's point though - you have to render the high barriers to entry condition false. If you can't figure out how to enter, the remaining conditions don't really matter.
  - stcredzero 14y ago
    > Basically you're using PE as a proxy for a measurement of attractiveness. How about PE as a proxy for "incumbency?" That is to say, you're looking at companies who figured out a formula to "print money" then let themselves get complacent and fat, thereby becoming targets for PE. This would explain why they tend to be not so agile. I just had an image of a cabal of attractive young women, somewhat resembling James Bond villainesses, but who are trained in business and economics, who seek out dalliances with PE firm executives in order to perform industrial espionage.
    - 001sky 14y ago
      Freudian slip? free-cash-flow is attractive to pe (=$$$), even for plane-jane business =D tech is a counter-example.
winterchil 14y ago
This is a brutal generalization so take it with some salt. I also don't subscribe to the "all PE guys are evil and unnecessary" philosophy but with just this teaser description it would be easy to think I support it. Anyway, on to your answer. Private Equity firms typically want to run their portfolio companies as profitably as possible. This means cutting down service, R&D, technology, etc as lean as possible without damaging the existing product or brand. It also rules out lots of room for innovation as the companies chief reason for existing becomes generating enough profits to pay off the individual company's outstanding debt. Why is there debt? Private Equity firms will buy a company, streamline its operations, increase its profits, and demonstrate to banks/investors that it is financially stable. Once they've done that they raise lots of debt against the promise to pay off that debt with the future, dramatically increased, profits. They use the debt to pay themselves a bonus for taking over the company and fixing it. Why not wait and just pocket the company's profits over time? Well, that's how Warren Buffet does it (sort of), but by loading the company with debt they get their bonus sooner increasing the IRR for their own investors. edit: phrasing.
- 001sky 14y ago
  Counter-examples, or a couple examples of the salt: skype, getty images, doubleclick, etc. sometimes, it really does makes sense to add capital and/or shield the company from the public markets. When going through change, etc. builders and flippers are co-mingled though. just like vc presumably.
  - winterchil 14y ago
    Absolutely. And the distinction between "growth equity" and "private equity" gets ever more blurry over time.
tptacek 14y ago
Private equity firms buy companies to make them more profitable and then flip them. They are essentially committing themselves to the incumbent role in Christiansen's "Innovator's Dilemma". When a market is dominated by risk-averse incumbents, it is probably ripe for disruption.
- stcredzero 14y ago
  > When a market is dominated by risk-averse incumbents, it is probably ripe for disruption. Who originally formulated this idea? Was it you? This sentence is fantastic.
  - MatthewB 14y ago
    Agreed. I was thinking the same thing.
  - IsaacL 14y ago
    As GP said, read Christensen's "Innovator's Dilemma". He's the guy who first came up with the term "disruptive innovation", and it's more than just a TechCrunch buzzword -- there's a whole theory behind how disruption actually works.
    - i2pi 14y ago
      The concept dates back much further than Christensen. See http://en.wikipedia.org/wiki/Creative_destruction http://en.wikipedia.org/wiki/Creative_destruction
      - nazgulnarsil 14y ago
        Schumpeter should be required reading.
- jonnathanson 14y ago
  Are they actually committing themselves to the incumbent role, or do they recognize an industry in decline and then suck whatever profits they can out of the businesses before flipping them? Layoffs, pension raiding, fat trimming, etc. It's fairly easy, in theory, to take a bloated and inefficient company, cut it to the bone to reduce overhead, then position it as more profitable for resale. On paper, sure, it's more profitable. In reality, it's just a similarly bad company that's been trimmed up and given a new paint job. It's very similar to the real estate playbook: buy a delapidated property, touch up the exterior, then flip it as if it's shiny and new. (The beauty of PE, over real estate, is that PE firms can rig the game to benefit one way or the other, due to debt structuring. If they can flip the company for a profit, they win; if the company goes bust, they're insulated from the damage.) I would say that an overpresence of PE in an industry is a decent indicator that the industry is in trouble (or is ripe for disruption). But I think PE guys realize that, as well. They're just in it to make the quick, easy buck, rather than take on the burden of reshaping the industry. I wouldn't call them "risk averse" so much as I'd call them opportunistic. It's just a different kind of opportunity, and arguably a less socially valuable one.

by notJim 14y ago

marklabedz 14y ago

At the risk of putting words in rscale's mouth, its not that PE creates these conditions or that PE is even necessary for these conditions. Instead, PE tends to find and play in highly attractive industries (See Porter's 5 Forces for a classic view of "attractiveness"). PE involvement in an industry can be a good signal...

notJim 14y ago
Ahh, very cool. That makes a lot of sense to me. Basically you're using PE as a proxy for a measurement of attractiveness.
- marklabedz 14y ago
  Yes, that's a good way to look at it. Its really important to recognize the crux of rscale's point though - you have to render the high barriers to entry condition false. If you can't figure out how to enter, the remaining conditions don't really matter.
- stcredzero 14y ago
  > Basically you're using PE as a proxy for a measurement of attractiveness. How about PE as a proxy for "incumbency?" That is to say, you're looking at companies who figured out a formula to "print money" then let themselves get complacent and fat, thereby becoming targets for PE. This would explain why they tend to be not so agile. I just had an image of a cabal of attractive young women, somewhat resembling James Bond villainesses, but who are trained in business and economics, who seek out dalliances with PE firm executives in order to perform industrial espionage.
  - 001sky 14y ago
    Freudian slip? free-cash-flow is attractive to pe (=$$$), even for plane-jane business =D tech is a counter-example.

winterchil 14y ago

This is a brutal generalization so take it with some salt. I also don't subscribe to the "all PE guys are evil and unnecessary" philosophy but with just this teaser description it would be easy to think I support it. Anyway, on to your answer. Private Equity firms typically want to run their portfolio companies as profitably as possible. This means cutting down service, R&D, technology, etc as lean as possible without damaging the existing product or brand. It also rules out lots of room for innovation as the companies chief reason for existing becomes generating enough profits to pay off the individual company's outstanding debt. Why is there debt? Private Equity firms will buy a company, streamline its operations, increase its profits, and demonstrate to banks/investors that it is financially stable. Once they've done that they raise lots of debt against the promise to pay off that debt with the future, dramatically increased, profits. They use the debt to pay themselves a bonus for taking over the company and fixing it. Why not wait and just pocket the company's profits over time? Well, that's how Warren Buffet does it (sort of), but by loading the company with debt they get their bonus sooner increasing the IRR for their own investors. edit: phrasing.

001sky 14y ago
Counter-examples, or a couple examples of the salt: skype, getty images, doubleclick, etc. sometimes, it really does makes sense to add capital and/or shield the company from the public markets. When going through change, etc. builders and flippers are co-mingled though. just like vc presumably.
- winterchil 14y ago
  Absolutely. And the distinction between "growth equity" and "private equity" gets ever more blurry over time.

tptacek 14y ago

Private equity firms buy companies to make them more profitable and then flip them. They are essentially committing themselves to the incumbent role in Christiansen's "Innovator's Dilemma". When a market is dominated by risk-averse incumbents, it is probably ripe for disruption.

stcredzero 14y ago
> When a market is dominated by risk-averse incumbents, it is probably ripe for disruption. Who originally formulated this idea? Was it you? This sentence is fantastic.
- MatthewB 14y ago
  Agreed. I was thinking the same thing.
- IsaacL 14y ago
  As GP said, read Christensen's "Innovator's Dilemma". He's the guy who first came up with the term "disruptive innovation", and it's more than just a TechCrunch buzzword -- there's a whole theory behind how disruption actually works.
  - i2pi 14y ago
    The concept dates back much further than Christensen. See http://en.wikipedia.org/wiki/Creative_destruction http://en.wikipedia.org/wiki/Creative_destruction
    - nazgulnarsil 14y ago
      Schumpeter should be required reading.
jonnathanson 14y ago
Are they actually committing themselves to the incumbent role, or do they recognize an industry in decline and then suck whatever profits they can out of the businesses before flipping them? Layoffs, pension raiding, fat trimming, etc. It's fairly easy, in theory, to take a bloated and inefficient company, cut it to the bone to reduce overhead, then position it as more profitable for resale. On paper, sure, it's more profitable. In reality, it's just a similarly bad company that's been trimmed up and given a new paint job. It's very similar to the real estate playbook: buy a delapidated property, touch up the exterior, then flip it as if it's shiny and new. (The beauty of PE, over real estate, is that PE firms can rig the game to benefit one way or the other, due to debt structuring. If they can flip the company for a profit, they win; if the company goes bust, they're insulated from the damage.) I would say that an overpresence of PE in an industry is a decent indicator that the industry is in trouble (or is ripe for disruption). But I think PE guys realize that, as well. They're just in it to make the quick, easy buck, rather than take on the burden of reshaping the industry. I wouldn't call them "risk averse" so much as I'd call them opportunistic. It's just a different kind of opportunity, and arguably a less socially valuable one.