Views on the future of Private Equity

Anubis's picture
Rank: Senior Chimp | banana points 24

I'm currently working in IBD and after weighing up what I want to do next, PE seems to be the winner as I've found myself becoming increasingly interested in the industry and the nature of the work.

However, from my standpoint, it seems like the industry is way too crowded, too much capital chasing too few deals; there's nothing like an overly competitive auction process to kill your IRR.

I recently had a conversation about this with an IBD old timer and he was of the opinion that we're going to see a polarisation in the market with funds that have diversified into other areas (distressed debt, real estate etc) at one end, and specialist PE funds that only operate in one or two sectors where their expertise (aided by partners with operational experience) can genuinely add value, at the other.

What are people's views on this? Will we see less generalist PE shops over the next decade or so?

Moreover, is compensation on the way down? I've not personally seen the data to back this up, but I read a post on WSO that said:

- Today only half of all buy-out funds in Europe earn carry (beat the hurdle rate of 8%)
- Transactions are today priced at an IRR of 15-17%, down from 23-25% 5 years ago

If this is indeed true, are we likely to see GPs pulling their money out of PE and towards other alternative investments with the potential more attractive returns (and similar risks) e.g. HFs?

I still want to go into the industry regardless, but my enthusiasm may be tempered if I am essentially working my butt off to board a sinking ship, especially with having to face the competitive private equity interview process...

Comments (71)

Nov 23, 2014

One thing for certain, your path to the top will be much much longer and harder than for many in previous times. There are just so many more firms out there and it's uber competitive between funds (fundraising ain't easy either) and there are so many candidates trying to get analyst/associate positions. So try to have an idea of what you may want longer term before making the jump and/or keep an open mind.

Otherwise I think this is a timeless debate and there is no right answer other than, things will change and then they will change again. The big generalists will either carve out specialist funds (which we have seen) or allocate to those sectors in their actual funds and hire said people. They will make a ton of money in that area, and that team might spin out, go independent or become senior in that organization or lose a ton of money in that area, if the latter in which case said specialist fund gets shut down/run off and PE firm goes back to being "generalist".

Good generalists who make money consistently and have loyal LPs will stay that way - that's what they are getting paid for... though they may diversify into other products (HF, sector funds etc), to "give" their LPs more "diverse" offerings (ie. generate more management fees). Specialist funds that are good will stay specialist and tweak with their strategy to stay with the times. Things are cyclical and change all the time, so just like in any industry you will have shakeouts and bubbles.

PE is well established now so moving up will be tough. It's not like the 80s where people were getting to senior positions pretty quickly. People forget that a lot.

A bit of an unstructured ramble, apologies...

Good Luck

I used to do Asia-Pacific PE (kind of like FoF). Now I do something else but happy to try and answer questions on that stuff.

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Dec 1, 2014
Jamoldo:

One thing for certain, your path to the top will be much much longer and harder than for many in previous times. There are just so many more firms out there and it's uber competitive between funds (fundraising ain't easy either) and there are so many candidates trying to get analyst/associate positions. So try to have an idea of what you may want longer term before making the jump and/or keep an open mind.

Otherwise I think this is a timeless debate and there is no right answer other than, things will change and then they will change again. The big generalists will either carve out specialist funds (which we have seen) or allocate to those sectors in their actual funds and hire said people. They will make a ton of money in that area, and that team might spin out, go independent or become senior in that organization or lose a ton of money in that area, if the latter in which case said specialist fund gets shut down/run off and PE firm goes back to being "generalist".

Good generalists who make money consistently and have loyal LPs will stay that way - that's what they are getting paid for... though they may diversify into other products (HF, sector funds etc), to "give" their LPs more "diverse" offerings (ie. generate more management fees). Specialist funds that are good will stay specialist and tweak with their strategy to stay with the times. Things are cyclical and change all the time, so just like in any industry you will have shakeouts and bubbles.

PE is well established now so moving up will be tough. It's not like the 80s where people were getting to senior positions pretty quickly. People forget that a lot.

A bit of an unstructured ramble, apologies...

Good Luck

Great post.

Do you think a lot of anecdotal evidence is what pushed people into PE? Or atleast, gunning for it?

Seems like it's the holy grail of places to be, but guys who are billionaires now were flourishing in a bit of a new market.

I'd compare it to tech guys hitting it big during the late 90s...

I mean, yeah, you can COME UP in the tech world today... But many are jumping in because what they heard happened when it was booming.

And it's much tougher to make the world shattering app today than it was just 4 years ago due to competition.

Nov 23, 2014

In the 1980's, you could have become a millionaire by the age of 30 selling munis to retirees in Florida. Just like that would be difficult now, things in PE or hedge funds are also harder now. Maybe not as difficult as the first example, but everything that is easy money doesn't stay easy for long. Going to a hedge fund is still better than almost anywhere else, all things considered. You're almost certainly not going to become a billionaire if you join KKR and stay there for a long time like the founding partners did.

Dec 1, 2014
DickFuld:

In the 1980's, you could have become a millionaire by the age of 30 selling munis to retirees in Florida. Just like that would be difficult now, things in PE or hedge funds are also harder now. Maybe not as difficult as the first example, but everything that is easy money doesn't stay easy for long. Going to a hedge fund is still better than almost anywhere else, all things considered. You're almost certainly not going to become a billionaire if you join KKR and stay there for a long time like the founding partners did.

100% true. Schwartzman was even pretty late to the game when they started Blackstone, in terms of drawing absurd amounts of income, though of course they didn't miss the boat. A lot of money was made in PE in the 90's but not like the 80's, and nowadays with so much competition flooding the industry income is trending down.

Dec 1, 2014

My understanding is that getting carry can be an uphill battle.

Dec 1, 2014

Everything that has been said above, but I'd also add that HF's aren't having the best of times now either, and this isn't someone in PE trying to crap on HF's by any means, but their returns haven't been too great recently and I think I just read today that more funds have shut this year than since 07/08 when so many blew up. Just like PE used to be easier (a term I use cautiously), HF's used to be much smaller and nimbler and could beat the market rather than be the market. So I don't really see a big shift in the LP landscape where they drop PE . If anything, with things like Calpers (or sters) pulling out of HF's, I'd argue the opposite. In addition, remember that carry in PE is almost certainly taxed as a long term cap gain and as far as I know HF's are a short term gain/ordinary income so from the pov of the guy working in it, it's a better deal tax wise.

PE is currently different than it was and it will be different in the future. The same can be said of HF's, IB, trading, tech, medicine, etc. @"DickFuld" is completely correct: I actually knew a guy who moved to one of the Keys and made a few hundred grand a year selling muni's to retirees and lived the life in the 80's/early 90's. Highly doubt he's doing that now. However I don't think PE is going to change that much.

I'd caution against always looking back and thinking that the good ol' days were so much better than now. When I graduated from college in the mid 90's and got into REPE, all that everyone talked about was how awesome the 80's were for RE. When I got into more traditional PE, people talked about the 80's and the awesomeness of the corporate raider days. In the early 00's (or whatever the they're called), I talked about how awesome the dot com boom days were and traders talked about the glory days of pre-decimalization. And now we all talk about how great the world was pre 07/08. I know guys older than me who still reminisce about the days before the end of fixed commissions. While there's some lumpiness to it, I'd lay money down and say that folks in Wall Street style finance jobs make more now on average than they ever did. With the amount of money at play and the sheer intelligence that surrounds Wall Street (in combo with the greed), we'll always make far more than the average professional in nearly every other field.

PE now and in the future:

-it's harder to make partner or to get into the partner track because more people want it and less people have retired because of the recession. Remember that carry in PE is a long term game and a lot of guys who are in their later 50/60's who would have retired in, for example, '10 or '12 or today didn't because their funds didn't do as well as they had planned because they invested during the bubble and overpaid or harvested in the crash or directly after the crash. There are more funds than ever, but more guys stuck around for another cycle because they either planned on making more money or didn't want to go out on a flat fund. It'll be interesting to see what happens when a lot of these guys retire. However there are more than enough suits to fill their chairs.

-entry multiples have increased recently but you just have to be smart about not buying simply to deploy capital. I honestly don't know how guys in big MM or megafunds do it because every deal is an auction. It's a reason I'd argue for getting into the smaller market. In the dozen or so years I've been in the MM/lower MM, I've seen many more deals being part of an auction, but there still are off market deals available, and there's a lot of opportunity in buying a platform auction deal and doing a bunch of smaller bolt-on's with off market deals and being able to greatly increase the value of an investment. It just takes a lot more work to not just receive calls from M&A bankers marketing a deal than it does to go out and find direct deals.

-fundraising is tough, but it almost always has been except for a few glitches such as 2006. But good investors will always be able to attract money. Starting a new fund is very difficult admittedly. I've always found the LP herd mentality pretty amusing, and I suppose ironic, because they're willing to throw money back at big funds with recognizable names who lost them money or were flat, but they hesitate to invest with newer guys who have great track records. I don't see LP's getting any smarter.

-as others have stated, you're most likely not going to be Henry Kravis if you get into PE now (although who knows, maybe one or two guys will in 40 years) but they and other similar guys basically started the private equity business. It was probably pretty risky for them to leave a solid Bear Sterns partnership for a relatively untested field, although with the egos involved they most likely didn't have a minute of personal doubt. Today, you're joining an established business with much more security and more defined opportunities. In the 80's how many PE/corporate raiders could you go work for?

-I agree with the bifurcation of the industry with smaller specialized firms who concentrate in a particular niche and the planet wrecker megafunds who have really become alternative asset manager platforms, and public co's at that (I find that ironic: private equity, which says it's better to take a company private and improve it outside of public company scrutiny are themselves public companies). I think this will continue, but I don't see the smaller funds (and I'm not just talking about a micro $100MM fund, but anything below the funds that have dozens of unrelated strategies and tens of billions of current AUM) going away. There are tons of smaller LP's who can directly invest in PE funds where they don't have to or can't deploy hundreds of millions at a time because they'd be 25% of the fund.

Apologies for the ramble. Just a few thoughts.

    • 3
Dec 1, 2014

I basically agree. I was probably a liter+ deep in Bombay when I wrote the comment above and didn't really mean to draw a distinction between PE or HF. My main point is that, while the money is going to be relatively good in PE and HF, you will never become a billionaire by joining someone else's fund. Or, at least you shouldn't expect to. The same way I would tell you that you wouldn't be able to do that in an investment bank even though Sandy Weill and I did it.

It doesn't matter if we're talking about PE or HF, the answer is the same. It is extraordinarily difficult to make ridiculous money in those areas because institutional investors will continue to go with the safe bet for their career, which means the big will likely get bigger. The only real way to get that sort of upside is to start your own firm, which is exponentially harder to make exceptionally successful than twenty years ago.

To give an example of how much harder it is in the hedge fund world, ponder this: convertible arbitrage was one of the more popular investment strategies in the eighties and even the nineties. Now, there 's practically nothing to be had there because everybody knows how to price basic call options that are embedded in these bonds.

But, to support the point of @"dingdong08", activist strategies are much more effective BECAUSE of the size and clout of those funds. Nobody is going to give a shit about your suggestions with a $20 million position in your company. But, of course, if you have a much larger position, you're much harder to ignore. People adapt their strategies, like they do in anything else.

Dec 5, 2014

this is fascinating

Dec 5, 2014

Interesting perspective but I disagree on the grounds that leverage will no longer be tolerated to the extent that it has been used over the past 3-5 years. While valuations begin to come down many companies are reluctant to sell their assets for reduced multiples (unless they are in need of a liquidity event to survive). Over time the bid/ask spread will decrease but I do not see it happening in the near term. Credit markets and deal flow will remain sluggish over the next 8 - 12 months.

Another consideration that you havent addressed is that PE firms went on a buying spree over the past 3-5 years and have been preparing their LBO portfolio companies for a sale. Well guess what, no one is buying and PE shops over paid. We bought at the top and will now have to sell at the bottom or be forced to reckon with portfolio management and reduced acquisition activity.

I think the the tech sector is the way of the future and VC will likely pick up as the internet continues to become an even more integral part of our lives. Alternative energy will also remain hot (unless oil drops to historic levels and we become complacent again).

Dec 5, 2014
junkbondswap:

Another consideration that you havent addressed is that PE firms went on a buying spree over the past 3-5 years and have been preparing their LBO portfolio companies for a sale. Well guess what, no one is buying and PE shops over paid. We bought at the top and will now have to sell at the bottom or be forced to reckon with portfolio management and reduced acquisition activity.

But that is the flexibility of PE - even if you overpaid, if you were smart and cautious in your acquisition processes, you can hold the portfolio for a while - a few years may even be enough in an optimistic view. Returns won't be stellar, but if things go alright you at least potentially have preservation of capital.

Dec 5, 2014

We are not much different from the guy who decided to jump into the housing market at the top by borrowing cheap debt and buying over-valued assets, which are now decreasing in value on a weekly basis. Lets be very clear, intelligence and cautiousness often go right out the window in times of exuberance and cheap money as hubris and investor demands drive PE strategy. Also, if returns do not meet your investor IRR threshold dollars will go to other asset classes. Not to mention that if that clown Obama gets in office you can rest assured that regulation and taxation will be extremely burdensome on the PE model.

Im just playing devil's advocate and I am happy to be in a comfortable position on the buyside and realize that there are billions of dollars waiting on the sideline that must be put to work. Good thread so far...

Dec 5, 2014

jbs literally hit the nail on the head. caution and prudence are not highly valued traits when the rest of the firms in your industry are chasing hot money.

many acquisitions made during the recent boom were both over-leveraged and overly optimistic in terms of future projections. thankfully, flexible covenants (i.e. "covenant lite") have been advantageous for PE-backed companies; that said - if the economy continues to worsen, don't be surprised if more go belly-up.

Dec 5, 2014

Finally, an interesting discussion.

junkbondswap is right on a number of points, but we're all going on the assumption here that all PE firms overpaid. In fact, over the life of our latest fund, I can only recall one company that we paid over 9.0x for (and that company is easily the best performing company in the portfolio right now). Of course, we sold 3 companies in early 2007 to megafunds who overpaid handily for them and received incredible amounts of leverage to buy them.

Let's not kid ourselves here, private equity professionals are not the contrarians we think we are. In fact, we're very closely tied to the health of the overall financial markets. I'm in the midst of an acquisition right now which I think exemplifies both sides of the argument here. Yes, multiples have been compressed (we are paying less than 6.0x) but leverage is incredibly hard to come by. The banks are frozen at this point. More frozen than they were in late 2007. Not even the usual MM suspects (CIT, CIBC, GE, RBS, RBC, et all) are willing to underwrite at this point.

But who is willing to underwrite? The lending arms of the hedge funds. Ironically enough, the fund model may be what saves us all. They have capital to put to work, just like we do. And on top of that, they get the benefit of charging market rate. So you're seeing unitraunche structures of L + 800 or 850, and the hedge funds are banding together to form their own club deals so they don't have to syndicate or deal with flex pricing. That might be the answer, at least temporarily. The PE funds turning to the credit funds and cutting the banks out of the process.

Interested to hear your thoughts, I have to get back to work...

Dec 5, 2014
GameTheory:

junkbondswap is right on a number of points, but we're all going on the assumption here that all PE firms overpaid.

which indeed not all did - many deals were done in the lower end of the spectrum, especially lower MM.

GameTheory:

Let's not kid ourselves here, private equity professionals are not the contrarians we think we are.

No joke - but there are industries where the correlation isn't particularly strong - or at least individual companies. And I suppose that is what I meant by being cautious - looking at firms that are throwing off the CF that would at least enable holding to be an option. And, in at least a VERY FEW cases, operations could be improved to realize near term non-growth related CF increases.

Plus, as I mentioned in another thread, we may see an increase in companies being purchased out of BK - which can often mean a (hopefully) properly restructured firm at a reasonable price. Sure - a lot of shops right now won't or can't look there, but I bet when you look at chapter 11 filings, more will be purchased than emerge.

notyourtypicalbanker:

2) Raising capital on a deal-by-deal basis: Maybe I'm wrong, but I don't understand the need for a structured private equity fund in this kind of economy. You're obligated to deploy scarce capital and even with any potentially enticing opportunities you're severely limiting yourself in terms of transaction size. Although fundless sponsors get bad mouthed sometimes, I think the very core of that investment model could prove to be fruitful in a bear market.

your first point about going internationally was a good one. I think some of the MM and lower MM firms have started to realize this, and there has been some potential there. for your second point, sure, as much as fundless sponsored can get pissed on, they can bring value, especially from the proprietary deal standpoint. still, my experience has been that the standard structure PEG is the easiest source of funding for a fundless sponsor. I don't know if I can see all fundless sponsors interacting with each individual investor (and handling the required maintenance involved).

and even if my points are wrong - this is a good thread.

Dec 5, 2014

Interesting topic.
I'm lucky to have an offer to join one of the healthy BBs in 09. And there's also a potential oppurtunity for me to start career in a ok PE (think similar to Summit or TA).
But I am signing the IB offer. The entering class for IB is very small, and the new leaders are emerging. I do think whoever survives this down cycle will be in high demand.
And I am not sure about PEs right now. With this kinda market, how do they raise funds? how do they sell their portfolio companies or keep their portfolio companies grow? and i don't think the glorious days of LBO will come back soon.
just my 2 cents.

Dec 5, 2014

JBS and GT, you both bring up excellent points. I don't disagree that the current predicament for PE firms is in part due to the irresponsible usage of leverage in past buyouts and investments.

When I think of the future of PE, I am interested in looking for two relatively "new" and by-and-large untraditional investment strategies/trends arise in the midst of this crisis:

1) MM PE Firms with Scale: Traditionally, it has been the big megafunds that braved the waters of the emerging markets, but times like these behoove mid-market PE firms to increase their scope geographically. Megafunds who have occupied this sphere before will face stark competition from MMs who can not only provide the financing but can also provide the operational advisory to help companies grow. Why scale internationally? Great demand for capital infusion in companies in Asia/LatAm/Europe, better access to debt financing with relatively better terms, and more opportunities for exits. This last point is especially important. The number of foreign buyers has increased drastically over the past decade: Cross-border deals summed up at about $354 billion in 2007, effectively representing an increase of 73% from the 2006 total -- I only see this continuing.

2) Raising capital on a deal-by-deal basis: Maybe I'm wrong, but I don't understand the need for a structured private equity fund in this kind of economy. You're obligated to deploy scarce capital and even with any potentially enticing opportunities you're severely limiting yourself in terms of transaction size. Although fundless sponsors get bad mouthed sometimes, I think the very core of that investment model could prove to be fruitful in a bear market.

Dec 5, 2014

...Private equity is just long-only equity with massive leverage and no ability to exit trades that turn bad. Sounds great right? Until funding markets come back liquid products will be much more popular.

Dec 5, 2014

Interesting thread.

I'm in a MM PE shop in Europe ($800m-$1bn AUM).

The situation of the banks has clearly worsened over the course of the summer, particularly in September. It's not as bad as it seems to be in the US (I'm referring to GT's post). So far I haven't noticed any increase in the role of hedge/debt funds. What we rather see is an increased role of mezzanine financing, whith current prices of E+500 cash, 500 PIK and warrants getting mezzanine providers to IRRs of 16% when the equity sponsor reaches 25%.

Senior debt pricing has risen tremenduously but is still cheaper than in the US in my view. (E+ 275bps on the A Tranche) However, it has become very hard to raise more than EU200m in senior debt so we do not see many deals with EVs in excess of EU350m.

I think we benefit from the comparatively stronger balance sheet of European banks (German, French, Spanish). The Northern banks are bankrupt and out of the market (Iceland, etc.) But the number of players in the leverage finance space is shrinking day by day. + There is no more syndication to CDO/CLO funds which formerly bought c. 70% of the debt packages underwritten for the large LBOs, so we see a surge in club-type deals with bank syndicates present at closing and no syndication phase.

Bondarb:

...Private equity is just long-only equity with massive leverage and no ability to exit trades that turn bad. Sounds great right? Until funding markets come back liquid products will be much more popular.

If things go well, leverage will probably get you to 10-15% IRRs max. No PE funds targets this kind of returns. Returns on excess of 25% IRRs come from multiple arbitrage, Accretive build-ups, and earnings and cash flow growth.

Dec 5, 2014
Muskrateer:

If things go well, leverage will probably get you to 10-15% IRRs max. No PE funds targets this kind of returns. Returns on excess of 25% IRRs come from multiple arbitrage, Accretive build-ups, and earnings and cash flow growth.

More and more, though, it seems that multiple arbitrage is harder to come by, and it's harder than usual for build-ups. Simply put, seems there has been downward pressure on IRR for a few years.

Dec 5, 2014

muskrateer is hitting the nail on the head with regards to the eurozone. mezz is definitely starting to play a role, and there are special mezz funds already moving out there that have a first mover advantage in this market.

i agree with the OP that this is a good time to be in PE because of the lower valuations and entry multiples.

from an REPE point of view, i can tell you we are busy. yields are still rising and if history repeats, then it will definitely overshoot the mark and we will see a lot yield compression in a few years which will be a significant driver of IRR. I don't think that NOI growth assumptions are strong for the short term though.

i'd be interested to hear if people think the industry will have more specialized shops popping up or if the general fund is still the way to go?

Dec 5, 2014

Mezz debt providers are really doing well.

RE, I think in this kind of environment you're doing yourself a disservice if you specialize too much in one particular sector. In a changing landscape, you want to be as opportunistic as possible and broaden your scope - in terms of geography, transaction size, and sector focus. That's why I think fundless sponsors will do really well. No obligation to commit a certain percentage of the fund to a target, which gives you a lot of flexibility to do some great deals.

Dec 5, 2014

I've been away from this forum for the last month (for both work and leisure), but it's nice to see an interesting discussion again. Here are my perspectives based on my experience at a $2-5 billion MM buyout shop, based on what's been going on in the current market:

(1) Fundraising -- I'd say the toughest part for us is the fundraising process. I'm guessing this is probably true of other PE shops because the markets are not doing well and cash is tight all across the board. I don't think there is any segment of the buyout market that is immune to the obvious contraction of available funds.

(2) Leverage -- At the lower to middle MM spectrum, debt is still available (in spite of some resistance). As a junior guy, I don't have a real perspective of what things are like in the overall market - and maybe things are worse as GameTheory pointed out, but we are still getting financing. Turns of debt have come down and pricing has come up, but not in a way that would be as prohibitive as some might imagine. I don't think lending has dried up here in the way that it has on the large-cap side from what I hear and read, and funding seems to be well fine through 2009. However, there appears to be a general concern about where pricing will eventually shake out in the future (perhaps 75-100 bps from where we are today), new potential underwritings are being screened much more carefully and skeptically, and overall, it seems like the tone among lenders concerning 2009 is fairly bearish. Simultaneously, there are other lenders out there who do believe it's also important for them to keep their underwriting options open. Specifically, as some lenders are probably going to be so scraed that they don't end up getting any deals done, this may create opportunities for others to put money out into good deals.

(3) Selling -- All factors considered, the general sentiment is that it this is not a seller's market. I don't know how much elaboration is needed here.

(4) Buying -- One of the most resonating sentiments right now is that it is a good opportunity to keep an eye out for good deals. As others here have mentioned, valuations have come down materially, and if you recall some of the medium to large PE buyouts that were done in 2002-2003, many of those exits have performed extremely well. Why? It was a simple matter of buying when the markets were low and exiting when the markets were high. There's no question that good deals are hard to come by as the buyout market is simply not frothy compared to what we saw even a year ago, but companies are still being put up for sale and at least at our firm, there is a bit more open-mindedness to considering middle-of-the-road companies as takeout candidates purely on the basis of valuation. It's unclear where the low point of the market is going to be, but we're constantly reminded to keep our eyes open for good bargains.

(5) International expansion -- economies don't look that much more optimistic in Europe or Asia as a whole, but given that the overall deal environment has slowed down, it's not a bad time to consider setting up satellite offices overseas and building new professional networks. When the markets start improving, PE firms will want to have the geographical footprint to take advantage of that uptrend.

Those are my key observations concerning five topical issues concerning private equity. I would be curious to hear the thoughts and impressions of others here. Hopefully these perspectives make for good discussion points.

Dec 5, 2014

numi - your thoughts pretty much match my own and what I've been hearing from others.

it seems there are a number of good deals out there based on valuation. I don't think it will bring about traditional multiple arbitrage, but it can provide the opportunity for results born of the same idea (aka value investing, I suppose). the other thing I'd add - and I may have mentioned this before so sorry for the repetition - is that PE will need to have an increased focus on actual operational improvement, especially for existing portfolio companies.

Dec 5, 2014

Outside of deal flow, the busiest people in the industry right now seem to be the middle office guys at banks. They spend their time drafting and signing waivers, because with what's happening in the economy, a TREMENDOUS amount of companies currently under LBO in Europe are breaking covenents like crazy (debt/EBITDA, Capex, etc.), and that is, even though they are still, in the vast majority, able to repay their debt and serve the interest payments.

This is usually the first step towards defaulting and 2009 will be a very tough year for a LOT of companies, especially for all these acquisitions which were excessively levered in cyclical sectors such as retail or construction.

Dec 5, 2014

I haven't even read the replies - just the title of this thread....

It is one of the most ridiculous propositions I've ever heard

Dec 5, 2014
yesman:

I haven't even read the replies - just the title of this thread....

It is one of the most ridiculous propositions I've ever heard

Why? It seems perfectly reasonable to me.

The public markets are in shambles at the moment. I believe this has got a lot to do with the non-symmetrical returns afforded by short selling. This mechanism is allowing prices to be driven down, putting artificial economic pressure on previously solid companies. We are seeing this in Australia, especially smaller finance companies and infrastructure assets.

When these same assets are owned privately, often directly by pension and hedge funds, they produce solid, long term returns - exactly what they are meant to be doing. Price should not play any part in the calculations of an end owner.

Private equity is just disintermediation, taking the exchange out of the equation. To think private equity is all about leverage and LBOs is just not true. That is one strategy that was implemented, which went along with flipping the businesses.

Coming up will be a period of examination of the role of the exchange in modern finance. I believe the way of the future is some hedge fund/PE hybrid that is purely looking for value plays which allow funds to take control of a company. Liquidity is worth nothing to these investors.

Dec 5, 2014

hmmmm.....nope

Dec 5, 2014

hmmmmm ... yep

===
http://bankertimes.cominvestment banking news

Dec 5, 2014

Claiming that PE is the future is actually fairly probable. We'll see a dip in banking revenue over the next year and on going depending on the markets because there will be a lot of competition in M&A, fees for advisory get compressed and there is a decline in pay scale, lots of price undercutting. Buyside will pay based on how much money is made, so yes if pe firms make good calls "fix that company" and sell then there will be lots of money to be made. Still light at the end of the tunnel.

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Dec 5, 2014

As I mentioned, I believe family offices are hugely underserved. Three key questions!

What product would you offer to family offices in order to differentiate yourself:
- What are the financial terms:
o Management fee [1.5% on AUM?]
o carry [15.0% on 8% hurdle rate; deal-by-deal basis?]
o Retainer [family offices are willing to pay a retainer for search funds, wouldn't they be willing to pay a retainer for this as well?]

- What are the envisaged non-financial terms:
o Yes/no on ever project [likely key as family offices are becoming more reluctant to invest into blind pools]
o Board seat
o Who has final say on decisions (sale, management)

How do you get access to capital:
- Competitive auctions:
o How can we make sure that we have access to capital in a competitive auction:

How do you get access to deal flow:
- Which geographic markets / segments offer potential for the best investments

I believe 1 and 2 are easy, there is a huge demand for such a product, but in the end you still have to invest the money in the market, how can you do that?

Dec 5, 2014
bbballer:

As I mentioned, I believe family offices are hugely underserved. Three key questions!

What product would you offer to family offices in order to differentiate yourself:

- What are the financial terms:

o Management fee [1.5% on AUM?]

o carry [15.0% on 8% hurdle rate; deal-by-deal basis?]

o Retainer [family offices are willing to pay a retainer for search funds, wouldn't they be willing to pay a retainer for this as well?]

- What are the envisaged non-financial terms:

o Yes/no on ever project [likely key as family offices are becoming more reluctant to invest into blind pools]

o Board seat

o Who has final say on decisions (sale, management)

How do you get access to capital:

- Competitive auctions:

o How can we make sure that we have access to capital in a competitive auction:

How do you get access to deal flow:

- Which geographic markets / segments offer potential for the best investments

I believe 1 and 2 are easy, there is a huge demand for such a product, but in the end you still have to invest the money in the market, how can you do that?

Interested in the retainer concept re: family offices, if you could please expand that would be great.

A vastly under served market is the debtor-in-possession financing industry. Rates for short-term, typically asset covered loans, are pretty high, and investors can get 10-15% returns (inclusive of fees) for a 3 month investment. Issues arise from the complexity around the process and the time-sensitive needs to comprehend liquidation value and priority of BK claims. Also, the down-side is strong.

I think this, built into a fundless sponsor could give you the deal by deal carry structure you would want with a recyclable pool of capital that can be deployed into the public markets between deals.

The Rx market is very slow now, and by entering now and proving returns, a robust track record could be a strong thing for when the down-cycle inevitably comes.

Father to Junior EightAceTres, the projected top summer analyst in Gleacher's 2034 Investment Banking program.

Best Response
Dec 5, 2014

couple points. The it's not you its me mentality is wrong.

fault falls both ways- LPs are guilty as hell too.

On the PE side

1. the PE sector labor cost is too damn high. PE, is ridiculous where artificial barriers to entry are erected- high GPA, extra curric activities, school/pedigree, excessive schooling. Liken this to pharmacists that have to go to school for yrs when a pill vending machine can "add value" to 10,000 times its price and serve hundreds of thousands 24 hours a day. XML, big data, and micro tasks can be done by regular paralegals. Think auction dot com or EBay for PE m&a where sellers sell for zero cost, buyers pick up a small premium- no middle man trying to bid everyone up. The job is actually quite easy when you automate, eliminate egos and work redundancy. (hands up for PB redos last minute)

2.Differentiated? Let the market decide to stays or goes.

3. Consolidate the big funds.

4. Allocate quicker and make it 6-8 months for 85% allocation or else liquidate back. zero mgt. fees pre allocation.

4. be a CRE (capital raising entity) first, a PE firm second. Primary should be raising funds.

5. Vertically integrate, and get original. Stop with all the outsourcing and bullshitting about proprietary this and disciplined that- 98% of the decisions you make is based on research you didn't originate.

6. Give to get - tax breaks are great but recognize the capitalist cycle, make, build, buy break rebuild, sell. get govt and banks in on the gig to build small business so that you have something to buy and break in the future. also recognize that small business is the backbone of an economy- if you say fees are too small see rule 1.

For LPs

1. people need to work in order to earn money in a capitalist economy. stop bitching about excess fees that outperform hurdle. the the metrics in the world didn't see 2008, so shut the fuck up.

2. redefine risk. perceived and actual risk is far different. Statistically 1st time mgrs outperform in same sector/same thesis deals because their overhead is lower, aim is more concentrated, hence fees are less and mgt. is super motivated by fear of failure. period. SO open up more allocation towards this.

3. losers average losers. Timeframe. stop investing in 10yr + funds liquidate at 4-5 yrs with a 1 yr extension.

4. Stop acting like KKR, BlackRock or carlyle is the only funds you can invest in and encourage their bad behavior. Then complain to everyone.

5. Be transparent yourselves to the people that contribute to the forced pension withdrawals.

6. Stop trying to vertically integrate yourselves (in house investment)- this only causes conflict of interest problems because you have a passive pool of money coming in unlike PE where you have investor/customers (lps).

Both side- cut the bullshit jargon, stop trying to fancy up everything to "add value" stop using phrase add value.

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Dec 5, 2014

forgot to add;

if its not a blind pool its not PE.

PE is about having an investment thesis about the market and sector you wish to invest in.
The benefit is you can deploy capital quickly and compete in auctions.

also deal by deal deals need fund docs and capital needs to be segregated- basically 1 asset 1 fund- which is ridiculously expensive and inefficient. Deal by deal encourages mgt. to buy the asset first with their money or a debt side car mark it up to sell to the rubes in the main fund.

Weak players with weak hands that don't know how to pitch do deal by deal and try to make assumptions based on this perception that "everyone" wants deal by deal- which is not correct.

even small RE hates doing deal by deal, fund or no fund because it lowers returns with excess overhead.

trying to do backflips for LPs like committees and approvals and all that back and forth says that investor is not right and that you have zero trust with them.

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Dec 5, 2014

holy fuck what a bunch of haters in this forum. Far more experience here than most- and I get monkey shitted on almost every post?

Fuck trying to help in at this bullshit website.

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Dec 5, 2014

'Twas I who monkey shat you on these two posts. The reasons I did so were because (i) I could barely comprehend what you wrote and (ii) I disagreed with or thought incorrect a number of points that you made. Monkey shit seemed easier than quibbling with you online.

In particular I take exception to every point in your post @ 10/28/14 at 5:26pm. To wit:
- There are many deals which are rightfully categorized as private equity that are not done through blind pools. Pledge funds, search funds, straight fundless sponsors, family offices, rich guys, one-off operators, etc, are all capable of doing private equity deals. Maybe somewhere way down the curve of formality you get to have an "is this really art" type conversation, but (a) I suspect when you have that conversation you conclude that yes, fundless operator guy doing a buyout is still PE, and (b) what's really the point of the conversation?
- Many PE deals are done based on a bottoms up analysis that has nothing to do with a market thesis.
- Many PE deals involve a very slow, protracted deal process -- sometimes spanning multiple years from first introduction to a deal. While there are certain situations wherein there is a need to move fast, my experience is that racing to a close on a vanilla LBO is rarely necessary.
- Every deal, whether done by a blind pool or a guy off the street, involves its own considerable structuring or legal work. The cost of doing the legal on any given deal is going to be orders of magnitude larger than the cost of forming an LP to aggregate investor capital. So the friction of going through that process on a deal-by-deal basis is really not difficult. Moreover, if you were doing a deal outside of a traditional PE structure and you only have a few investors, you can just structure your economics into the securities of the deal, have everybody invest directly, and just skip the whole one-off fund formation process.
- I don't know what you mean about incentivizing management to buy a company with a debt sidecar before selling to the rubes, etc. Feels to me like a reactionary claim that probably doesn't bear out in the real world, but feel free to elaborate.
- There are tons of people who use a deal by deal model who aren't "weak hands who don't know how to pitch." This is an idiotic and frankly short-sighted comment. The deal-by-deal model makes a ton of sense for a lot of people in both the PE and REPE world for several reasons, such as: (i) the deals aren't comingled so you get carry at first successful liquidity event; (ii) the economics are way better than what one would get as a cog at another fund; (iii) you don't have to deal with the ass pain that is administering a traditional fund; (iv) you don't have the same investment constraints (strategy, size, industry) or ticking clock (5 years to invest, 3-5 year holds) that you have in PE. In REPE the drawback is that you need to be rich and ballsy starting out as you often need to personally guarantee mortgages. in PE the drawback is that it's hard to get intermediaries and sellers to believe you are credible and show you deals; however, if you DO know how to pitch, you can get around that... and even if you don't, the market is becoming much more accepting of this.
- Not "everybody" wants deal by deal. But the market has clearly moved aggressively in that direction.
- Why would deal by deal (i) lower returns or (ii) increase overhead? Statement makes no sense.
- You're going to do backflips for LPs no matter who you are or what your structure is. LPs are your customers. If somebody writes a check for you to do a deal, and gives you economics and a sponsorship role in that deal, they clearly trust you. If they decline to do a deal, it could be because it just doesn't make sense in their portfolio for one of a zillion reasons.

I hate that I just spent fifteen minutes writing this up. Monkey shit was easier

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Dec 5, 2014

shit back at you.

Basically I present a master class in this field, but its not for everyone because not everyone can do this.
Its obvious the forum cannot handle this inside and high level information.

IF you cannot pitch, it doesn't matter who is on the board, who you are, or the thesis or deal- its dead in the water. IF you cannot control the way the deal goes- it means you are giving it up to the client.
Ever wanted in a club- but there is a line? yes, like that idea but far more complicated with business deals.

Your viewpoint can be valid, and is valid and validated for many, many, firms.

What I am stating is that it seems that there are deeper issues bballer is and is going to run into- I am suggesting a better way to structure deals.

I agree- its far easier to do deal by deal carry- ON the outside.

Never having done deal by deal carry but rather whole of fund carry I see, again my opinion, this as superior.

what this takes to work is organization and talent- which is why the majority cannot do this whole of fund carry.

But if we borrow from our stock market(ing) friends they raise in 90 days. Always have always will.

Why do we PE guys, who out return and are more solid have to work deal by deal? Some even have committees of LPs. The other reason is PE is long only, you can combat this by buying when the market is right and sell that accordingly as a package at liquidation or individually. YOU are also able to make IRR type gains that slow deployments and deal by deal cannot.

To me this is lame, lame, lame- because if you are running deal to deal- most get greedy or "rent seek" by doing other roles (mgt consulting to portfolio co's, prop. mgt, other jobs), especially in lower sub 100m aum funds- because fees are too small here.

Whole of fund Carry:
On the accounting side, far easier and cheaper for audits. No clawbacks, you can recycle LPs money.
Waterfall calc is a breeze. (if you are a smart guy you will realize what the hidden bonus is here, if you don't its because you are a junior). Also zero clawback and a clawback on a young firm will kill the firm, dead- call up your partners tell them that you need that couple mill you gave them years ago back, or else they are all getting sued into oblivion. Deal by deal risk Lps money far more because of this.

Debt sidecars (side letter):

Look up what a debt sidecar is before quipping. It has nothing to do with mgt incentives. (WTF? shakes head)

Its for tough LPs that want preference that come in with big money or are cornerstone investors but being LPs you cannot give them preferred terms because of the OM/prospectus GUARANTEEING all LPs pari passu terms. Every big firm does this. THIS is why you undersize main offerings, but have an over allotment % and have this sidecar ready- its vip treatment, but you are raising even more.

PG's on property- never did, always asked, said "sorry that's not available" never pressed. Isn't this the whole point of incorporation and D&O insurance? (what deals are you doing?). ONE of the key terms smart LPs look for is if you leverage other properties/assets when you have a portfolio- if they are separate they don't fall like domino's on a rates rise. PG's were popular around 2000's but not now if you come in as a pro now its only in ship finance.

RLC1- you sound very young, junior- study rhetoric and structured arguments, it will help you sling the shit you feel the world needs. The thing about getting better is looking outside what others are doing- the best are the best because they don't do it like everyone else. if something is idiotic state why-

Anyway- that's it not putting anymore work in to this forum. see ya.

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Dec 5, 2014

Ding Ding Ding. Jerry! Jerry! Jerry!

I'm too drunk to taste this chicken -Late great Col. Sanders

Dec 5, 2014

thanks for the heads up, good to hear what those guys have to say at every opportunity.

bonderman seems like a jokester, really chill guy...

Dec 5, 2014

I wouldn't call these guys the best sources, it's in their interest to be bullish to stay in business.

Dec 5, 2014

well, i just wanted to say that it's from the people that know what they're talking about, even though they are clearly biased

Dec 5, 2014

Kravis of KKR recently had some very interesting assertions on the future of PE in Japan. Basically saying that the current state of the corporate sector mirrors that of the LBO driven 1980's in the U.S. Over the next few years expect to see a huge amount of PE activity in Japan. Luckily for me, I am learning Japanese...

Dec 5, 2014

True about Japan, the whole place is all about huge interlinked traditionalist conglomerates. Will be interesting to see the power struggles when that system and the PEs clash.

Dec 5, 2014

Does anyone know if the above video is still available? Thx

Dec 5, 2014

WTF do you people reference videos and articles without posting the link.

Dec 5, 2014

PE is a cyclical industry that is directly correlated to interest rates and financing availability. You are already seeing significantly reduced M&A activity (at least relative to the boom years) as debt has been unavailable (at least on terms that provide sufficient leverage to reach acceptable IRRs). If carried interest becomes taxed as regular income and not LTCG then this will further diminish comp. There is already a backlash against the 2/20 model as PE shops are finding it more difficult to produce sufficiently high enough returns to warrant such fees. Each decade has its hot industry and PE certainly hit its zenith in the past two years. The key is to indetify the industry before it becomes the "hot" industry and if your goal is to get into PE you may be a little late to the party. This is not to say that PE/HF/VC are still not great career opps I just foresee a lot of downward pressure on these types of enterprises as the public demands more taxation, transparency, and accountability.

Dec 5, 2014

Thanks for the insight

Dec 5, 2014

junkbondswap is right. i don't think you'll ever see a comparable mega-buyout phase like the one that took place over the past two years, but PE will still remain a very prominent industry.

in addition, a large inefficiency in the PE space is the amount of firms and the number of actual deals (especially in the large cap market). i wouldn't be surprised if a lot of the funds that started during the boom went out of business in the coming years.

Dec 5, 2014

It's incredibly tough to track how many funds "go out of business." First of all, you always hear if a shop is raising another fund, you never hear if said shop decides not to raise another fund. Funds usually don't go out of business per se, they just do poorly in their current funds and fail to raise another. It's not like hedge funds, where they blow up within days or weeks, it may take years for a private equity fund to realize investments and take losses on the books. Even then, I doubt many PE shops "blow up," as in all of their investments go sideways. Most likely they didn't meet the IRR hurdle and are spurned by their LP's.

That being said, I have no idea what the 10 year outlook looks like - I don't even have an opinion since it's too far out to even predict. My 1 or 2 year outlook is pretty bleak. PE hiring will dry up this year - sorry current IBD analysts. Many companies will trip covenants, and if and when they do, it won't be pretty. Lenders will come down hard, and worst of all lenders will be hedge funds holding paper. They will show no mercy. Exits will be few and far between - the equity markets are crap, the debt markets make it impossible to sell to another sponsor, strategics are few and far between. I think we see a bunch of funds using excess dry powder to buy back alot of their bank debt that's trading below 80 (seriously, trading at even 85 implies a default rate in the double digits), which is about the smartest thing anyone can do right now.

Dec 5, 2014

Hey guys,

Thought I would weigh on this issue. I think everyone has covered the main issues facing P.E. - lack of funding / decrease leverage turns / more stringent covenants, multiple compression, issues with the taxation of carried interest, increased capital competition, and management fees....

That being said, it wont be impossible to achieve decent returns (but not outlandish) -but I think that in order to so, P.E. firms will have to take a more active role in improving / helping to develop the business of the target rather than a pure play on a "financially engineered" deal (i use that term loosly).

I also think that middle market has an advantage in the current market conditions for the following reasons:

1) Middle market firms often deal in fragmented markets (economy of scale, roll-up aq.)
2) You don't have the issues with syndication that are currently blocking mega deals.
3) At least at my firm, we have worked with the same lenders on multuple deals establishing a relationship with certain banks allowing us to achieve another quarter to half turn of leverage or relax certain covenants.
4) Hopefully the firm has some sort of operating expertise and / or industry related contacts for bringing in management that can drive the growth (cash flow) of the business.

I'd be curious to see what others think.

Dec 5, 2014

So if PE-Funds are not anymore the next hot thing - what will be the next big boom ?

Dec 5, 2014

MM growth equity

Dec 5, 2014

I stand corrected. MM deal volume has slowed to 1/3 of what it was in july. It looks like returns on small loans are just not attractive enough when compared to discounted bonds from highly rated companies for intitutional investors.

Dec 5, 2014

Maybe Private equity in other countries will kick of really well like China, India, latin american countries and all.

Dec 5, 2014

Ah, so you're trying to catch the next big bubble. Want my advice? Dont. Its not entirely obvious, that the next one is even coming, and youre chances of guessing where it'll inflate are slim. I think you'd be better off just doing what is interesting for you. It is not far fetched to say, that the peak of PE in terms of comp, prestige, etc. is already behind us. Which means that making a lucrative career in that field will be a tad more difficult. And it is a possibility that FX trading is next to be taken for the ride. But those are still pretty big ifs.

Dec 5, 2014

fx trading is a zero-sum game. everything's relative, for one currency value to go up, another must go down. in many ways it doesnt make sense to say that fx trading is going to be the next big thing, as it's literally impossible to create a bubble in currency trading.

Dec 5, 2014

the spread that people make profit off of is not zero sum, and that can go away

Dec 5, 2014

The same argument was being thrown around pre-financial crisis. As the LBO markets were becoming especially frothy, PE investors had a vault full of dry powder and attractive investments were becoming increasingly scarce as so many parties had so much freely available capital to deploy.

We've heard of all the horror stories of the LBO but completely absent in this dialogue are the successes of LBO's. This is for a few reasons.

First off, an economically beneficial investor just isn't as sensational. We haven't seen any articles in mainstream media about the hugely successful J Crew investment... how about Dunkin Donuts... how about Burger King?

Second, many of the firms PE investors invest in are unknown to the average person: e.g. First Data Corp. Very very well known LBO amonst the banking/PE community, but very very unknown company among Main Street. So when PE adds tremendous value for First Data (I'm not familiar with how the company has fared, I'm just using it as an example), no one on Main Street knows or cares neither does the Media. When Simmons Mattress, a relatively well known company, goes into bankruptcy -- mind you, at a time where corporate bankruptcy filings are at record levels -- its easy to use this as an example of the evils of private equity LBO's.

Third, and this links back to the first point... very seldom does the media ever discuss empirical studies done for the purpose of determining if PE investors DO add value or not. These studies, specifically Josh Lerner of HBS who is perhaps one of the most respected academics in the investment banking/private equity space and Brov and Gompers whose work is equally respected, establish that LBO'ed companies generally outperform their non-PE LBO peers for a variety of reasons. Most notably: (1) increased ability to incentivize management since most of the management team has a substantial portion of their personal wealth invested in the company and their superior performance is very well compensated, (2) leaner operations, (3) reduced distractions associated with public status (e.g. investor relations, meeting analyst estimates, short-term myopia), (4) PE LBO investments are long-term greedy (3-7 years) vs. public equity investments which are anything but.

There are a great many reasons why the PE model is superior, in most cases, to public equity markets. And the above examples, specifically the empirical studies, still don't capture the magnitude of outperformance since much of the outperformance is during the completely private (non-publicly disclosed periods).

Dec 5, 2014

I absolutely agree. The value of privatization and motivated management is a no-brainer. That being said, at the end of the day a large percentage of ROI is derived from the ability to leverage. As access to capital is becoming limited, as well as the assumption that the market for inefficiently run companies are contracting due to larger and larger funds looking for deals, coupled with an increase in the levels of education among the workforce (read better management) and therefor better run companies than in the past, the" bettering of the company" factor is shrinking. Again I completely agree with the benefits of LBO's and think you wrote an awesome post, I'm just playing devil's advocate.

Dec 5, 2014
aleph:

coupled with an increase in the levels of education among the workforce (read better management)

Definitely disagree with this statement. The qualities that make people all-star managers (e.g. creativity/innovativness, gut instincts, ability to inspire the people around them, etc...) cannot be taught in a classroom. Greater degree of education does not equate better management team.

In addition, PE investors don't look for companies with broken management teams... they look for companies with star management teams. So I would argue that if the trend is towards increasingly competent management teams (which I disagree with), this would translate to an increasingly powerful tool (i.e. management team) available to the PE investor.

Looking forward, I would say PE investing will continue as it as, albeit it will progress on through the life-cycle just as anything else does. Returns will continue towards a path of convergence with the overall market absent any significant developments in the way investments are made. Leverage levels were at pre-financial crisis highs for only a brief period, PE investing has been a successful model for decades and I expect it to continue. While it may be a 'drinking the kool-aide' outlook, I would go so far as to say that there will once again be a significant development in the PE business model which will facilitate on-going outperformance. If you historically look at the United States, there has always been something that propels us to the top. As one era comes to an end, something new is pioneered to propel us to (actually keep us at) the top. I view the PE industry as the fabric of American capitalism and economic prosperity and believe it possesses the same characteristics/tendencies.

Dec 5, 2014

I stand corrected, your right I made false assumptions.

Dec 5, 2014

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