Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

Private equity, public equity, & Venture Capital

by wchurchill Sun Mar 18th, 2007 at 05:36:56 AM EST

This started as a comment to InWales' diary entitled Call for G8 action on private equity, but turned into a diary.

I felt I initially had to address the differences in private equity and public equity, which is really the difference between a private company and a public company.  So I composed a story that took a private company through the steps of becoming a public company, and tried to point out the differences and use some examples.  In doing so I was able to use one facet of the private equity market, Venture Capital (which you will notice was addressed in the Wikipedia reference from Afew), since it is venture capital that is sometimes involved in taking a company from being a private company to becoming a public company.  I meant to move on to the other areas of Private Equity after drawing these distinctions, such as the buyout segment which is getting all of the publicity today, but I ran out of gas.  I'll see if this turns out to be a helpful diary, and if it is try to gather energy to write about the other segments of private equity.

From the diaries ~ whataboutbob


I would first draw the distinction between a private company and a public company.  If you start your own company tomorrow, say taking some money you have saved, and opening a store on the high street, or maybe selling a new piece of software on the internet, you have started a business, which you own yourself--privately.  You have to make some choices as to how the government and the rest of the world treats you from a legal and a tax standpoint.  You could just run the business as yourself, InWales, and report the money you receive from your customers as income, and deduct the money you spend as expenses to attain that income, and report it on your personal income tax form.  And legally you and your business could be one in the same--ie., if you do something someone views as wrong, they could sue you, and not just your business--ie. if you lose the lawsuit they could lay claim to your personal assets, such as your home (depending on various laws in the country you live in).  But clearly, you own your business yourself.

You could also take a step, which is different country to country, and set up your new business as a corporation.  This would separate yourself from your business to some extent.  It may mean that from a tax standpoint, your business reports sales and its profits, and the business is taxed by the government under different rules and taxation for corporations.  And then you personally would have to also pay taxes as an individual, just like you already do.  So your business would pay you a salary for example, and then you as an individual would pay taxes on the salary.  The corporation also distinguishes the business from you in a legal sense.  So you may be able to separate your personal belongings (example home) from your business, and if someone sues the business, the business is liable. If someone sues you personally you are liable.  But it's possible that the business could lose the suit, and you might be protected from losing your home.  Very sticky point, because this varies so much from country to country.  But you still own the business, so even though you now call it a corporation, it is a business owned by you as a private individual.

Maybe you bring in a partner, who contributes money and works for the corporation.  You and he/she decide he owns part of the company.  So you share ownership, often called equity, of the company.  Maybe you bring your family on board later, sons and daughters, and you allow them to also become owners, by contributing their labor,,,,or perhaps by buying into the company, say if your brother earned money somewhere else, and wants to join you.  You agree to give him 10% ownership, equity, for his money.  But the company is still private, owned by private individuals.

Say you are wildly successful, and you opened a store on the high street, and you see that you can expand nationally, opening stores on lots of high streets.  but you need cash to buy land, build stores, etc.  you could borrow money from a bank, and open one other store for example (and many small private companies do exactly that).  But, you think your idea is so great that you want to open 100 stores (and I also want to get to public equity), and the bank rolls its eyes and tells you no way they are loaning you enough money for 100 stores.  But you are excited and really want to do this, and get the money and do it fast.  And to get that money, you are willing to trade some ownership in your company to other people in return for their cash.  You can get lots of cash this way, if new potential owners agree that you have a great idea that will earn money,,,but these new owners will own the company with you,,so you'll begin to lose complete control of your company.

One place to get this money reasonably quickly, is from a venture capitalist.  This person exists to work with people like you,,,,providing money in return for ownership,,,,and hoping to grow his money.  He normally has put together his own "private company" (usually called a partnership), and he has people who have given him their money, to invest on their behalf.  They have likely seen him do investments like yours in the past, and they've been successful--so he has a track record of success,,,,taken $1 million from several people, and five years later given them $2.5 million back.  But he and his "partnership", are organized privately--they sign contracts with each other as to how much money the "venture capitalist" will earn,,,,and how much he will make if he invests their money wisely and gets a great return for the other partners and himself.  (over simplifying here, but conceptually on course).  Historically the venture capitalist works with small start up businesses, thus the name venture, and provides money, sometimes called capital, to entrepreneurs like you,,,in the hopes of both of you creating something new out of this partnership.  (Basically Google started very much like this.)  

So your company started out being private and owned by you.  Grew to include friends and family,,,still private and owned by all of you.  You all owned all of it,,,you owned 100% of the equity.  then you needed big money to grow your business fast,,,from people willing to take a risk,,,so you found these private partners, called venture capitalists (VC's).  Now all you private people own all the company together--you own with the VC's, 100% of the equity of the company.  So you are still in the world of private ownership, or private equity,,,,but you have morphed into a larger group of owners.

Venture Capitalists are buying equity in early stage companies with the financial motivation to earn a profit.  They are making investments that are generally risky, because they are so early stage, so they expect a number of their investments to fail, and in these failures they would lose all of their investment.  However, they raise money from their partners in "funds', collecting commitments these days for $100 million to as much as $1 billion or more.  They would hope to invest in 10 to 20 companies, hoping that their winners will more than offset their losers, and thus the overall fund, or monies raised, will see a good return on investment.  The startups that are winners will need to have what is called an "exit event", which means the startup company will be sold to a larger company, so the VC's can return monies and hopefully a positive return to the investors.  The other option for an exit event is for the company to "go public".  This means that the company offers shares, equity ownership, to the public on the public stock markets, such as in the US the NASDAQ or New York Stock Exchange.  (The original founders of the startup, such as you in our example, know this of course, and you may stay with the company and be the CEO through all of this, or you may decide running a big company like this is not what you really want to do.  But all of that presumes success of course.  As you might imagine there are many failures and many great success stories--many who end up loving the whole venture capital process, many who end up hating it.  This often correlates with the success of the venture--I would imagine the Google founders are pretty happy with the process, though they are not the CEO today,,,,but certainly are incredibly wealthy.)

Often the "going public" route is a good one not only from the standpoint of giving the investors a chance to cash in on their investment, but also because the startup company may need more money to fund their business.  As an example, this is often the case in a bio-tech company, which is developing a new drug.  It takes years and $100's of millions to develop a new drug, conduct the clinical trials, build manufacturing, hire a sales force, etc., and of course many of these companies fail.  Just as an example, there is a company called La Jolla Pharmaceutical Company which is today in the hopefull final phase, Phase III of a new drug for a disease called Lupus.  

La Jolla Pharmaceutical Company is dedicated to improving and preserving human life by developing innovative pharmaceutical products. The Company's leading product in development is Riquent®, which is designed to treat lupus renal disease by preventing or delaying renal flares. Lupus renal disease is a leading cause of sickness and death in patients with lupus. The Company has also developed small molecules to treat various other autoimmune and inflammatory conditions.

A little more about Lupus from a recent 10K filing by the company:

Lupus is a life-threatening, antibody-mediated disease in which disease-causing antibodies damage various tissues. According to recent
statistics compiled by the Lupus Foundation of America, epidemiological studies and other sources, the number of lupus patients in the United
States is estimated to be between 500,000 and 1,000,000, and approximately 16,000 new cases are diagnosed each year. Approximately nine
out of 10 lupus patients are women, who usually develop the disease during their childbearing years. Lupus is characterized by a multitude of
symptoms that can include chronic kidney inflammation, which can lead to kidney failure, serious episodes of cardiac and central-nervoussystem
inflammation, as well as extreme fatigue, arthritis and rashes. Approximately 80% of all lupus patients progress to serious symptoms.
Approximately 50% of lupus patients will develop kidney disease which is a leading cause of death in lupus.

The company was founded in 1989.  It has spent more than $250 million to date, and still does not have a drug approval, therefore, no sales and no profits as of this time--obviously not a Google.  It is very difficult to raise that much money from private investors, for a risky startup company.  So often a bio-tech company will raise early stage money from VC investors, hoping to discover molecules, develop science that shows the drug may have some applicability to solving certain diseases, and make some initial progress on the long science and clinical trial program needed to get an approval of the drug.  At some point they may develop the company to a point that they can present the company's status on their development, identify the opportunity if successful, and then attempt an "Initial Public Offering" to raise funds to complete the trial.  The nature of the risk of the investment will be clearly laid out in the offering documents, but so will the size of the potential markets if the drug is approved and successful.  So some public equity market investors will want to include a high risk/high reward stock such as this in their portfolio.  La Jolla to date has not been successful in gaining approval, as their first attempt at a phase III approval failed, though there was significant positives out of the trial to encourage the company to raise more money, and investors to put more money in, in hopes that this current Phase III with an improved, strengthened product and a better designed clinical trial will be successful.

But a company like La Jolla was far to risky of a proposition for the public markets in its early days.  They could not have raised money until they had shown significant reason to believe they might have a success.

Once you are in the public market, your company is heavily regulated in terms of financial reporting requirements on a public basis.  You are owned by public investors, and there are reams of documents and legal requirements for reporting.  The requirements are far, far, far less stringent for a company that just has private investors.  Not that fiasos don't happen, because there are crooks everywhere in life, and Enron and Tyco show that is true in the public equity markets.  But investors are far more protected in these public markets than they are in private markets.

Display:
Thanks for this excellent and very clear introduction to the world of private equity, wchurchill! I have no time to comment now, and I will come back later. Just a few points :

  • your presentation explains clearly that private equity is the normal way for business creation and early business development, however, today, the biggest part of the private equity deals growth comes from buy-outs, which preferred tool is leverage, and that's another story (and that's this part which raised the concern of trade unions). I assume you will address the buy-out issue in yor second part, so I'm impatient to read it.

  • what characterizes the private equity, with exception for the company founders, is the fact tant it is short-term oriented. It aims at harvesting the highest profits as soon as possible. This is true even for venture capital.

  • It is slighly off topic, but it would be interesting to discuss the case of public-private partnership in venture capital.


"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Sat Mar 17th, 2007 at 09:34:59 AM EST
Yes, good and useful diary.

I worked a bit with Branson in the Seventies, and was very interested in his business methods then. I assume they have changed ;-)

He functioned very much as a Venture Capitalist - but with a difference. Many people came to him with different ideas, mostly connected with Virgin Records, but some were from different areas addressing his same audience.

For him then , it was about a solid business plan. He would put up most of the dough on the basis of the plan, which had to yield 12% return on invested capital. He ralso equired a commitment from the owners, so they took part of the risk. He had gathered around him a bunch of accountants and legal advisors to help him assess these plans, and they often guided the start-up at the beginning. But he was very intuitive in selecting which start-ups to go with.

As long as he got his 12% - no more, no less - every year, he didn't care how much the co-owners made. Some made millions, a lot got ploughed back. For the start-up owners, it was highly motivatiing. But if any plan failed (in providing the 12% return) the business was terminated quite fast.

This 12% was, of course, a very good rate of return. Only vintage stratocasters could offer similar growth and you'd have to sell them to get the cash;-).

There was another element to the Branson MO - still evident today. His father was a High Court judge and Richard was fairly savvy about the law and lawyers. He used these weapons quite regularly, but rarely against people he was in business with, since it would be a reflection on his poor judgement. Like David and Goliath, he was never afraid to take on the big boys. And I think he has triumphed rather more often than he has failed.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 11:01:55 AM EST
[ Parent ]
Very interesting comments on Branson.  I know very little about him other than he has been very successful, and I have a generally favorable opinion for some reason.  He sounds from your description that he is very bright, and also very fair to his entrepreneurs--the latter is not only to be praised, but also will likely keep the flow of entrepreneurs coming to him.

Most of the VC's do not limit their rate of return goal.  I haven't looked at the numbers recently, but most want to be in the upper quartile of VC's in terms of IRR, and I believe that requires in most "vintage years" of funds returns that are more like 45%, IRR's that is.

by wchurchill on Sat Mar 17th, 2007 at 12:44:22 PM EST
[ Parent ]
Yes - I wasn't sure whether his 12% was really fair - it's way over the non-risk rates, and above a lot of 'satisfactory' risk rates. But maybe that was the point, he wasn't looking for the big kill, he'd already done that with Tubular Bells. I believe his inspiration was the thrill of entrepreneurship, and that wealth was a very distant, almost insignificant motivator.

For him, business was fun, or it had to be. He did, and I had quite a few conversations with him about it, want to change the world. Yet it wasn't in the goody goody, sense of change, but in just making life more fun. I was staying at his place just before the launch of Virgin Airways, and all he wanted to talk about was the logo on the planes - nothing about the business or even the service concept. It was the logo and how it would appeal to the potential audience. But that IS the fun side.

I am biased of course, but his business success is, for me, inspirational. Not at all in the sense that I could do the same - because I don't have the chutzpah or brains - but he showed that there was an alternative, and that original thinking could be rewarded.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 02:04:03 PM EST
[ Parent ]
what an incredibly neat experience you have had.  that is really great!
by wchurchill on Sat Mar 17th, 2007 at 02:17:13 PM EST
[ Parent ]
I wish I had paid more attention at the time, but London in the late Sixties, early Seventies just seemed normal to me, since it was all I had ever known. My teenage daughters don't really have much idea what it  was like to grow older with the emergence of computers. For them it is just like me and electricity or water, I expect it to be on tap. I take it for granted. They take all this interconnectedness as normal, and thus they treat it in a very different way to my experience of the struggle to reach this point.

And I am sure their kids will be wondering what is so special about virtual reality, or millions of people gathering together virtually to change corporate decision-making.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 03:46:09 PM EST
[ Parent ]
thank you for your generous comment.  I do agree with all of your subpoints.  It was my intention when I started to write this to just keep on going, continuing into the world of private equity buy-out, and other segments.  I got on a roll and kept writing, but as I drew to the end of the VC part, I was exhausted.  I need another energy burst like that.

Your comments are right on,,, that the buy-out segment is growing dramatically, and leverage is an important element, with all the risks that leverage brings.  And you are also correct on the Internal Rate of Return focus of private equity, and that goal of course means that more money returned, and returned faster, are the key elements by which they are measured by their limited partners.  Those goals are not necessarily in line with goals for the overall health of the business--not necessarily contradictory, but one would like to see more synergy in the board room.  I'm a big proponent of other elements of the business model, the business model for the individual company, not the VC's.  And these elements would include things such as high level of commitment to quality; close working with the customers understand evolving needs and thus achieve new innovative products; very fair pay for all levels of employees, including stock options for all if it's appropriate; and basically having business strategies, objectives, and ethics that win the hearts and minds of the employees, etc, etc.  Most VC's would not be as excited about some of these goals as a high quality senior management team for the business would be (I guess that comment is overly kind to most private equity people).

I'm unfamiliar with the public-private partnership concept in venture, but that would be an interesting model and discussion.

by wchurchill on Sat Mar 17th, 2007 at 12:38:40 PM EST
[ Parent ]
One of these days I'll look at central banks published stuff, I assume private capital total amount is there somewhere, as is total public capital

Do you have a rough idea of the total amount and public/private ratio?

by Laurent GUERBY on Sat Mar 17th, 2007 at 02:35:45 PM EST
[ Parent ]
good question.  that would be interesting to see.  I can't recall seeing this kind of data, but I'll try to look around a little.  there must be some overall estimates.
by wchurchill on Sat Mar 17th, 2007 at 03:35:21 PM EST
[ Parent ]
As we move in the spectrum og private/public companies, how does employees' position change? Under which ownership do they have more negotiating power? Do they gain a lot influence with taking shares of their (public) company?

As I understand, shareholder value is the king indicator of company's success. Morevoer, corporations are (kind of) legally oblidged to maximize shareholder's value, are they not? How is can be legally determined whether the board does its best? Can  long-term success be easily lost in a collective drive for fast profit margins?

It sounds to me that gaining maximal profit for investors can put a lot of pressure on workers. Is there good evidence that this pressure is increasing? How long were Ford and General Motors were giving "generous" salaries to their workers?

by das monde on Sun Mar 18th, 2007 at 03:52:50 AM EST
[ Parent ]
Interesting question.  I think this is more of a mixed bag.  Legally workers don't lose any rights as they move from a public to a private company.  Unions offer the same positives and the same negatives to employees in both situations.  

Shareholder value is important in both settings.  you point out that the private equity guys may be very short term because they want to make their money as quickly as possible, improve the company and sell it.  Yet further up thread someone comments on the pressure on public companies to make quarterly projections, and points out the temptation to eschew the long term to improve the short.

you find good people and good leaders in both settings, imho, and the opposite as well.  personally, I don't find a conflict between investor and employee goals.  well motivated and well paid employees build unbelievable companies.  and leadership, ceo's, should easily be able to make that point to investors,,,and drive for great results.  there is not conflict with customers either--innovate, give them quality and service, and they will flock to you.  this can be done by private companies and public companies.  but it takes strong leadership with intellectual depth, good ethics and values--qualities not always easy to find, + a ton of other qualities.

by wchurchill on Sun Mar 18th, 2007 at 02:11:53 PM EST
[ Parent ]
I think that just as in politics, leaders with "intelectual depth, good ethics and values" are very rare species in buisiness as well. It is not so much because it is hard to train yourself proper discipline, but more of the dominant buisiness culture. Inspired people, not so much by immediate tons of money but by long term development plans, have harder time to break through when investors cry only for most effective returns. This is not to say that these people cannot succeed (Branson is an example), but very few have the ability to satisfy the "basic" market race requirements and have non-monetary fun.

The goals of investors, employees and customers might be similar, but basic impulses differ quite much.

One other naive question: when people speculatively buy shares in the market while the company is not issuing them, are they really "investing" in a technical sense? No new money comes to company's pocket, it is just appreciation of (presumably) growing value of the company, right?

by das monde on Sun Mar 18th, 2007 at 08:12:58 PM EST
[ Parent ]
I am very looking forward to further instalments, if that is any encouragement ;-)

These are things that are 'never taught at school', and, to me, one of the very best features of ET.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 02:07:06 PM EST
Nothing about finance is taught in school :).

99.99% of the population doesn't know that private bank create money and not central banks.

by Laurent GUERBY on Sat Mar 17th, 2007 at 02:33:58 PM EST
[ Parent ]
You stole my line!


"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 03:31:52 PM EST
[ Parent ]
It seems a very important subject to me - not for the profit vision, but simply to understand it as a structure, because wherever you stand in society, it affects your life.

I passed A-Level economics in Britain (with Art and Eng Lit) but I never had any real idea of how it applied to the world I was living in.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 03:37:31 PM EST
[ Parent ]
The first time I took Economics (an accountancy paper) I failed it - it was the first paper in ANYTHING I had ever failed.

It bore no relationship to Reality as I understood it. I passed second time around by learning the crap parrot fashion, and forgot it for 20 years.

Now I know what the problem is (as least to my own satisfaction). The assumptions used are total and utter bollocks.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 03:45:10 PM EST
[ Parent ]
Churchill - when you get ME involved in an economics diary, you really have done a service to mankind ;-)

And Chris, your professional view of the bollocks is inspirational: I have never been exposed to so many challenging new ideas in one place, as here at ET over the last couple of years.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 03:51:13 PM EST
[ Parent ]
Nor me, Sven. The Veblen stuff currently is just the latest, but there's always something new.

Btw. Did I ever e-mail you the "Monster"? Branson would love it, but I never got near him.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 03:54:52 PM EST
[ Parent ]
You did not email me with it. I don't really have contact with Richard any more. He married Joan, one of my best friends then - in fact I kind of introduced them - but I am surely just a distant memory now. It has been 30 years - even though we have been in brief contact several times since.

But I did open his mind to two things: one was how to remove a watch from somebodies wrist wihout them knowing (A very drunken evening at a Russian restaurant in Helsinki), and hot air ballooning, on a Sunday in Nummela about 1976.

For these, I ask you forgivenance...

But he taught me far more than I ever taught him, by miles.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 05:34:13 PM EST
[ Parent ]
A long, long time ago, in a Galaxy far far away....

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 05:46:47 PM EST
[ Parent ]
Just! (in the Finnish meaning).

Don't try to tell me you don't have some heroes from way back in your first decade on earth that didn't affect your present life?

Chris - we are boys still - and hold on to it. We can never be as altruistic as we were then. All my values stem from my family environment; I just didn't get to realise it until recently. I may have done very different things from what my parents envisioned for me, but I did follow their core values eventually. I only took my time to understand what those core values really were - because I looked at them so superficially, then.

I don't think my parents had a plan. But I do think they did their best to use their lives to fulfill themselves, as well as making considerable sacrifices to ensure that their children could also experience that fulfillment. I don't have a plan with my daughters either. Like everyone else, this is a first tiime experience. One cannot have a plan in these circumstances. What one can have is an attitude.

An attitude, IMHO, is essential to acheiving fulfillment

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 06:08:04 PM EST
[ Parent ]
I can't really disagree.  Econ PHD programs and top level MBA programs do touch on it--but I think the emphasis is very heavily macro-economics.  a lot of our discussions cover micro-economics, finance, as well as macro-economics.  (and actually accounting as well, both government, non-profit and for-profit accouting).  I think you are right and that much of this is learned in RW, the real world.
by wchurchill on Sat Mar 17th, 2007 at 03:40:00 PM EST
[ Parent ]
I had accounting and econ (macro and micro) courses in my french engineering school.

But the thing is that basic accounting (what accounting is for, how profit and taxes are computed for a company, flux vs stock, not the list of legal accounting stuff :) and how money works (borrowing and lending, state borrowing and how banking work, not econ macro ideology) can easily be taught to 15 years old and it's not done.

I remember arguing that in french econ blog, and I pointed out that lots of my early-age friends that didn't go very far in school (dropping out at 16-20) do run they own small company now so they had to learn that stuff anyway in real life (sometimes through expensive mistakes), but I was laughed away (ivory economics...).

by Laurent GUERBY on Sat Mar 17th, 2007 at 04:30:26 PM EST
[ Parent ]
(borrowing and lending, state borrowing and how banking work, not econ macro ideology) can easily be taught to 15 years old and it's not done.
IMHO, one of the issues about teaching/learning is that you need someone who wants to learn.  And sometimes, relating to myself in my late teens and early '20's, I didn't see the relavance of what people were trying to teach me, in many of my courses.  also some of my profs were unbelievably boring--especially some of the brilliant ones post undergraduate degree, who have written seminal papers and books on important finance topics like option pricing, money policy, etc.  

Maybe as an example of what I'm saying,  I didn't understand probability theory well until I started sneaking into the race track, horses, in my late teens.  I spent a couple of summers there, after I finished my shift at the factory, learning probablilities and odds.  Then much later in life I learned other things in statistics when I was in a position where I had to review manufacturing and quality control data--all of a sudden sampling techniques and all that r-squared kind of stuff made sense almost immediately, because It was helping me understand something I really needed to understand.  (Similar experience when I had to learn sales forecasting, and the importance of sales accuracy and inventory levels to customer service levels.  You know this kind of stuff and put disciplines in place, and your customers love you,,,,because your products are there when they are needed.)  But I could only vaguely get these concepts in school.

You need to relate these topics to people's lives, so they can become interested in them,,,,,and then make them fun.  I have an idea for an accounting book which I may write, because i think I know how to make accounting relavant and interesting.  But it just takes a long time to fit in writing.  But i think I'll get this one done in the next several years.  I have younger friends and younger family members that could really use it--even if I didn't get it published

by wchurchill on Sat Mar 17th, 2007 at 04:48:23 PM EST
[ Parent ]
That's a generic argument for not teaching anything :).

For the people I have in mind, at 15 they already know they'll drop out and this means dealing with money sooner than later (I'm not talking about people that will go to university here).

There's a wikibook project on accounting, looks like it's not very far:

http://en.wikibooks.org/wiki/Accounting

by Laurent GUERBY on Sun Mar 18th, 2007 at 04:34:40 AM EST
[ Parent ]
When everything now comes pretty easily, it is so hard to learn and practise proper ways.

The context here is that Danny (10) has found a way of skiing that suits him, and isn't much inclined to work at improving his technique. I tried to explain to him that as he gets bigger and heavier, he will grow out of his technique. (Little kids float down a ski run like snowflakes. For a 200-lb adult, the math is way different.) Then his skiing would actually get worse.

Me: "See, son, if you don't work on your form, you'll just go downhill."

He: "Dad, it's skiing. You're supposed to go downhill."

by das monde on Sun Mar 18th, 2007 at 08:27:52 PM EST
[ Parent ]
The question in education is ALWAYS the underlying motivations in any taught situation. A good teacher is one who can confer that the subject they teach is relevant, and relate it to the set of rules by which the teacher's audience think they live. Then, what they teach has meaning.

Education, in it's true sense ,(IMHO), is mind expansion - learning to look at life through another person'seyes (and brain). Education is an extension of the brain, first within itself, then with people nearby, and finally with people you have never met.

Somehow I feel that, until you start to think of all the people that you have not met yet, you don't quite make the category of being a member of the human race. You become a person who doesn't want to meet new people. But that's just me on a slightly fascist bent,  which, for the moment, for some unexplained reason, seems perfectly logical

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 05:49:54 PM EST
[ Parent ]
The Monster should be with you: mad( in terms of being TOTALLY outside the Box) but nevertheless feasible....

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 06:08:08 PM EST
[ Parent ]
The 'what-if' attitude.  There's this grey land between science and art, in which fact and fiction compete for our attention.

One polar extreme is about what we think we've got, and the other is about what we think we could have.

The oscillation between these two views is actually the alternating current of reality.

You can't be me, I'm taken

by Sven Triloqvist on Sat Mar 17th, 2007 at 06:29:41 PM EST
[ Parent ]
The oscillation between these two views is actually the Alternating Current of Reality

Wilde to James Whistler: "I wish I'd said that!"

Whistler: "You will, Oscar, you will...."

Good line, Sven.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 07:52:12 PM EST
[ Parent ]
I like this Irish saying: "A stranger is a friend one has not yet met"


"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Sat Mar 17th, 2007 at 06:56:13 PM EST
[ Parent ]
that I have to learn to love Colman?

You can't be me, I'm taken
by Sven Triloqvist on Sat Mar 17th, 2007 at 06:59:42 PM EST
[ Parent ]
You just have to shake hands with him, remember?

"It's the statue, man, The Statue."
by Migeru (migeru at eurotrib dot com) on Sat Mar 17th, 2007 at 07:02:44 PM EST
[ Parent ]
Oh, that's right! I just can't win against your instant photographic recall ;-).

You can't be me, I'm taken
by Sven Triloqvist on Sat Mar 17th, 2007 at 07:40:37 PM EST
[ Parent ]
as you only partly point out, is that public equity is subject to pretty stringent disclosure requirements - usually imposed by the stock market on which shares are listed, whereas private equity is subject to very few such obligations (beyond the obligations that usually applies to all corporations to publish some basic accounts).

Thus, these days, private equity is seen as a way to go around discosure requirements - either to avoid the cost, the liability (notably with the Sarbanes-Oxley Act that follwoed the Enron meltdown) and the outside scrutiny on your business.

Another important point is that public companies are currently bedevilled by the "agent-principal" issue, i.e. how do owners make sure that managers have the owner's best interests at heart, and not their own? when you see the stock option and golden parachutes that some managers have obtained, it's become a real issue. Private equity is seen as a solution to that, because it makes ownership and management a lot closer (the owners manage directly, or are a small group enough that it is easy for them to establish oversight over the managers they choose).

Finally, in the financial sector, private equity is a great way to set up funds that do almost everything banks do, but with a lot fewer rules applying to them (capital adequacy ratios, diversification requirements, know-your-customer stuff, public repuation issues, more disclosure, etc...)

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Mar 17th, 2007 at 04:45:05 PM EST
Simple anwer, Jerome.

Reinvent "ownership" by using a different enterprise model.

One where the financiers, and the users of finance, genuinely share the risks and rewards.

The PLC is a toxic legal form, that's the truth of it: truly sociopathic.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Mar 17th, 2007 at 04:53:13 PM EST
[ Parent ]
to expand a little on this point from a US perspective, there is a fairly signficiant amount of regulation that makes sure that investors in private equity are qualified--qualified in the sense of previous investment experience, qualified in the sense of having a reasonably significant amount of money so they can afford a significant loss.  And then also that the private investors reveal certain potential conflicts of interest--for example, affiliations with brokers, positions on boards, etc.  the original intention of all of this was to prevent small investors from being taken advantage of, in the sense that they may not understand what they are getting into.

As we add regulations to the public companies with SarbOx, maybe CEO pay in future,,,we're going to stretch the difference between private and public companies.  Actually it appears that a consensus is developing that SarbOx went too far.  The villians at Enron are in jail, none of them prosecuted under SarbOx, but instead under existing regulations at the time of the crimes.  In many ways SarbOx has become the accountant's full employment act--auditor fees in a public company I'm familiar with have tripled.  we just need to make sure that new regulations make sense, and we don't have the age old problem of unintended consequences--like a significant % of public companies going private, where the small investor won't be able to invest.

I believe these issues are being studied now, and recommendations will surface.  I'm not sure that it is a really big problem yet, because public companies have the tremendous advantage of being able to raise funds much more quickly, and from a much larger investor pool than private companies.  That is an advantage that is not easily offset.

by wchurchill on Sat Mar 17th, 2007 at 07:06:18 PM EST
[ Parent ]
Another interpretation is that it's not SarbOx stuff but just increased wealth inequality that makes a bigger share of the available funds in the hands of fewer people.

Bank lending and IPO are to bring the "lots of small inverstors" in (sum of small deposits or small share purchases), may be these are no longer needed now...

No data to choose which story has the biggest factor :).

Another point is that accountants have been made legally responsible by recent cases, asking for more money is a way to ask for more independance (because you can refuse more direct orders/clients), it might not be fully a result of SarbOx creating more work but just logic on existing regulation and recent legal outcomes.

As always, one narrative is not enough :).

by Laurent GUERBY on Sun Mar 18th, 2007 at 04:45:08 AM EST
[ Parent ]
As you know, there has been quite a bit of angst in the US that the hedge fund and private equity business is moving to London where it is much more lightly regulated than in the US. The point is that kind of money will always be based in the least regulated environment.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sun Mar 18th, 2007 at 05:03:32 AM EST
[ Parent ]
Actually I've not heard this rationale for the private equity relocations out of the US, to London specifically.  I've heard a similar discussion, but in a very different context.  That concept is more of the following:

Private equity firms in the buyout segment are taking more of a global view.  They are looking at buying out firms headquartered overseas.  And by necessity, this will move their business outside the US to some extent.  London of course would be an ideal location.  As an example of this, I invested in a buyout fund recently where they gave you options as to how you wanted your personal investment distributed between US and International--you could choose nothing outside the US, 10%, or 20% outside.  (should be interesting for them to administer).

Second, the reaction to regulation I've heard as it regards moving outside the US, has been focused on small companies that are evaluating going public.  SarbOx adds an estimated $2 million per year of spending to such companies, which is a big number for them.  Some companies have therefore gone public on the London Stock Exchange, or others.  The problem they have run into is there does not seem to be as much liquidity for small companies on those exchanges.  You need people buying and selling a stock actively to make a market, and I've heard that is not happening.

I have not seen much data on either of my points--information is more anecdotal.

I would be interested in articles or data on the point you make.  The regulatory issues in the US are more focused on public equity companies, so I'm not sure I understand the rationale for the argument.

by wchurchill on Sun Mar 18th, 2007 at 01:22:51 PM EST
[ Parent ]
Speaking of investments, here is a Dutch headline:

Pension funds invest in weapons

It appears that Dutch pension funds are investing, for example, in companies producing cluster bombs or land mines.

What does this mean? Are there no better investments for retirenment?

by das monde on Sun Mar 18th, 2007 at 08:35:12 PM EST
[ Parent ]
Private is also seen as a way to escape the stupidity of the "analysts" and quarterly valuations. People complain that the same morons who thought that the Iraq war would be a "cakewalk" are still pontificating on US TV, but the Wall Street analysts have similar records of accuracy and also seem invulnerable. Are the financial analysts in Paris and London of similar quality?
by citizen k (sansracine yahoo.fr) on Sun Mar 18th, 2007 at 09:21:39 AM EST
[ Parent ]
so the analysts are in the same mold, and work the same way (and for the same group of big investment houses) and repeat the same prejudices. Most of the coverage for Europe is done in London in any case, so you have a "purer" version of dogma there thna you'd have in the local capitals...

In their defense, good analysts are really good, and provide really invaluable insights and perspective.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Mar 18th, 2007 at 09:53:25 AM EST
[ Parent ]
There are good analysts of course, but it's amazing how few "sell" recommendations there were (and for all I know, still are)

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sun Mar 18th, 2007 at 10:36:48 AM EST
[ Parent ]
Or how surprised the analysts are by Enron, the GM junk bond rating, the housing loan collapse, ....
by citizen k (sansracine yahoo.fr) on Sun Mar 18th, 2007 at 12:47:31 PM EST
[ Parent ]
actually the analysts work in a very different way today.  Previously they were hand in glove with the investment bankers, which was a definite conflict of interest.  CEO's could definitely beat up on an analyst who derided the CEO's company, threatening to take his investment banking business to another firm.  Legally that has been changed and it's made an impact.

I've always felt the issue with analysts is that your customers don't value your work--ie., you can't get paid for doing these reports.  There were independent analyst firms in the early '70's, and they had trouble staying in business.  It might be a good time to try that model again--but with so much money to be made in the deal side, investment banking, and all of the financial arbitrage opportunities,,,,,I would imagine good analysts would be tempted to go where the big money is.

Also, imho, analysts just provide a platform for an investor to begin his own evaluation of a company.  One has to do the hard work themselves--no analyst is going to just give you a wonderful way of making millions.  If he had that capability, he would just create a fund and run it and make big money for himself.  Luckily the requirement for transparency in US markets today keeps investors on more of an equal footing,,,,,and the internet has been an incredible evening of the playing field.  I referenced that La Jolla 10K in the diary, and you can get that information as quickly as an analyst.  You can also listen in on the company conference call yourself.  Do your own research on the company's business--in this case a disease called Lupus.  It's not all that difficult to have more knowledge than the analyst,,,,but it takes focus, time, and hard work.  There are no freebies here.

by wchurchill on Sun Mar 18th, 2007 at 01:36:23 PM EST
[ Parent ]
Excellent diary and fantastic discussion.  This is a topic I never thought I'd have a chance of understanding, and yet something has clicked into place.  Laying it out clearly like this helps so much, thanks.
by In Wales (inwales aaat eurotrib.com) on Sun Mar 18th, 2007 at 08:41:11 AM EST
Because what the trade unions are worrying about is neither the way SMEs are created and grow, nor venture capital, but the fact that, nowadays, numerous medium and big companies are taken over by private equity funds. This should be addressed in the next diary...

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Sun Mar 18th, 2007 at 09:28:08 AM EST
[ Parent ]
Part II may take a while.  As you know, it really takes a lot of effort to do one of these.  And I'm sure like you, we both have tons going on in our lives.  so there may be a pretty big time gap.
by wchurchill on Sun Mar 18th, 2007 at 02:14:54 PM EST
[ Parent ]
I repost here a comment posted in In Wales' diary, with a few changes.

Your story illustrate only one case of private equity deal, and a rosy one. Sure, this kind of situation exists, and VC can have a positive impact on business, as shown in this Survey of the Economic and Social Impact of Management Buyouts & Buy-ins in Europe made by the Centre for Management Buy-out Research (CMBOR)1, University of Nottingham on behalf of the European Private Equity and Venture Capital Association (EVCA). Caveat: a) given the sponsors, this survey might be focused on the positive experiences, and b) it was published in 2001...

However, VC is not the biggest part of PE deals: according to the EVCA's Preliminary Figures for European Private Equity Performance and Activity for 2006, out of 90 billion € raised by private equity funds in 2006 only 16 billions go to venture capital and 71 billions to buy-outs, which represent 78% of the investment made by private equity funds...

Two remarks:

-    A PE fund aiming at short-term profit will likely tend to reduce the wage bill and to sell some of the purchased company's assets in order to improve the cash flow generated, hence a higher IRR. Likewise, it will tend to limit long-term investments in order not to lower the cash flow generated.

-    In case of a highly leveraged operation, the debt might be affordable by the company, but it will be used to pay for the company's shares acquired by the buyer and thus will not allow using debt for other, more productive investments.  Furthermore, the burden of the debt will prevent the company to distribute equitably the fruits of productivity gains...

There is an interesting paper from the UK Financial Services Authority: Private equity: a discussion of risk and regulatory engagement.  Excerpts:

First, a revelation:

Not all public authorities around the globe follow the open market approach favoured by the UK.

And we learn that, from the private equity funds point of view, health, safety and wages requirements... are "undue burdens"...

In venture capital investment there are concerns that excessive company (nonfinancial services) regulation (e.g. health and safety requirements, the minimum wage, flexible working etc), could cause undue burdens on companies. This could limit the scope for venture capital investing by limiting the profitability of potential target companies.

And about the realism of bankers, ever heard of "limited rationality"? Re-read Nobel Prize Herbert Simon:

Banks face increasing competition in their bids to win the mandate to provide the debt finance for private equity transactions. Such finance provision (particularly in relation to the top tier of private equity transactions i.e. the larges deals) is now generally the subject of a competitive auction. The private equity fund manager frequently takes the most advantageous elements of individual banks' bids (i.e. the most debt finance offered on the cheapest and most flexible terms) and combines them into one highly leveraged package, asking the banks to accept those terms or lose the mandate. Winning a mandate can be highly lucrative in terms of both transaction fees and other fee-earning ancillary services the banks may be invited to provide, so there are strong incentives for banks to participate in these auctions. As private equity firms frequently re-use the same banks for consecutive deals, the banks are reluctant to impair their relationship with the private equity fund manager by rejecting a particular transaction, potentially losing the right to provide lucrative debt finance packages for future deals.
Leverage levels are being competed upwards because of this process and
increasingly appear to approach the limits of prudence. Snip)

Some lenders may no longer be prioritising strict risk-return criteria based on the credit quality, transaction value and interest rate when deciding how much to lend. (snip) Purchasers of this debt may be either unaware of, or under-pricing, the inherent risk.

On the assumption that a re-financing on more favourable terms will be possible, private equity owned companies are increasingly being initially financed with a capital structure that is unsustainable in the long term.

19% of the private sector workforce is employed by companies that have received private equity backing. As the situation of these companies becomes less stable due to their over-leveraged status, so these jobs start to look increasingly precarious. The impact of a private equity market downturn on the UK economy could therefore be felt not just through the transmission mechanism of capital markets but also more directly via the unemployment rate.

About transparency? Well,

The situation will be further complicated by the general opacity surrounding the transfer of leveraged loans and their related risk. There is no general market-wide transparency surrounding loan risk transfer. Risk transfer mechanisms allow lenders of record to have a materially different level of net exposure than their lender of record position may suggest. Lenders are unlikely to be under any legal or contractual obligation to disclose their true position, even if they form part of a work out committee. Even the debtor company and its private equity backer may be unaware of the true extent of the net exposure of the lenders of record so the chance of a counterparty possessing all of the relevant facts is extremely slim.
This opacity as to counterparties' true exposures can create significant difficulties. Risk transfer mechanisms may distort incentives in any credit event negotiation, leading parties to act in ways that are unpredictable to, and potentially to the detriment of, their fellow debt holders.

And, finally, the coup de grâce:

Many of those companies formerly owned by private equity fund managers that have been floated on the stock market recently have underperformed the market, bearing out fears that private equity will only sell off assets from which all of the growth potential has already been stripped.

Here is an interview of the European Commissioner Charlie Mc Creevy (EU Internal Market) on the subject.


"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet

by Melanchthon on Sun Mar 18th, 2007 at 12:43:27 PM EST
you have provided some great reading here Melanchthon, and it will take me quite a while to go through it--like maybe a few weeks (because I do other things).  but it really looks good, so I want to do it and thank you for it.  One quick comment about the snip from Simon,
Banks face increasing competition in their bids to win the mandate to provide the debt finance for private equity transactions.,,,,,,,,,
, it sounds a lot like what happens in business every day.  these banks are just a powerful, actually moreso, than the private equity guys.  sure there is a temptation to get the business, and sure the pe guys are setting up a very competitive negotiating situation.  but it sounds like an equal playing field.

but anyway, I look forward to readiing it.

by wchurchill on Sun Mar 18th, 2007 at 02:27:07 PM EST
[ Parent ]
I made a typo: the quote is not from Simon, but again from the Financial Services Authority's paper.

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Sun Mar 18th, 2007 at 02:37:42 PM EST
[ Parent ]
I once read an article that argued how buy-out frenzy is a crucial part of the economy cycle. Do you want to guess, which part of the economy cycle?
by das monde on Sun Mar 18th, 2007 at 08:17:43 PM EST
[ Parent ]
This is really interesting, not the least because the original diary was about worries caused by the current trend of public companies being taken private in leveraged buyouts and (allegedly) being hollowed out and discarded.

"It's the statue, man, The Statue."
by Migeru (migeru at eurotrib dot com) on Mon Mar 19th, 2007 at 04:39:50 PM EST


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