Who dat

Watching Paul Krugman bitch slap Jon Moulton on Newsnight was fun. Like for all Jon Moulton, rightly, made his (public) name speaking vast amounts of common sense about Rover as the Phoenix debacle took shape, it turns out he’s a pro-austerity fella and as such deserved all he got. One wee thing that confused me though is the way he keeps getting introduced/described as a venture capitalist, because my understanding is he’s not.

Like calling Moulton a venture capitalist is like calling a dentist a gerontologist. So sure a dentist and a gerontologist are both medical fellas, but they’re ones with very distinctive specialisms/areas of expertise, who do different things and use different tools. Similarly, whereas a venture capitalist typically focuses on early stage businesses and typically, besides commercial savvy, provides technical expertise related to what it is a business does as well as equity, yer man Moulton is better described as a private equity bod, who targets well established concerns e.g. Reader’s Digest, and provides/inflicts generic financial engineering alongside commercial savvy. Plus, his deals typically involve oodles of debt with a cheeky wee bit of equity on the side.

Rather than pedantry, the nomenclature being used matters. A lot. Back before the credit crunch crunched private equity became one of capitalism’s more evil, unacceptable faces, one dominated by multi-millionaires who paid less tax than their cleaners and who couldn’t attend a black tie do without protestors barracking them as they rolled up in their respective Aston Martins, Ferraris, Bentleys etc.,. And while that was here and then, over in the US right now there’s a wee, politicised debate about the worth of private equity prompted by the fact Mitt Romney made his fortune in it.

Ahhh, I’ve answered my question about howcome private equity people are now being called venture capitalists by the mainstream British media haven’t I? It’s a way of involving them in public debate whilst avoiding debate and disassociates them from what was previously said and thought. Plus, venture capital is a much more moral, credible and legitimate activity – the strike rate for venture capital investments is much lower than it is for private equity i.e. venture capital really does involve the risk taking that provides one of the major justifications for economic inequality. Plus, venture capitalists genuinely do help bring new things to the table, Facebook being an obvious example, a media thang that’s in as sharp a contrast with the investment made in Reader’s Digest by Jon Moulton’s company as it’s possible to find. So perhaps rather than be inaccurate the BBC etc., should use a new label in line with how these guys are now being presented, howzabout they call Jon Moulton et all, the bearer’s of God’s golden balls of economic common sense?

Except, getting some accuracy into the chat would also highlight private equity’s current problems (though funnily enough not ones that apply to venture capital to anything like the same degree, which stem from the fact we’re in a credit crunch.

This is because the private equity model and private equity profits are predicated on the ready availability of credit; the more private equity borrows to leverage a deal and the cheaper it borrows, the more profitable it is. Unfortunately, since late 2007/early 2008 there has been a step change in the availability of credit and the terms on which it’s lent. Basically, it’s far harder for private equity investors to buy up a company and make money primarily on the back of swapping expensive equity for cheap credit. Instead, they have to work a damn sight harder and be more creative i.e. they actually have to add value.

Now a couple of things follow on from this. One is what in fucking hell was a high profile private equity boy i.e. a player in an entire industry/asset class predicated on borrowing as much as possible as cheaply as possible, doing arguing against the use of cheap debt to ease the economic misery of tens of thousands of people. Seriously. Like private equity loading a business up with debt so half a dozen people can buy more Tuscan villas is a good thing whereas government borrowing to build necessary infrastructure that also cuts unemployment is bad why exactly? And to borrow Paul Krugman’s chat about how economies differ from households, my liability/debt is your asset i.e. the holes in British bank balance sheets that taxpayers subsequently filled were partly punched into them by private equity boys who made personal fortunes as a result.

The other thing, of course, is that if I was a venture capitalist, “ahem” private equity investor, I’d be smart enough to realise the cheap credit days are gone for the foreseeable future so would be looking elsewhere to make my millions.

I know, if we can’t cut the cost of the debt that’s integral to the private equity business model, lets look at influencing other costs, most obviously labour. And hey presto we’ve just had another “venture capitalist” Adrian Beecroft i.e. no he isn’t he’s a private equity bod who just happens to give money to the Tories, producing a government report recommending changes to employment law geared almost entirely to cutting labour costs in ways that (a) would have a significantly adverse impact on what lots of people earn and (b) would consequently increase the tax credit subsidy employers already receive.

So the view of leading “venture capitalists” is that only private equity should be allowed to borrow big, with the taxpayer taking the risk, and that taxpayers should also hand over even more money than they already do to “venture capitalists” via the tax credit subsidies paid to the recipients of shit wages in the companies they buy so they can get even more Aston Martins, Ferraris, Bentleys etc.,. Alternatively, howzabout spades start getting called spades and private equity, private equity.


A July 24th P.S. -  the distinction between Private Equity (was leveraged buyout as a mate minded me) and venture capital clearly matters in the US if not here judging by the attempts now being made by venture capitalists there to disassociate themselves from Mitt - he was private equity not venture capital , geddit! - Romney.

Big Boy? Pants.

The Epicurean Dealmaker blog, is a really good blog that's both more literate and articulate than this thing and far more popular. But ……..… from a British perspective at least his latest chat on private equity strikes me as a bit iffy.

Add in a J-curve reference and I reckon his succinct summary of what private equity is and does could grace any finance dictionary. Except, reading it again I reckon there's another thing missing; history, which matters because the Dealmaker’s account is intended to justify as well as explain private equity.

For the Dealmaker private equity “is a valuable part of the financial ecosystem. It is particularly suited to helping businesses which require some sort of transformation, in structure, methods, and/or capital, in order to improve their value …. they are not asset strippers, “vultures,” or liquidators, either. Think of them instead as boot camp drill instructors, whipping out of shape or underperforming laggards into top-flight athletes.”

Hmm, this is the new management with no vested interests taking over and stripping out all capital consuming fat, chopping off any inefficiencies and implementing a new business model view of private equity where making money is almost entirely about adding value then selling on. It’s a lovely view and perfectly in keeping with what any self-respecting member of the British Venture Capital Association (BVCA) – the British private equity trade association - would tell you in public (Jon Moulton being a possible exception here).

Except right from the outset there's some economical with the truth thangs going on. An obvious one is that the bulk of the BVCA’s members aren’t venture capitalists at all just as the bulk of BVCA member deals by value and volume don’t involve venture capital. Rather, they're private equity bods who buy and sell established concerns, an arguably less moral activity than venture capital investments in wholly new businesses (the US equivalent here presumably being the rebranding of leveraged-barbarian-at-the-gate-buyouts as private equity). So yeah, this is a type of finance that tends to hide behind more user friendly labels.

Anyhoo, I reckon the Dealmaker misses a big trick with his chat on “dividend recapitalisations, when he says “dividend recaps … the relatively recent phenomenon of financial sponsors borrowing additional debt through their portfolio companies during the life of their investment, and using the proceeds to pay equity dividends to themselves and their limited partners”.

Now note the immediate qualification – “this is a relatively recent phenomonenon”, then ponder a while the actual nature of M&A activity over the last 100 or so years in Britain which is this - it occurs in waves.

Like according to Leslie Hannah’s Rise of the Corporate Economy you can, somewhat arbitrarily here, identify the peak of previous UK M&A waves occurring in 1881, 1898-1900, 1919/20, 1929, 1959-68 and 1973. Latterly, ONS data shows the number of mergers and acquisitions unsurprisingly peaked in 2007, the total having grown strongly from 20003/04.

So there you are then. Whereas the Dealmaker sets out generic notions as to the benefits of Private Equity, the reality appears somewhat different; actual dealmaking activity has repeatedly clustered around specific points in time. This, of course, is due to the influence of period specific factors, an obvious one latterly being the shifting willingness of banks to lend. I say shifting because well it does as was illustrated by the pre-credit crunch emergence of cov-lite debt i.e. debt sold to private equity investors with few if any of the covenants previously imposed by lenders so they could manage the risk they’d decided to take on. And lets be clear the emergence of cov-lite lending and the associated willingness of banks to lend against ever more aggressive multiples was a product of them competing to lend so they could hit their quarterly/annual sales targets.

What it was not was not a sudden recognition of private equity’s boot camp-like qualities. Rather, in practice bankers were eventually tripping over themselves to throw money at private equity. Now here is where a big boy defence presumably comes into play - bankers are big enough and ugly enough to do the appropriate due diligence and if they weren’t, well tough.

However, a criticism of private equity the Dealmaker seeks to challenge is that it loads up companies with unsustainably high levels of debt that ultimately fucks them in an eventually making lots of people redundant kind of way. Now if I was minded to argue private equity wasn’t to blame for well anything really, I’d argue that if someone offered me mad amounts of debt for hee haw, then of course I'd take it. Heck I could even cite the example of Focus DIY, bought for a couple hundred million and collapsed owing businesses, shareholders and funders around £1bn i.e. the private equity buyers had gone mad for the “dividend recaps” the Dealmaker mentions just in passing. Except with Focus this appeas to have been how the money was REALLY made and as the Dealmaker points out making money is the primary purpose of private equity. Operating efficiencies, new store layouts? I guess, but really it was about borrowing as much as possible then taking as much of that money out the business as possible via dividends (and I'm no even mentioning the sale and leaseback asset stripping other private equity bods did elsewhere in increasing numbers in the run up to 2007).

Except, that’s not quite in keeping with the boot camp instructor account of private equity is it? Rather, its about being able to spot someone dumb, desperate and/or arrogant enough to lend more (and more) cash than was ever paid to buy a business so as to do a "dividend recap" as a key determinant of private equity returns. And if the business fails, as Focus did, and people lose their jobs, then hey ho.

The other thing recent experience shows is that in an M&A wave, you know a fad, a euphoric precursor to a crash during which a disproportionate number of deals get done, being able to identify patsies, ahem, bankers (and in an aggressively competitive environment there will always be a few) becomes increasingly important as all the low hanging fruit gets plucked (a practical example here being the chat about taking Sainsburys private that in reality appeared based on f'all more than the ready availability of cheap debt vs expensive equity). So much so in fact, given the persistently wave-like nature of M&A activity, I reckon its worth taking away any qualified references to "dividend recaps" and emphasising how a key skill (value add even) of private equity is its ability to spot a dumb banker at 100 paces. That and exploit tax arrangements of course.