Wednesday, March 30, 2011

Private Equity Unveiled

I was having coffee with my bud Ignoto on the patio outside the Palookaville Borders today, in the warm breezes and the spring sunshine.

"Three questions," I posed to Ignoto, who knows much more about this stuff than I do.  "One, is it true that there was a ton of private equity investing between '03 and '07?  Two, can you generalize as to what they spent it on?  And three, isn't it true that they lost a bundle?"

 Answers: "Yes as to one and three" (which is pretty much what I expected).  "As to two--well, let me tell you how private equity makes its money.  Forget about 'undervalued investment opportunities.'  Forget about improved management,' blah blah.  The components are: (a) easy money; and (b) nonrecourse finance.  The banks were desperate to move money; the PE firms are strong enough they can insist on nonrecourse.  So, leverage up on debt, say six-one, and keep what flows throw to the equity.  It's that simple."

Nonrecourse.  I should have though of that.   

Fun fact: The annual budget of the Securities and Exchange commission is about $1.1 billion. Seven top Wall Street investment fund managers--each individually--make more than that.

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