into shares that are sold to public investors. During raging bull markets, IPOs become a popular way for private-equity firms to exit deals because they can get top dollar.
Sales to strategic buyers: If a private-equity firm wants to sell its position in a company, and the stock market is depressed, it may court big companies that may be interested in the deal.
Recapitalizations: If a private-equity firm can’t find a buyer for a business, or if the timing isn’t right, it may consider restructuring the makeup of the company’s financing. The company, for instance, may take on an additional investor as a way to reduce the amount of debt.
Why leverage is used
Private-equity firms and investment banking operations have a tight relationship because they’re very mutually beneficial. Private-equity firms are constantly looking to buy and sell firms, which is exactly in the wheelhouse of investment bankers. Meanwhile, because private-equity firms rely on financial events like IPOs to exit positions, investment banks can make money on these deals when they’re opened and closed.
The pros and cons to debt in deal making
Debt can be like dynamite for investment bankers and private-equity firms. When companies borrow, they can invest in new capacity or equipment using other people’s money. The investment can push up profit without asking shareholders to put more money into the business. That’s the upside of debt.
But debt comes with a big downside. The company must pay an interest rate to borrow the money. That interest rate is a cost that must be less than the returns being obtained from the assets bought with the debt. Also, if the interest gets too onerous and the company can’t keep up with the payments, the company may be forced into bankruptcy protection.
PRIVATE EQUITY: NOT THE TICKET TO RICHES
Private equity firms had their absolute heyday in the mid-2000s. But they rose to prominence again in 2018 and 2019.
One of the key ingredients to private-equity firms is access to cheap money. And in the mid-2000s, private-equity firms could borrow from just about anyone with a pulse at extremely low interest rates. Banks and bond investors were more than willing to lend and buy bonds offering private-equity firms practically unlimited amounts of money to buy companies. Meanwhile, pension plans and other large institutions were lining up to invest in the private-equity firms’ investment funds used to hunt down and buy companies.
Some of the biggest LBOs of all time took place during the boom years of 2005, 2006, and 2007. Car rental firm Hertz, technology services firm SunGard Data Systems, retailer Toys “R” Us, and retailer Neiman Marcus were all bought up by private-equity firms in 2005.
The crescendo of the private-equity boom was capped off when one of the top LBO firms, Blackstone, decided to sell stock of itself in an IPO. Individual investors saw the IPO of Blackstone as a way to get on the inside track of the world of high finance. But how wrong they were. In fact, Blackstone was selling out at the peak of the LBO craze.
The company sold shares in an IPO at $31 a share on June 22, 2007. But individual investors who bought the deal were paying up just as the LBO business was about to hit a wall. Shortly after the IPO of Blackstone, the financial crisis of 2007 hit. Suddenly, banks were too nervous to lend to LBO firms, and bond investors didn’t want to lend money to the speculative ventures. Shares of Blackstone fell from $31 a share to less than $5 a share in early 2009.
But the story isn’t over. Interest rates fell again in 2019. The Federal Reserve cut short-term rates to stoke the economy. That is a green light, again, for private-equity firms like Blackstone. As of late 2019, shares of the private-equity firm were trading for more than $48 per share.
Private business sales
Much of what investment banks do is out in the open and public. When a giant company like Microsoft buys LinkedIn, there’s no secret about it. For one thing, LinkedIn was a publicly traded company, meaning the shares are held by the public and free to trade on a public marketplace, called a stock exchange.
But sometimes investment banks work behind the scenes to help sell off or allow private companies to conduct sales. These deals take a bit more massaging because there are no publicly traded securities from which to glean a value of the company. When dealing with publicly traded companies, there’s really no secret in terms of what price tag investors are putting on the firm. The value of a public company is its market value, which is the per-share stock price multiplied by the number of shares outstanding.
But with private companies, there is no objective and dispassionate way to measure the value of the company. The value is, plainly stated, a meeting of minds between what potential buyers are willing to pay and how much the seller is willing to accept.
Appreciating the rationale of private sales
It’s a classic American story. A young entrepreneur invents a technology in a garage or dorm room and knows he or she is onto something big. Some entrepreneurs, like Bill Gates of Microsoft, may stick with the idea and build and expand and create a giant publicly traded company.
Other entrepreneurs, though, know that building a company takes time and a string of not just one-hit products, but several, to fend off competition. Additionally, building a company requires the ability to tap many business skills, ranging from marketing to finance, not just research and development.
For that reason, it’s not uncommon for young fledging companies with a hot technology to simply sell themselves to bigger companies that already have an organization in place to put the technology to use right away. In deals like this, investment bankers are called in to put a price tag on the company and technology being bought.
Seeing where private transactions are the best choice
During the Internet boom of the late 1990s, going public was the ultimate goal of many companies. The dream of creating a company, selling the shares to the public and becoming instantly fabulously wealthy was the reason many Internet companies existed.
But some companies actually want to do just the opposite. There are major, short-term pressures associated with being a publicly traded company. The biggest obligation is that public companies must provide the investors a complete rundown of their financial performance during the quarter, disclosures you can read about in Chapter 7. This required disclosure is fine when the company is doing well — kind of like plastering a grade-school paper with an “A” on it on the refrigerator door.
One classic example is computer maker Dell. The company had been struggling with slower sales of personal computers. It wanted to go private to give it the time to restructure its business. Dell’s management team offered to take the company