Page 158 - (DK) The Business Book
P. 158
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AS THE ROLE OF
PRIVATE EQUITY HAS
GROWN, SO HAVE
THE RISKS IT POSES
THE PRIVATE EQUITY MODEL
ome economists believe
IN CONTEXT that “private equity” is
At first, private equity came
FOCUS only from large investors S misnamed, since it is a
model based on debt, not equity
Profit and risk wanting long-term gains.
(the value of assets owned outright
KEY DATES by an individual or company).
1959 Fairchild Semiconductors, Private equity involves “leveraging”
the first venture-capital-funded a balance sheet by loading debt onto
start-up, is created. But in the 1980s, smaller the business. This is similar to the
investors used leveraging controversial practice of “leveraged
1978 US investment group
and debt to buy companies. buy-outs” (LBO), in which a
KKR pays $380 million to take company is acquired using a high
manufacturer Houdaille percentage of borrowed funds,
Industries Inc. private; this is loading it with a high level of debt.
probably the first private- Such levels of debt pose
equity transaction. inherent risk, as US politician Jack
This type of private equity
1988 KKR buys conglomorate requires high short-term Reed highlighted. Pressure on
RJR Nabisco for $25 billion in profit (to service debts). managers increases—good profits
are necessary in order to minimize
the biggest private-equity
interest charges on the company’s
purchase the world has
debt. The theory is that this forces
yet seen.
managers to perform better, but
2006–07 A peak year for Long-term opportunities critics claim that a company run on
private equity—in the US are likely to be overlooked the private-equity model is likely to
alone, private equity in favor of short-term profit. maximize short-term profit at the
companies buy 654 cost of long-term business growth.
companies for a total of
Less pressure, more focus
around $375 billion.
To its supporters, the main strength
As the role of private of the private-equity model is in
equity has grown, so what it removes. First, it removes
have the risks it poses. the regular profit pressure from
shareholders that is faced by bosses
of a publicly traded company. For
