[pembrook]

So yes, PE funds are probably overvalued right now and there are a lot of PE funds getting rich off management fees while not providing promised returns...but this comment is so wrong I don't know where to begin.

First, VC stands for venture capital, which is a subset of private equity that does zero LBOs and doesn't even acquire any businesses. VC funds buy equity in startups, and take on zero debt to do so. You have your boogiemen totally confused.

Second, the entire point of a PE fund that uses a leveraged buyout strategy is that they need to sell the acquired firm at a profit to make any returns to the fund. LBO funds don't 'cashflow' businesses, and saddling a business with a bunch of debt is antithetical to that purpose anyways.

Third, this is not "risk free revenue." It's a high risk strategy to use the debt to increase the value of the business by improving operations enough that you can sell it for a profit to the fund. If you saddle a company with debt and DON'T increase the value of the business beyond the debt you took on, the PE fund will not be in business for fund 2.

The risk-free revenue while the fund is alive comes from the management fees that investors in the fund pay (usually 2%, which is way too high IMO, but has nothing to do with the debt or the acquired businesses).

Please do not write confident sounding comments about things you don't understand, it spread misinformation and makes the internet a worse place.

[superxpro12]

As someone who's life is currently being affected directly by PE middle-manning something I spend a LOT of time on, I am sensitive to this issue.

IF you have problems with the vocab and terms, fine. But I have seen personally this issue in my life, that is affecting my bank account.

And we have seen example after example of these LBO's ruining otherwise functioning businesses. It's happening. All over the place.

[mbesto]

> And we have seen example after example of these LBO's ruining otherwise functioning businesses. It's happening. All over the place.

Your anecdotes and the anecdotes in media are no statistical evidence for "this is happening all over the place".

Yes, PEs/LBOs deserves criticism, but "PE" and "LBO" isn't a one size fits all situation.

[pembrook]

It is absolutely possible (and even likely!) that a bad PE fund was the cause of the issue you're talking about. But there is also a media hysteria around PE, and a lack of understanding among the general public of what it is.

It's just as likely the business that was acquired was already failing or unsustainable to begin with (hence why the owner wanted out at low multiples). LBO funds don't acquire promising businesses at 5-10X revenue like tech companies do, they usually buy businesses at low multiples that are past their prime or failing in an attempt to revitalize them (with debt, since you can't raise capital by selling equity in a failing business).

Obviously this will not always work out great, given the trajectory of target companies was already not great to begin with. Momentum is the strongest factor in all markets.

The problem is, Private Equity has become a conspiratorial catchall boogieman and scapegoat for every problem under the sun, so it's hard for me to assess without further details of the situation.

[maest]

> Momentum is the strongest factor in all markets

Nit: beta is the strongest factor in all markets. Which is actually relevant for the success for PE funds in general, as a rising tide lifts all boats and people taking on debt to finance equity generally post outsized returns in bull markets.

Anyway, the rest of the stuff you're saying I agree with.

[pembrook]

Yes, beta is the overwhelming source of returns. I was referring to factors in the sense of the University of Chicago research on market inefficiencies (where momentum is the strongest factor for inefficiency).

If you buy a “factor-weighted” etf the idea is it’s tilting you into those “factors” away from pure beta like buying whole market.

PE you could argue is largely just leverage plus an illiquidity factor play, since if PE just returned beta (which these days it might!) you’d be smarter to buy the S&P500 with equivalent leverage and not pay crazy fees.

[financltravsty]

Background: I work for a PE-owned company and I have friends in PE (associates up to MDs).

On your second point: LBOs aren't the only tool in the toolkit, and it's not as popular as it was decades ago, so I would lean towards the parent simply conflating "buying an ownership stake in a business in some capacity using other people's money" with the strict definition. Regardless, yes PE firms need to figure out how to get 20%+ IRR throughout a short timeframe (usually a 5 year holding/funding cycle) -- however this is through any means necessary. Philosophically, it's about increasing efficiency of operations and growing the business. In practice, it's financial engineering because PE firms do not have the operational skills to make any value-added changes to firms besides driving costs down.

Saddling a business with debt is reductionist. I've seen absolutely nonsensical financial structures that make no sense for a layman, but in practice end up "using the business' finances to 'own' (beneficially) the business" (see: at the most vanilla, the strategy of seller financing in SMBs). No this is not technically "putting debt on the books" but it is in all practical respects a novation/loan transfer that can leave the purchased co financially responsible for servicing any debt that was used in its purchase.

On your third point: what I wrote above can be used as context. It's not risk free revenue, frankly it's very risky unless you're in an inflationary environment where your assets will grow regardless of your business operations solely because the overarching economy is growing and you're riding a tailwind. However, it again boils down to financial engineering. It's not as simple as assets - liabilities = equity. The calculations used to determine valuations are so ridiculously convoluted. The amount of work that goes into financially analyzing businesses and finding "loop holes" that can justify higher prices is the core business model. The debt factors into it, but there's ways to maneuver around it through various avenues.

For example:

* debt-to-equity conversions (reclassification of debt as equity)

* refinancing

* sale-leaseback (selling company's assets to a 3rd party and using that money to pay down the debt, then leasing the equipment back)

* creative interpretations of what is actually debt (e.g. reclassifying real debt as a working capital adjustment or a "debt-like")

* dividend recapitalization (a nasty trick of loading the company with debt, paying that out as a dividend to the holdco, then selling the company at lower enterprise value. They still extracted value for their LPs/investors, despite the exit being lower)

* separating the debt from the operating company into a different holding company that services the debt