Private equity financing is booming and reshaping corporate America, even at its highest levels. Prior to the current boom, 2000 was considered to be private equity’s high watermark, with private equity being behind an estimated 4 percent of all public company acquisitions. Last year, an estimated 18 percent to 20 percent of such acquisitions were funded by private equity. Indeed, eight of the 10 largest private equity deals of all time closed in 2006.
Smart Business spoke with Donald K. Densborn, shareholder/director at Indianapolis law firm Sommer Barnard PC who works extensively in corporate financings, buyouts and investments, to learn more about what’s driving the private equity boom and how it might impact businesses.
What’s driving the growth in private equity transactions?
In my estimation, it is a confluence of events that has brought the M&A marketplace to a tipping point. We have had a very strong economy for a long period of time. The federal tax environment has never been more favorable, but there is a rush of concern that the new Congress may close the window. The cuts in the capital gains tax, first under Clinton and then under Bush, lit a fire that refuses to burn out, even as we have confronted terror and war. At the same time, interest rates have been low, providing a ready supply of debt capital to finance these transactions.
In the public markets we have seen enormous wealth creation in the last decade, but as returns have leveled, institutional investors have taken interest in the potential for higher returns from alternative investments, including private equity. Corporate profits, for the most part, have been fabulous. Public companies have been making special dividends and engaging in stock buy-back transactions that have fueled the system. All that money needs to go somewhere.
One of the trends now is for private equity firms to buy public companies and take them private. Recent Securities and Exchange Commission rule-making has paved the way for a return of tender offer activity. This all has played right into the hands of the private equity specialists.
There is so much private equity money available for deals, that private equity firms now are often willing to pay more than strategic buyers. Traditionally, it was the strategic buyers who were willing to pay more. In addition, it is now common for private equity groups to move faster and to keep target managers intact whereas strategic buyers tend to be more cautious and immediately want to consolidate.
Are there legal advantages to a public company going private?
The regulatory response to the Enron fiasco, particularly Sarbanes-Oxley, has made it even more burdensome for companies and dangerous for corporate executives to operate in public-company mode. Mix in the growing criminalization of business for example the Justice Department’s ‘Thompson Memo’ that essentially says they’ll throw the book at companies that don’t have a strong corporate governance system, the SEC rule-making and listing requirements aimed at curbing corporate fraud and abuse, the Supreme Court's Caremark decision, activist state attorneys general, and all of private securities litigation going on and you see that, beyond financial considerations, the regulatory environment is a factor in some ‘going private’ transactions.
Will these trends involving Wall Street firms impact the private company marketplace?
If you are asking whether the KKR’s of the world will start to train their sights on smaller companies, I expect so. Today there are many large private equity firms chasing a finite universe of publicly-held companies. I am sure they will continue to look to public companies for opportunities, but I predict they will seek smaller deals, especially if you consider add-ons to platform companies, as time goes on.
If a private company is interested in exploring a buyout, what should it look for in a financial adviser?
An investment banker or financial adviser is essential. If a capable adviser can be found locally, then all the better as personal relationships count, close interaction is required and the focus tends to be more intense. Some advisers specialize by industry. Special industry expertise may be indicated, even if the adviser is remote, but I tend to worry a bit about loyalty, confidentiality and priority with the distant specialist.
Does all the private equity activity dim the outlook for strategic acquisitions?
Strategic buyers have not gone away and don’t count them out. Corporate boards and CEOs want growth. Record profits have generated cash that needs to be deployed. If their prospects for internal growth decelerate, strategic buyers, especially in regulated industries, will continue to seek growth by acquistion. These are heady times.
DONALD K. DENSBORN is a shareholder/director with Sommer Barnard in Indianapolis. Reach him at (317) 713-4402 or email@example.com.