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Thursday, March 01, 2007


Scott Peterson

Thanks for the link to this paper. My interpretation of the paper's results is that the mechanics of buyouts can be fine-tuned so that a buyout firm generates increasing profits as it gains experience, while the same is not true of VC's. This makes sense to me as VC's generally are investing in technological advancements where forecasting which companies will become blockbusters isn't possible.


SP: "My interpretation of the paper's results is that the mechanics of buyouts can be fine-tuned so that a buyout firm generates increasing profits as it gains experience, while the same is not true of VC's."

Let's not forget that the two are fundamentally different businesses. That is, each of the two business models is unique.

VCs put "make or break" money into the business, expecting to lose all of it if the venture fails. The BO business buys a business asset that, even in failure, has a residual value. Not only, but it obtains a business that is imperfect (obviously, or it would not have been for sale) but perfectible.

Consider the different risk factors:
- the VC funds a venture based upon an unproven idea that could open up a huge market, which (were it the first to market) could lead to very, very large revenues before competition reduced margins. It could also fail utterly.
- the BO buys a business that is proven but failing for a variety of reasons. Pruning both the workforce and the non-functional divisions, by newer and more competent management, can often return the business to profit. Besides, frequently, there is estate value if nothing more than property that has resale value. The investment is rarely a completely total loss.

It is no surprise therefore that the BO cannot take previous experience and apply it to new ventures. Neither is it a surprise that VCs are much more limited in that latitude, given that each new venture is a business model with unique market parameters.

So, it is not a surprise either that VCs are and will remain a high-risk business not for the faint of heart.


typo: It is no surprise therefore that the BO CAN take previous experience and apply it to new ventures.


Unfortunately, the question that remains is... how cyclical is the BO business? And how dependent on current interest rates? Leveraged buyouts, turning share capital into debt capital are common features of the BO boom. Trouble is, debt is mostly popular because of low interest rates. If interest rates are reliably low for the next 10 years then this will turn out to be "prescient work by the Invisible Hand, restructuring the economy to take advantage of new financial conditions" but if interest rates prove to be volatile, then the whole BO boom will look a lot more like failed financial engineering that destroyed enormous amounts of wealth...


Given the levels of unemployment both in the US and Europe (where the money is being borrowed), and the dollar depreciation, I doubt the BO binge is over for the moment.

With the dollar as it is, many Yank PECs are looking outside the US for opportunities. I hear that several American PECs are very active in real estate in Europe and particularly Paris. The deals are very lucrative.

There is also the fact that there are a good many "opportunities" in Europe of companies that are ripe for a takeover - they are neither bankrupt nor about to go bankrupt, but they are not doing at all well. Many are looking desperately for a buyout from local sources and getting no where.

European banks are not risk-prone. So, the American PECs have taken their place. The outcry at dismissals is locals, makes the nightly news, but the culprits are far, far away. A local PEC would never get away with a BO that dismissed people.

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