Financial Markets and Institutions (2-downloads)

buyout, instead of a private company going public, a public company goes private.

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Chapter 22 Investment Banks, Security Brokers and Dealers, and Venture Capital Firms

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In a typical private equity buyout, the publicly traded shares of a company are

purchased by a limited partnership formed for that purpose. Since the public shares

are then retired, the firm is no longer subject to the controls and oversight required

of publicly held companies, nor does it have to answer to diverse stockholders.

Advantages to Private Equity Buyouts

Private equity partners and the managers of privately held firms cite a number of

advantages to the private equity ownership structure. First, as private companies they

are not subject to the controversial regulations included in the 2002 Sarbanes-Oxley

Act. Many managers and CEOs complain that meeting the requirements of Sarbanes-

Oxley is frustrating and takes valuable time away from more productive activities.

Second, CEOs of publicly held firms often feel under pressure to produce quar-

terly profits. In a private equity scenario, CEOs frequently have more time and flex-

ibility to enact the changes needed to turn around subpar companies. Instead of

trying to convince thousands of diverse investors of the wisdom of a particular course

of action, the CEO of a privately held company only need convince the managing part-

ners of the private equity firm. This increased freedom has attracted some of the best

known corporate leaders in the country, such as Jack Welch (former CEO of GE),

Michael Eisner (Former CEO of Disney), Louis Gerstner (former CEO of IBM), and

Millard Drexler (former CEO of Ann Taylor and Gap Inc.). One reason top CEOs have

been attracted to privately held firms is that they can be compensated more easily

with an ownership interest in the firms. Typically, executives are recruited with a

small cash salary and an opportunity to invest their own money in the firm, often tak-

ing as much as a 20% ownership position. Some believe this more closely aligns the

executive’s interest with those of the private equity partnership.

Investors in private equity partnerships are well compensated for taking the risk

of purchasing poorly performing companies. Partners typically earn a 1.5% fee for

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