How Rotten Behavior by One Buyout Shop Spoiled an Opportunity for All Other PE Firms

One bad apple really can spoil the whole barrel.

That was the gist of my thoughts after meeting an executive a few weeks ago. I was at a private equity conference where the exec, who is the president of a chemical company, loudly proclaimed that he wanted nothing to do with PE.

“Why?” I asked.

“They’re a–holes.”

I asked why he felt that way. In the 1970s, the exec and two college buddies started a chemical company in the Midwest. The company did very well, and, in 2007, his two friends wanted to cash out, he says. One wanted to retire and the other wanted to work part-time. The exec was willing to stay on another five years and manage the company, so he decided he would buy out the other two.

“This is what happens to privately held companies looking for liquidity,” the exec says. “Everyone starts together with a common purpose, but then after 30 years you need to decide what to do.”

Each of the three partners owned one-third of the business. All three agreed that PE would be a good way to help the exec finance his buyout.

The partners hired a financial advisor and put together a book. They spoke to five different PE firms and selected one. All of the parties, including the PE firm, agreed to the terms of a deal. The exec would buy out his partners with backing from the PE firm. Once the deal closed, the exec would see his stake increase to 49% from 32%. The PE firm would own 51%.

Once the PE firm realized how motivated the other two partners were to exit the business, it switched tactics, the exec says. The private equity firm abandoned its plan to back the owner and instead sent a letter to all the shareholders. “They decided they were going to buy out my two partners and do a hostile takeover of the company,” the exec says.

The partners of the company were surprised by the attempt, the exec says. The PE firm was trying to double-cross the exec, who had invited them into the negotiations. The PE firm was also violating the confidentiality agreement it signed, the exec says.

All three of the partners refused to sell out to the PE firm. “We circled the wagons,” the exec says. “Anyone who would treat partners of 32 years like this, we would never [deal] with them.”

Once the three partners refused to sell, the PE firm slinked away. (No lawsuits were filed.)

Four years later, the chemical company has weathered the economic crisis without laying off any employees, the exec says. In fact, it has doubled in size and is once again looking at liquidity options, he told me. The company is exploring a public offering or selling out, he says, but PE firms aren’t on the list of possible buyers.

“I could never get the shareholders to turn over to private equity because of the experience we had,” says the exec, who is now 63. “I could never do it. We unfortunately saw the worst behavior. They didn’t even respect the agreement they signed. Making a buck was much more important than being honorable business people.”

With such hatred for PE firms, why, then, was this exec at a private equity conference?

He told me that as a potential seller he needed to see what was happening in the marketplace. “The conference gives me an opportunity to see what is going on.”

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1 Comment

  • As a former sell-side banker I can say candidly that this kind of behavior is standard operating procedure for private equity firms. Ethics and common courtesy dissolve and oral understandings and handshake agreements aren’t worth the paper they’re written on. Bait-and-switch is the order of the day. I have personally seen private equity partners exploit the courtesy of use of a CEO’s office to go onto her computer, find her personal diary, and use its contents against the company in negotiations. I have seen attempts to limit my fee in a substantial proportion of term sheets. Post-closing treatment of minority holders is so often abusive as to become trite.

    Frankly, this CEO and his financial advisor committed the common error of surrendering deal control to a single bidder early in the process and validating that bidder’s efforts to establish trust. The only way to experience good behavior is to enforce it by actively controlling the process, cultivating multiple simultaneous alternatives, anticipating the worst, and actually ejecting miscreants from the process.

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