Just Asking…

Earlier this year, there was lots of talk about how private equity firms were buying up discounted debt in their own portfolio companies. Leaving aside the now-obvious pricing folly, here is my question: How are firms going to handle the obvious conflicts of interest?

For example, imagine Turkey Capital bought Gobble Corp. by using capital from its third fund, and debt from a syndicate of Wall Street banks. It later raised a “corporate opportunities” fund to buy distressed debt, and spent some of that money on Gobble Corp. loans. Today, Gobble Corp. is struggling to meet the interest payments on those notes. Where does Turkey Capital stand?

If Turkey Capital’s third fund and corporate opportunities fund do not have the exact same limited partners, then it has a giant conflict of interest. Any action taken to benefit one of the funds could have a negative affect on the other fund, which means that it would be effectively favoring certain LPs over others. Maybe the two vehicles have “independent” advisory boards and/or management committees, but how independent can they be while operating under the same brand.

Kind of reminds me of that old case where the State of Connecticut sued buyout firm Forstmann Little, over an old telecom investment gone bad. Gist was that Forstmann had bought the company with one fund, then recapped it out of a subsequent fund. Connecticut sued, because it had only been in the first fund. The two sides ultimately reached an out-of-court settlement requiring that Forstmann Little pay Connecticut $15 million, plus return another $1.2 million it had withheld from the state to cover legal expenses.

Not exactly apples to apples, but it’s the anecdote that came to mind…