Could the acquirers become the acquirees? I’ve heard rumblings of private equity consolidation for a few weeks now, stemming from research done by law firm Simmons & Simmons. The study found that 79% of 700 surveyed PE pros expect increased consolidation in 2009.
I dismissed this as unlikely, but the topic continues to surface in conversations. There even are some trader rumors that Blackstone and KKR could acquire 3i. Would struggling buyout firms really merge with each other? At the very least, the image of PE pros nervously biting their nails in fear of a hostile takeover is ironic, since they’re usually the ones inflicting such fear on public company employees.
Either way, there are several issues with this idea, which I’ve laid out in a nice little list.
There have been very few mergers between private equity firms. The handful that I can think of are bolt-ons for the purpose of strategy diversification, like Blackstone Group’s purchase of GSO Capital and Ripplewood Holdings’ combination with MidOcean Partners.
One of the only instances of combining both names and operations was Apax Partners’ 2005 takeover of Saunders Karp & Megrue as a way to expand its U.S. buyout breadth. Saunders Karp & Megrue’s legacy funds are still in operation, but subsequent funds, operated by the combined team, were raised under the Apax name.
There’s also the Bain Capital and Hellman & Friedman’s attempted purchase of Neuberger Berman, a situation in which a private equity firm would have resided in the portfolios of two other private equity firms. I have no idea how to categorize that.
Merging an existing fund would be so messy as to be impossible. How would you cut up the carried interest? How would you value the portfolio in a way that is fair to new and existing LPs? How would you ever get unanimous LP approval? The only way this would work is to merge the firms, leave the existing funds as they are, and re-brand any new, combined future funds. Even then you would need to be careful to follow the LPA restrictions on who is managing the fund.
Private equity is a people business, plain and simple. The merging of private equity firms could only work if they are firms that have invested alongside each other regularly and like each other. Note that one doesn’t require the other. Otherwise, the acquirer could end up losing the very thing it purchased: the talent.
Look no further than the Apax Partners/Saunders Karp deal for proof. Not long after the deal closed, Alan Karp, who had become the firm’s Co-CEO in the merger, and U.S. consumer head Chris Reilly left to form a new middle market buyout shop. (That firm, called KarpReilly, is raising $250 for its debut fund. Read more on that here)
Compare the private equity ego issue to that of law firm mergers. Law firms seem to merge all the time, and partners bounce around between various law firms. They don’t have carried interest or non-compete clauses in their contracts. From what I hear, if a high level PE partner leaves, it better be to start his own firm, otherwise the move will be viewed as a downgrade.
How do you sell a merger to an LP? Not unlike the CEO of a public company sells his or her shareholders on the company’s latest acquisition. If we’re talking about the “umbrella” merger mentioned above, there shouldn’t be a problem. Nothing has changed except the firm will save on back-office costs. If it’s a merger where future funds are a combined effort, LPs could bristle. One LP said the sales pitch would have to go something like this: “In connection with our key person transition strategy, we want to merge to gain economies of scale, have more capital, and potentially lower our management fee. Since we’ve co-invested for years with FirmX, this merge will simply be an extension of what we’ve always been doing.”
So the benefits seem to be twofold: Cost savings on back-office operations and transition strategy. Now that IPOs are out of the question, a merger might be a good way to let key men cash out and set up their exit strategy. But do the benefits of outweigh the headaches?
In conclusion, I’d like to quote a PE lawyer on the topic. He said, “The merging of private equity firms would be like the mating of turkeys and ducks: interesting to watch, but unproductive.”
** One Caveat: The survey I referred to above seems to lump hedge funds and private equity firms together. Because it is more liquid, a hedge fund shakeout and consolidation seems easier to imagine. But can we learn to distinguish between the asset classes already? It’s like talking about the media industry without distinguishing between new media and traditional media. There is overlap, and many companies do both, but they are not the same thing. There is hope, though. When I Googled “mergers between private equity firms,” the search engine recommended I also try “difference between private equity and hedge fund.” At least this shows people are trying to learn the difference (or recognizing one exists). Unfortunately one of the top results for that search is a Wikipedia page that doesn’t do much to distinguish the two.