Private Equity (and its Public Side)

Four things matter if you run a private equity firm: deal flow, access to capital, portfolio-company performance, and exit strategies.

PE firms should not be confused with their cousins, venture capital firms. VCs tend to invest in the “next big thing,” a breakthrough technology that creates a whole new market.

By contrast, private-equity—or leveraged buyout—firms look for predictable cash flow in their investments. They want to capitalize their portfolio companies with some measure of debt, and banks and other lenders look to the all-important EBITDA (earnings before interest, taxes, depreciation, and amortization) to know how much money to lend for a particular transaction.

The granddaddy of the local buyout business, leading deals since the 1980s (and active as a VC firm before that), is Norwest Equity Partners (NEP), whose sole limited partner is Wells Fargo. Also prominent are Goldner Hawn, Spell Capital Partners, Stone Arch Capital, and Tonka Bay Equity Partners.

The effects of such firms and their transactions can be wide ranging. First, consider the trickle-down to professional services firms. For each portfolio company, PE firms often pay fees twice—once on the way in, and again on the way out. Investment bankers, lawyers, and accountants all look to PE firms for high-margin, sometimes eight-figure, engagements.

For instance, legal fees paid in the October 2009 IPO of AGA Medical, a Plymouth-based medical-device company and a portfolio firm of New York’s Welsh Carson Anderson & Stowe, totaled about $3 million, according to the IPO prospectus. Unfortunately, that didn’t go to a Twin Cities law firm. Instead, Simpson Thacher & Bartlett of New York collected that particular prize.

Second, the performance of PE firms impacts, at least indirectly, the wallets of all Minnesota taxpayers. The Minnesota State Board of Investment (SBI), to diversify its portfolio, invests in what it calls “equity alternative assets.” They accounted for $4.2 billion of the portfolio as of June 30, 2009, and included venture-capital, property, and natural-resources investments. But the vast majority of the 130-plus names listed in this investment class in the board’s report are PE firms. On the list are a who’s who of the buyout business: Blackstone, Kohlberg Kravis Roberts, and Warburg Pincus, to name a few.