You Should Have Been There to Learn How Eating Too Many Cookies Fed the Economic Downturn
by “Should Have Been There” guest blogger, Larry Blumsack, President, Zoka Institute
If you weren’t at the last Dealmakers Breakfast you missed one of the best tell-it-like-it-is speaker to address ACG Boston. It was Professor Colin Blaydon the founding Director of the Center for Private Equity and Entrepreneurship at the Tuck Business School, Dartmouth College and former Dean of the Business School. With a dry sense of humor he summed up the woes of private equity and the current economic crisis as a dietary issue. He defined it as the “case of eating too many cookies” and blames the problem “on both the servers and the takers.” At the end he lays out a healthy diet for Private Equity.
Blaydon believes that PE is as much at fault as sub-prime for our current downturn. He called it a perfect storm of value creation from 2002-2007 resulting from economic recovery, debt market expansion, LBO expansion and PE industry institutionalization (like Blackstone going public). The result was record setting debt, deal valuations and fund creation. Debt verses equity on deals was as high as 85%. He attributes the collapse in July, 2007 in part to LBO deal flow seize up that spooked short term investors with a limited exits for them because of a frozen debt market. That left PE in its current liquidity crisis often not knowing who is actually holding the debt.
He noted that the primary diligencer from banks changed from ’02 to ’07 from Chief Credit Officer to Chief Syndication Officer. This alone should have been a harbinger of what did happen.
The professor stated that if PE stayed focused on what they do well – strengthen and build companies over the long term instead of flipping companies as quickly as they can – General Partners and Limited Partners would have benefited. This is the focus PE needs now to benefit from an economic upturn. In addition, the financial industry including PE needs to have adequate reserves and be able to accurately set net asset value.
Blaydon went on to say that PE investment has produced healthy returns during each of the three most recent global economic slowdowns. In order to do so, PE needs to have a strong vested interest in the success of their portfolios and be patient for the payout.
He concluded by reiterating his point that every downturn came from a “financial innovation” which is a kind term for smoke and mirrors. He referred to junk bonds, the high-tech boom and the recent disconnection of lending from risk bearing as “financial innovations.” So Blaydon’s word to the wise was beware of the next “financial innovation.”
December 4th, 2009 at 4:10 pm
Great blog to read thanks.