Name: Daniel Croce
Company: Birchmere Ventures
I read your piece entitled "Let's be honest about private equity," and thought I'd offer my two cents -- although, candidly, I'm in venture capital, so perhaps my answers won't be directly applicable.
What is the ideal objective of private equity in the American economy?
To a) provide capital and strategic direction to an otherwise underfunded base of entrepreneurs and companies and b) reward investors for their skill in first recognizing value creation opportunities and then capitalizing on those possibilities.
How is private equity designed to meet that objective?
Fund structures are fundamentally designed to reward both limited partners and PE firms for successful investment activity. The illiquid nature of these investments, coupled with the pursuit of J-curve returns in relatively long-term partnerships, fosters an attitude of commitment between portfolio companies and PE firms.Please give specific examples of both how it has lived up to and failed to meet that objective.
Sharp incentives are rounded off by excessive management fees and built-in opportunities for PE managers to"get fat" in a number of ways -- many of which have little to nothing to do with alpha. The creation of external value -- whether to the portfolio company or to the limited partners -- is not necessarily a precursor to the creation of internal value, or wealth for the PE manager.
Examples of the industry living up to this objective are clear and abundant in the successes -- portfolio companies flourishing without massive job cuts, limited partners (in many cases, government entities) obtaining more than satisfactory returns, and PE managers being amply compensated for their skill.
The failures, though, are perhaps more poignant. Many firms in my backyard have invested in companies that are sinking like the Titanic -- not creating jobs but prolonging their inevitable disappearance -- returning a fraction of limited partner investments, and yet earning outlandish compensation in fee arrangements. They are rewarded for misallocating capital and miscalculating risk, while the stakeholders who are perhaps in the greatest need of value creation are left out to dry. What's worse, this reality is typically exaggerated in larger firms -- they have the branding leverage to charge more exorbitant fees, and the political sway to convince limited partners to invest again after sour experiences of lost capital.
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