September 6, 2013

Private Equity: The double-edged sword!

When it comes to Private Equity (PE), there can be numerous schools of thought. You have the group that would completely go gaga over PE. You have another that would simply want to wipe off this infatuation from the market. There is also one that would hold PE responsible for failed, inefficient and weak government policies. In India unfortunately, what we have (mostly) seen so far is the havoc that PE has caused. And I clearly see it as one key reason that has snowballed into the economic crisis that we face today.

It was back in 1946 when PE emerged in the American market in its true sense. The era between 1960s to 1980s saw the Vanderbilts, Whitneys, Rockefellers and Warburgs build fortunes in businesses ranging from real estate construction projects to airlines, banking to whatever moved on the streets of Silicon Valley. Running parallel and equally fast was Warren Buffet, who through Leverage Buy-Outs (LBOs) acquired one corporation after another. The US Congress then opposed every change in tax policy that could have made life more difficult for PE firms (the Carter Tax Plan of 1977 was the first of such acts that failed to be enacted). What followed up until 1990 was quite understandable (given the quick, sweet success PE had witnessed in its early years). Thousands of PE labels mushroomed across the globe.

But beneath this rolling of the Red Carpet was a weakly-constructed foundation. Cracks on the PE wall first became visible in the first half of the 1990s. Ills related to the massive rise in leveraged buyouts that were financed by junk bonds led to the-then collapse of the LBO industry. Amidst various companies that went into a tailspin was a big name – Drexel Burnham Lambert. This one company that was credited for the boom in PE back in the 1980s had several allegations made against it. The firm was charged with insider trading and had to file for Chapter 11 in 1990. Thus, one of the founding pillars of PE was turned to dust. Companies and markets across the globe experienced a similar avalanche.
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