A recent article in the Financial Times, “Private Equity Steps Up The Pace of Pass The Parcel” (Wednesday, June 18, 2014) shows an interesting trend that may affect fund of funds specializing in the private equity asset class. Anne-Sylvaine Chassany reports that the percentage of reported M&A transactions that private equity firms are completing with each other has risen from 7 percent in 2007 to more than 33 percent of the transactions announced so far in 2014.
The implication for families that are participating in large fund of fund vehicles is that you may be both a buyer and seller of the same company. Unfortunately, it is unlikely that both sides of the transaction will work out. Ms. Chassany reports that CVC Capital Partners and Leonard Green acquired Advantage Sales and Marketing, a California marketing agency for more than $4.0 billion at a multiple of 13x 2014 projected EBITDA. The Seller, Apax Partners, is projected to quadruple its equity.
So a fund of funds that owns a stake in both buyer and seller would be incurring a carried interest fee to the seller and then a management fee and possible future carried interest fee to the buyer.
This also ignores the real risk that at 13x the business has been priced to perfection. The likelihood that both buyer and seller will achieve comparable returns at this nosebleed transfer price seems remote.
That said, the practice of “passing the parcel” itself can make sense where the buyer and seller are each adding value as in the case where the seller acquired the business in a carve out transaction and added value by making the business a standalone entity. A subsequent sale to a private equity owner with a platform investment in the same industry could produce win-win economics.
The large amount of dry powder and buying power in the hands of private equity is only likely to accelerate the trend of selling to each other. It probably makes sense to look at how you are participating in the private equity asset class to determine if your approach is subject to unintended double dipping. You may also be buying what your alter ego is selling.
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