Wednesday, August 01, 2007

Private Equity IPOs

Private equity seems to be all over the headlines these days, with a range of issues coming to the fore. I'd like to focus here on the issue of private equity shops going public. To me, the rationale is very weak. One of the fundamental reasons why private equity firms add value is their superior model of governance and control. As I have written previously, private equity firms have expanded rapidly, in part because they solve some of the governance problems posed by the large publicly traded corporation, with its separation of ownership and control. In short, I believe the ownership and governance structure of a private equity firm has the potential to dramatically reduce agency costs relative to a publicly traded firm.

Going public changes things significantly. For years, strategic management scholars and consultants have argued (and shown empirically) that conglomerates (unrelated diversified firms) trade at a discount, that they are worth less than the sum of their parts. You all know the reasons - they have been well-articulated over many years. Well, if a private equity firm goes public, then precisely what is the difference between it and the typical conglomerate? The private equity firm begins to look much more like the usual unrelated diversified firm. A private equity firm no longer can argue that its governance structure poses a substantial advantage over the old style publicly traded conglomerate.

I have heard many of the reasons why private equity firms are going public, beyond the fact that it offers an opportunity for enhancing personal wealth. Access to capital, ability to recruit and retain talent, management successsion... none of these seems like a persuasive argument. These firms have been wildly successful raising capital and attracting talent, while remaining privately held. Even if there were some advantages to going public, they must be weighed against the substantial disadvantage outlined here with respect to agency costs and corporate governance. To me, those disadvantages clearly outweigh the possible benefits of conducting an initial public offering.