Friday Letter Constructive criticism

Mega-buyout chiefs have been conference hopping across the Atlantic the past two weeks, proffering candid, sometimes controversial views of private equity’s pros and cons. It is all part of a healthy discourse on the current state of an evolving asset class.

Hindsight is 20:20, as the famous phrase goes. We’ve been treated to a lot of it lately from private equity chiefs.

One example came this week from Guy Hands, founder of buyout house Terra Firma, who criticised the boom-time private equity practice of “pass-the-parcel” deals, or secondary buyouts. “We saw an increasing number of pass-the-parcel transactions between general partners, where limited partners essentially retained the same asset while paying fees and carry each time it changed hands,” Hands told an audience in Berlin.

Meanwhile, Carlyle Group co-founder David Rubenstein highlighted errors made by both bankers and private equity firms in terms of the vast amount of capital deployed during 2005 to 2007 in deals characterised by high multiples and large leverage ratios. “I analogise it to sex,” Rubenstein said in an off-the-cuff speech in New York last week. “You realise there were certain things you shouldn't do, but the urge is there and you can't resist.”

Rubenstein’s choice of analogy raised some eyebrows, but his candour is commendable. 

While some will argue the industry cannot afford to admit it used tactics it now deems questionable, comments like Rubenstein’s and Hands' are an important part of the asset class’ evolution. Analysis, self-criticism and dialogue – things that many GPs have ignored in the past – can provide a foundation to teach up-and-coming managers to avoid the repetition of past errors.

Constructive criticism also spurs creativity, a trait Henry Kravis singled out on Wednesday as crucial for any private equity firms that hope to survive this market dislocation. “You have to think out of the box about our business and recalibrate it,” the Kohlberg Kravis Roberts co-founder said, acknowledging that leverage will be scarce and deals smaller going forward. “All of us will have to adapt. We have to change the way we do business. If we don’t, we simply will be left out.”

Candid debates about private equity’s pros and cons – and how best to affront changing market dynamics – are also healthy for the industry's observers. KKR advisor George Fisher last week highlighted the industry’s continuing PR problem; seeing private equity’s leaders publicly discuss past shortcomings and future strengths may have the added benefit of demystifying and humanising the industry for a wary public.

To be sure, and as we suggested in our last Friday Letter, conference talk alone is not going to fix the financial crisis, nor deposit private equity back into a boom. But pooling frank assessments of the industry’s past pitfalls and future potential is an important step for an asset class facing the most complicated challenge in its short history.