Archive for March, 2014

PRIVATE EQUITY: how do they behave after the money arrives? (I)

If an entrepreneur gets a loan, nobody appears at the next board meeting. Private equity firms (PE) do, as their aim is creating value through deal management and governance.

  • As for “Deal Management”, authors refer to all formal and informal processes through which PE generate value. It distinguishes PE investing from other types of investment, not so active in nature.
  • As for “Governance”: we refer to the systems to ensure execution, accountability and ownership mentality.

a) Creating value takes many forms:

• Assisting management for better implementation of an existing strategy, for instance adding talent.
• Changing the strategy: sometimes for a more focused growth, that allows to free capital then used for paying down debt or other purposes.

b) Governance leading to value creation stems from the board; in PE, boards are made of investors, management and outsiders. Corporate governance details are negotiated with the deal; investos use to control the board through sheer numbers or special voting rights. And the board has fiduciary duties to shareholders, all of them represented, (unlike public company boards, where shareholders are dispersed, passive and not represented). Private equity boards are active, ty between shareholders, board and management, so that governance is strong.

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What do Buffet and Munger say (and do) about corporate governance?

Every year before Spring arrives, we use to find some interesting readings about Berkshire Hathaway`s shareholders meeting, the company investment decisions or views, and some other topics. In this post I will choose one of the more relevant themes Mr. Buffet and Mr. Munger refer to when they describe their management style and investment decisions: Corporate Governance Buffett and Munger`s preferences.

In June Rhee`s post in Harvard`s blog, (1), Mr Buffet`s choice when addressing corporate governance is described; it should be noted though that we are talking about firms where there is a controlling shareholder, (BH), so that the main conflicts are the choice of a Ceo, compensation, minority shareholders and others.

The first Buffet`s concern is communication between managers and shareholders; messages must be sent in simple language and relate to facts, with no predictions. Secondly, he is not interested in complex organizational structures, but in recruiting honest, capable, and hard working managers, and particularly in the case of Ceos, (their performance is difficult to isolate and there is no one senior to them). Third, directors need to be chosen for their savvy and owner orientation, as their main function is to select the best Ceo and to oust him in case expectations are not met. According to Buffet, other assets, such as independence or diversity, are not valuable by themselves. Read more…