Why private equity markets are on the rise now

By Felix Salmon
April 2, 2011
questions about private equity markets at the Kauffman Bloggers Forum today.

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I got some predictably super-smart reactions to my questions about private equity markets at the Kauffman Bloggers Forum today.

Matt Yglesias said he couldn’t see what the fuss was all about: the SEC was created to protect small individual investors from having access to super-risky companies that disclose highly limited amounts of information, and that’s exactly what it’s done. It’s a good point, especially in the context of another idea, from Steve Waldman, which was echoed in the comments to my post by absinthe.

It’s the concept of the winner’s curse: that it’s maybe no coincidence that the Russian clients of Goldman Sachs who are falling over each other to bid ever-higher prices for Facebook shares are much the same people as the Russians paying $100 million for trophy Picassos, or Los Altos mansions.

The theory here is that Goldman Sachs, SecondMarket and the like have identified a group of buyers who are willing and able to pay through the nose for assets which are rare and special and which few other people can have. So long as companies like Facebook and Zynga meet those criteria, the winners in any auction for their shares are likely to be cursed — or, to put it another way, the final auction price is likely to significantly overvalue the company.

Looked at in this way, the market in private equity is less an opportunity for plutocrats to get excess returns, and more an opportunity for intermediaries to extract large profits by selling them overpriced equity in overhyped tech stocks.

As for the timing of all this, Virginia Postrel said that maybe all it took was one or two companies going this route successfully, and then everybody — both management and investors — wanted to join in the fun. A catalytic event is by its nature unpredictable, but once the idea got out that there was a lot of money and attractiveness in private markets, it became self-fulfilling. It’s important not to use Facebook as an example of what can happen when companies go the private route — especially since recent news implies that it might go public early next year. It really is sui generis. But Facebook can still be an important catalyst, inspiring many others to take a serious look at alternatives to expensive and stressful public markets.

On which subject, many of the bloggers in Kansas City were convinced that Sarbox really is an important reason why public markets have become less attractive. The year 2001, in this view, saw not only the 9/11 attacks, which gave birth to the security theater of the TSA; it also saw the Enron scandal, which gave birth to the regulatory theater of Sarbox.

Finally, Tyler Cowen had a good point: now that the rich are getting richer, it’s easy to see how there might be no need for companies to tap the power of millions of small investors any more. If you can get all the equity capital you need from a handful of plutocrats instead, that’s surely a preferable route to go down. In this view, the rise of private equity markets is correlated to the rise of the international plutarchy. Which makes sense to me.

Update: Here’s the talk, for those of you who want to see the questions as well as the answers:


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I agree with the suggestion of “winners curse”. Even if they were public, I would have no interest in owning their shares at those valuations. Reminds me of the 1999-2000 tech bubble. There were certainly some winners out of that — but how many tech investors ended up making money?

Posted by TFF | Report as abusive

Forgetting Valley Tech, which is its own world, there’s no private equity market for transactions below 25m or so.

You either upsize to 30m or downsize to 5m and pass the hat around.

Posted by davew | Report as abusive

This is a misapplication of the concept of winner’s curse, which would apply in any auction scenario whatsoever. The problem, of course, is how a bidder can limit the harm from being seen by others to have won the auction at an inflated price. One solution, in fact, is to limit the number of bidders who participate in the auction. Private markets like Goldman’s Facebook deal solve that problem, whereas a public floatation would bring in the entire universe of potential investors. So the truth is that private market investors may be willing to allow Goldman an excess participation in the deal in return for keeping out everyone else on the planet (until later).

Posted by xyz70 | Report as abusive