Here’s one for Dear John Thain or anybody else wondering about what happens when a private-equity shop buys the debt of its own portfolio companies. Let’s say that the portfolio company in question goes bankrupt, and is taken over by its creditors – who are an arm of the very same private equity company who owned it in the first place. Management stays in place, and the fees remitted back to the private-equity company remain. But at the limited-partner level there’s a world of difference: the first set of equity investors is wiped out, while the second set of debt investors ends up with all the equity upside.
At the general-partner level, you can see how this might be attractive. With valuations falling through the floor, the chances of getting back to breakeven on the equity are slim, and that 20% performance fee is a chimera. But as soon as the debt is converted to equity, it’s entirely possible that the debt-fund limited partnership will make profits, and that the general partners will be able to skim off their 20%. It’s a bit like those companies which reprice their CEO’s options when the stock price falls: the people in charge get a second bite at the cherry.
Do I think this is going to happen? No, not really. But is there any reason why it can’t?