Something in Common? Private Equity & the Surety Market

There is a strong stigma surrounding private equity, which places blame on the industry for over-leveraging companies resulting in bankruptcies. This has led to a large distaste for private equity and many to label the industry as predatory. Sureties have been no exception to this phenomenon and traditionally have looked at private equity owned entities with skepticism, but is it fair?

While I am not unaware of my own personal bias, from my experience in my 4+ years in the private equity industry, I found the opposite to be true. While part of the strategy of private equity is to use leverage to increase returns, often the worst possible scenario was over-leveraging a company, leading to bankruptcy. I know that countless hours of time are invested in determining what level of leverage a company could support and countless hours are spent war-gaming out what to do in times of financial stress - all with one goal: avoiding bankruptcies.

Now that I’m on the outside serving the PE companies rather than working for one, I was curious if my experience was unique to my former employer or if it largely held true across the entire industry. Were the critics correct or does PE just get a bad rep?

It turns out, unsurprisingly, I am far from the first person to ask this question. Professors Edie Hotchkiss (from UVA’s McEntire School of Business), David Smith (from Boston College’s McIntire School of Commerce), and Per Strömberg (from Stockholm School of Economics’ Institute of Financial Research) authored a paper on this exact subject called, Private Equity and the Resolution of Financial Distress.

The professors looked at 2,156 PE firms that obtained leverage loan financing between 1997 and 2010. Their research showed that, “PE-backed firms are no more likely to default during this period than other firms with similar leverage characteristics.”

The professor’s findings went even further though, “When private equity-backed firms do become financially distressed, they are more likely to restructure out of court, take less time to complete a restructuring, and are more likely to survive as an independent going concern, compared to financially distressed peers that are not backed by a private equity investor.”

A worst-case scenario for a surety is a situation where a company goes bankrupt and the surety has to spend financial resources on legal teams to battle for compensation in bankruptcy court. The ability to negotiate outside of court and have a company maintain the ability to fulfil its operational obligation is always the preferred route. It turns out that private equity firms and sureties share that same mutually beneficial aim in the worst-case scenario.

When I joined R&P, I set a goal of aiming to not only educate the private equity market on the benefits of surety, but also to educate surety markets on the benefits of private equity. I believe there is a large value proposition for both sides of the equation and am excited to work with PE firms and our surety markets in the years to come on ways to save costs, free liquidity, and add value to all of our partners.

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