Giving Capitalism a Bad Name
One lesson I learned early in my entrepreneurial adventures is the Golden Rule: He who has the gold makes the rules. And I’m fine with that. I am generally a cheerleader for capitalism, free markets, risk taking, and the failures that often accompany them. But capitalism is not perfect, and one of the things that sometimes bothers me about capitalism is, well, the capital part of it. From Forbes:
Billionaire Michael Dell’s msd Capital and Pegasus Capital bought Monsanto’s Equal business, Merisant Worldwide, for $600 million in 2000 by putting up $160 million in cash and borrowing the rest on Merisant’s assets. Three years later the new owners had Merisant borrow $206 million in new debt and pay the proceeds to themselves; months later they did it again, this time for $75 million. The two moves gave them a 76% profit on their initial investment, while letting them continue to hold 100% ownership.
In addition to egregious abuses like these, price fixing in capital markets has always rankled me. Why is it that – with so many investment banks competing for deals, so much more info now available to investors, more stock exchanges now than ever, and so many alternative financing options – investment bankers always still manage to charge 7% of the gross? Not a very efficient market, eh?
I trust the editors at the Wall Street Journal will offer a clever explanation soon.
April 6th, 2006 at 10:39 am
Hi Derek,
Regarding your comment -
- “Why is it that – with so many investment banks competing for deals, so much more info now available to investors, more stock exchanges now than ever, and so many alternative financing options – investment bankers always still manage to charge 7% of the gross? Not a very efficient market, eh?”
- All the ‘more’ you mention isn’t new, it’s just more. This means that the old processes are just faster and not necessarily better. You want big changes, bring better to the conversation, not faster. Faster’s generally always integrated incrementally, as it can be amortized. ‘Better’ requires that risk be taken on, which is a different type of problem to solve. And note whom you’re suggesting to solve it. Don’t expect the people who created the problem to be the ones that solve it, as they’ve a vested interest in the solution they created…
- The IB ‘market’ may seem curious, but it’s not unusual, just more obvious. As it’s structured, it’s asymetric, with the IB’s holding all of the sym. This means that it’s unlikely to change in response to internal influences, as there are very few incentives for it to change originating internally. It will take something happening that threatens the big rice bowl from outside the market to make that happen.
- But things are the way they are for a reason. This market - like all markets involving money, is *very* conservative - and as a consequence, very relationship driven. Relationships count when it comes to capital formation, as numbers, even audited ones, are still way too easy to manipulate and misinterpret. This leaves about 80% of the due dilgence process outside the numbers, which explains why one of your local (Boulder) VC’s wants to take you bowling and drink with you before he puts money in your company…
- But unlike VC’s, IB’s measure and cut based on risk more so than opportunity. This makes the due diligence process doubly important. Doing due diligence well is real work, for which we generally get paid real well. But I say ‘generally’ as that 7% you mention is referred to as a “success fee”. That means that we only get paid if what we do works, which means we have to kiss a lot of frogs…
- And I agree with your thoughts on Dell & Pegasus, but I don’t see a victim. Even still, that loop hole should be closed.
Best,
Kevin Johansen, Director
Capital Markets Group
KJohansen@CapitalMarketsGroup.com
April 6th, 2006 at 10:54 am
Kevin, thanks for your comments. The fact is that in practically every other market, alternatives erode price. Merrill Lynch transaction commissions are still high, but not as high as they were before Schwab came into being. (And that was only possible when the Congress freed up the market for it.)
IB’s add a lot of value, but like you said, part of the reason they extract such high fees is information assymetry, which has been shown to make markets less efficient that classical economics says they should be.
Re: Dell & Pegasus, I think the victim is the employees. Yeah yeah yeah, their employment is at will and they can always look somewhere else for a job, but I doubt when they interviewed there that this scenario came up.
I don’t necessarily think what they did should be illegal, but it stinks, it’s immoral and at least as much light should be shined on it as all the Michael-Dell-boy-genius stories. Most business people I know aspire to run the kinds of companies detailed in Built to Last, Good to Great, In Search of Excellene and any number of other business best-sellers. This was a willful decision on the part of management to do the exact opposite.