Private equity stubs

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The latest playbook for a private equity buy-out is pretty attractive. Instead of lining up with a consortium of bidders, the preferred option is to buy businesses alone – ensuring full control and 100 per cent of the juicy deal fees that are otherwise shared between bidders. Meanwhile, to secure sufficient equity for big deals, the buyer gets banks to provide bridge equity. That is then parcelled out to limited partners, hedge funds and others. They, in some cases, are charged a “carried interest” fee. In a club deal, that extra carry obviously goes to the other funds instead.

So why is Kohlberg Kravis Roberts linking up with Goldman Sachs to buy Harman International and also offering a stub portion of equity to the audio company’s existing shareholders (who would not be charged carry)?

The link with Goldman could feasibly be because they were both sniffing around Harman and decided to team up rather than compete. The stub equity plan feels like the result of pressure from Harman’s directors. The last thing they want is a shareholder revolt along the lines of Clear Channel. By getting KKR/Goldman to allow up to 27 per cent of the equity in the new vehicle to go to existing Harman investors, there is a fig leaf to hide behind.

The stub will clearly be illiquid compared with regular equity. But there should be a secondary market of sorts. And, in today’s heady environment, there is unlikely to be a shortage of investors wanting a ride with KKR and Goldman without the usual hefty fees. It might not be private equity’s first choice as a structure. But if it helps smooth the way for take-private deals in a more sceptical post-Clear Channel environment, it might just gain traction.

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