Carmina Burana & HMS Pinafore
Management speak v Plain Speaking

The benefit of gearing

Interesting article in the press this week about Private Equity.   And there have been plenty recently that haven't been.    Basically it suggested that debt is not all bad.  Yes private equity investees don't pay much corporation tax as all the taxable profit is mopped up by the interest,  but the shareholders - and this is often our pension funds - sweat more value.   Now don't get me wront this isn't all good - it can lead to disfunctional behaviour in the business which is being run for very short term cash,  and if interest rates rise too far it could all fall out of bed. 

However an interesting contrast can be made with the quoted sector.  The FTSE 100 has net debt less that one times operating profit.  Private equity deals go up to eight times!  Different ownership shouldn't imply a completly different funding structure.    The suggestion was made that quoted company directors are now so focussed on corproate governance as to be risk averse.  When a cash bid is made they take it, bask in glory and move on to another nice job in the city.    What puzzles me is that the pension funds invest in both sectors.  At the private company end the same principal applies, a bit of debt is a relatively cheap was to fund expansion to grow the value of the shareholders equity.    But I've seen plenty of very successful private companies that have never borrowed.  I guess its all down to attitude to risk.


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