Is private equity in hot water?
Yesterday’s big private equity story was that the SEC reportedly sent “informal inquiry” letters to several firms, with an eye toward learning if general partners were artificially inflating valuations in order to enable fundraising. Unclear exactly what prompted this action, or if it’s related to some irregularities discovered via PE firm registration. Some initial thoughts:
1. I do not believe this inquiry is terribly widespread. Yesterday I spoke with a dozen notable PE firms and three private equity attorneys. None of the firms had received a letter, while none of the attorneys had a client who had received a letter (at least to their knowledge). Maybe the SEC believes such deception is the province of smaller firms with less existing LP goodwill, but it seems impossible at this point to believe this inquiry was launched due to fears of systemic corruption. If that was the concern, wouldn’t the SEC investigate private equity’s leading firms?
2. Three years ago I moderated a private equity panel that touched on the issue of Fas 157, the accounting rule change that required PE firms to mark their investments to market. In response, Marty Mannion of Summit Partners recounted how he walked into a meeting with his auditors, and asked if they had decided which one would be thrown under the bus and into prison. Not because of intentional fraud, but because of the inherent difficulties in marking private assets to public markets. Got a good laugh then. Maybe not so much today…
3. I asked a longtime LP if he believed that GPs intentionally massage the numbers when fundraising. His reply: “I am sure there are many firms that pump up valuations during fundraising, but that could just because they don’t put much effort into valuations in between fundraisings. In any event, it is not a practice that you can keep on doing without LPs who are paying attention figuring out quickly. The way it usually works is that the GPs pretty up their numbers and the LPs assume it’s all a bunch of baloney and the truth is usually somewhere in between. While there are definitely shady practices in the PE world, I am not sure subjective valuation issues are worthy of the SEC’s time and money.”
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