Tuesday, January 29, 2013

There is No Closing Statement in Private Equity

There is No Closing Statement in Private Equity

If you’ve ever bought a home, you’ve probably received a HUD-1 form at the closing.  The form has two columns of tiny print that detail all of the buyer’s and seller’s fees and expenses in the transaction.  Unfortunately, private equity firms don’t present their investors with itemized statements.  It’s nearly impossible to account for all of the fees because some of them are deducted at the fund level and others are deducted at the company level.  The success of the private equity model depends on the lack of accounting of the fees incurred.  If investors realized that 40% of their equity was paid out in fees in a successful fund, and even 25% in an unsuccessful one, they’d never show up for a closing.

Today we return one more time to the Bain Capital and the Bright Horizon deal.
A few readers have asked me to provide greater detail about my statement yesterday that the banks earned millions in fees for financing the Bright Horizon deal over the past five years.  I’m going to do the best I can to produce a HUD-1 statement for this transaction. 

Org Structure #1 (2008)

Before we dig into the figures, I want to be clear that there’s nothing illegal about the fees that were charged or anything wrong about how Bright Horizon operates as a business.  As far as I can tell, the company has an experienced management and has drawn knowledgeable people to its board.  Bright Horizon is simply an example of how private equity and the banks can sink their teeth into a company and extract fees.  Bright Horizon’s proxy statement when it went private and the recent prospectus are our best sources of data.  However, they are far from comprehensive or transparent when it comes to fees.

We start with the advisory fee paid to bankers by Bright Horizon when the company went public.  Goldman Sachs received about $13.3 million or 1.2% of the sale’s price.  However, because of all the entanglements between Goldman, the company, and Bain, a second banker, EverCore, was hired to also advise the company’s board.  EverCore received at least $3 million, and the board had discretion to pay them another $5 million if they so desired.  We don’t know if EverCore got its bonus.  Presumably, an investment bank represented Bain and its investors, and its fees of perhaps 1% or about  $7 million were charged to Bain Capital Partners X (the fund).  In summary, the advisory fees on the transaction to take Bright Horizon private might be anywhere between $21 million and $28 million.  In exchange for these fees, the parties received guidance on the appropriate price for and structure of the deal.

Next, the deal required debt financing, and, once again, Goldman Sachs stepped up to the plate.  In fact, two affiliates of Goldman Sachs provided all the borrowing.  GS Credit did the senior lending, and GS Mezzanine V did the riskier bits of the subordinated debt.  The two Goldman entities charged a variety of different fees, including a facility fee, an annual administrative fee, and an unused commitment fee.  The components aren’t itemized, but the total came to $27.1 million plus another $2.3 million to finance an acquisition in 2012.  Lawyers, accountants, and printers earned another $2.4 million.  These fees are designed to pay the bank for analyzing, structuring, and administering the loans.

Finally, there’s $15 million in underwriting expenses that will be paid to Goldman and the other underwriters for the IPO.  These fees compensate the banks for underwriting the IPO, paying commissions to brokers, and cover a variety of other expenses.  When we add the three components, investors have incurred between $68 million and $75 million in fees to bankers, lawyers, and accountants.

As I noted yesterday, Bain has earned two fees: one from its investors and the other for advising Bright Horizon.  These two fees come to about $67 million.  This means that Bain’s investors have incurred about $125 million so far on their $640 million investment, or roughly 20% of their capital.  I’m sure my numbers are off a bit since I had to make a bunch of guesses.  But I also know there were a variety of due diligence expenses and other advisory services that I haven’t unearthed.  The table below is a summary of all the estimated fees and expenses associated with Bright Horizon going private in 2008 and public again last week.

Believe it or not, investors aren’t done paying fees, because their profit in Bright Horizon is still unrealized.  Bain will continue to charge them a management fee, and the banks will charge a hefty fee to sell the shares at some point.  Not all deals are as successful as Bright Horizon, and thus the burden of fees, both seen and unseen, sink most private equity funds.  As long as investors tolerate this investment model, private equity partners and investment bankers will continue to live large on their fees.

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