Q1. What are the built-in tensions with a public private equity firm? How does Blackstone's structure attempt to reconcile them? 1. Transparency (disclosures of financial statements)
The reason why investors are willing to let the required rate of return decrease is the lower concerns about asymmetric information due to the disclosures of financial statements. In the past, in order not to be subjected to Investment Company Act of 1940, Blackstone once analyzed its operations and concluded that it was not an investment company. The SEC subsequently reviewed the conclusions and did not object. However, if it goes public, it will face problems such as its financial reporting, which should compliant with the GAAP. Therefore, Blackstone hired Jasvinder Khaira and tried to consider the business scope and to create the best business model. Nevertheless, we think that as an IPO company, Blackstone must fully disclose its financial statements and it is also the must-pay and tradeoff to lower the costs of capital. This is also the problem that Blackstone couldn't wholly resolve from purely adjusting the financial structure. 2. Risk of employees resigning triggered from the change of compensation package Before going IPO, underwriters raised the concerns from unitholders: ‘though it will bring benefits to the existing LPs as the managing of closed deals from employees, it may also let them neglect the growth of company from developing new deals.’ Part of carried interests, as proposing closed deals, should be converted into units and withdraw in the coming eight years. As a result, the benefits of both unitholders and employees can be adjusted into the same direction. However, the lock-up eight years of the units will face the volatility risk of stock price, which will also trigger the possibility of resigning trend. Therefore, the management team came up with the idea that the other part of closed deals should be converted into unpaid carried interests, which can be converted into shares immediately without withdrawing in the coming eight years. Then, employees can both care about the benefits of unitholders and LPs. [Note] Additionally, in order to compensate the shares dilution of the existing partners when going public, Blackstone established a pool of unissued shares and kept the shares in the pool at the 15% level of shares outstanding. Whenever employees get promotion in the future, shares will be taken from this pool as rewards and motivation for employees to work hard with the company and lowering the resigning risk. [Note]
The risks of professionals resigning mainly come from the following two parts: (i) Locking up for eight years of all carried interests will let them face the volatility risk of stock price and consider of quitting jobs; (ii) If converting all carried interests into units and vested immediately, employees will cash all of them out from the market and quit jobs as well. In order to get the balance, the hybrid way as mentioned above was adopted. 3. Volatility of stock price
After going public, stock price will be influenced by not only the disclosure of quarter financial reports but also the macroeconomic environment. It may cause the panic to investors as well. Investors may overweight the short-term performance and ignore the long-term value of the company. Blackstone still targeted on the benefits of Limited Partners, which meant it still cared more about the long-term rather than short-term performance. This investment strategy made its short-term profitability more volatile, which could be explained by the essence of private equity. That is, if there is a significant business/case done in one specific season, the earnings of the season will be much higher that the others. As a consequence, the stock price might volatile significantly. To reassure unitholders who might be disconcerted by the unevenness of private equity returns, and the resulting volatility in the stock price,...
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