If recent stock market rises give the impression the worst of the financial crisis may be over, get ready for more possible shocks. This time, however, the potential for a fresh crisis comes from the private equity world. Just like hedge funds, private equity epitomised the excesses of the boom years. And the implications for the Gulf can be serious because private equity funds were popular for a while among some investors and institutions in the region.
In essence, private equity firms buy companies using high levels of debt. Sometimes, the executives would also use the borrowed money to pay themselves hefty bonuses. Some may have taken profits from the companies they bought to repay the debt. That is good. Others might also have injected some of the borrowed money into the purchased firms. That can be good, too. The point is, it works in different ways, except for one thing: in all cases, it involves borrowed money loaded on to the leveraged firms that are acquired. Some leveraged buyouts carry debt of 20 times the firm’s annual profits, which is not a healthy sign even in good times.
For investors in the private equity funds, there is another issue. If they, too, had borrowed heavily to participate in the funds, they would find it difficult to liquidate assets in a distressed market to service their debt. But if they didn’t, there is at least one less worry.
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