Harvard professor defends club deals

In a recently released paper, Josh Lerner is arguing that the US Justice Department’s probe into private equity club deals misses the benefits of such deals.

Amid a US Justice Department probe of the private equity industry, Josh Lerner, the Jacob H. Schiff Professor of Investment Banking at Harvard Business School, has come out in favour of deal sharing, the subject of the probe.

In an article entitled “Private Equity Under Investigation: Justice Department Doesn’t Understand How Industry Works” appearing in the March issue of the school’s alumni magazine, Lerner presents what he argues are the benefits of club deals. Among the benefits, he argues, are the diversification of risks among the club deal participants and the many forms of expertise made available to portfolio company management team members.

Lerner addresses the Justice Department’s efforts to learn whether or private equity club deals are anticompetitive: “Far from being a static industry with ossified giants, private equity features brutal competition and enormous dynamism.”

Lerner notes that firms like Hicks, Muse, Tate & Furst and Forstmann Little & Co. have “dramatically downsized or announced their intention to cease operations after experiencing investment missteps and succession problems.”

Lerner also points to the success of venture capital as a paradigm for the benefits of private equity club deals. Deal sharing is good for investors because it helps them make more informed investment decisions. “Syndication allows venture investors to get a valuable ‘second opinion’ about potential additions to their portfolio,” he writes

It also helps to curb risk, Lerner says, because the firms can commit to more deals. “Syndication allows venture groups to undertake transactions that otherwise they would need to pass on, due to concerns about lack of diversification,” he writes.

Deal sharing also helps the portfolio companies by bringing in more experts. Since firms often add operating partners to the company’s board of directors, increasing the number of firms involved in a deal in turn increases the likelihood of more board members who are experts in the given field.

Late last year the Justice Department sent letters to several large private equity firms, including KKR and Silver Lake Partners, seeking information related to potentially anticompetitive practices.

Despite the Justice Department’s concerns, Lerner is optimistic about private equity’s benefits “to society as a whole.” He argues that “Washington must understand that the many benefits private equity provides by facilitating economic growth are unlikely to be sustained if the heavy hand of government intrudes, whether through litigation or regulation.”