Debt and Equity

Jon Moulton, one of the stalwarts of UK private equity and founder of Alchemy Partners, makes some interesting comments on debt and equity today. He believes that it is unethical for private equity companies to buy debt in companies whose equity they already own. The recent credit crunch has left banks desperate to sell difficult loans, many of which have been snapped up at significant discounts by private equity companies. That is good on the face of it as it provides some oil to a seized up financial system. However, in some cases, the private equity firms are already shareholders in the companies whose debt they are buying. This means that, as debt holders, they can block the other debt holders from enforcing a debt-for-equity swap which may be detrimental to their equity holding.
He also believes it is unfair to the investors in the private equity fund. If you buy debt at 90p in the pound, your potential gain is limited to 10p. If you buy equity in a distressed company, on the other hand, your potential upside is unlimited. The reason that people invest in private equity funds is to make significantly above-average returns.