800 Million Euros in the Side Pocket

Private equity firm partners are starting to play games to ensure at least they get paid. Their fund shareholders will howl if this doesn't work out, but hey the partners have expenses they need to pay. Basically, some funds, rather than selling a portfolio company to someone else (such as the public) are selling companies from one side pocket to another. Side pockets hold investments that are hard to value, like private companies, and incentive fees are only paid when an investment is sold and gains are realized:

Look at ProSiebenSat's €3.3 billion ($4.44 billion) purchase of rival European broadcaster SBS. Kohlberg Kravis Roberts and Permira control both. But different pockets are involved. Permira Europe III is the investor in SBS. Permira IV is the ProSieben shareholder. With KKR, there are no fewer than five pockets involved: two are invested in SBS; but three completely different KKR funds have the stake in ProSieben.

The result is that the €800 million or so of profits that the two private-equity firms make on selling SBS can be credited to their old funds. Even if the deal proves a bad one for ProSieben, the money won't get handed back from one pocket to the other.

This is very good for the partners who work for the buyout firms -- particularly when it allows them to cash in their slice of the profits. But the outside investors, the so-called limited partners, need to scrutinize these types of transactions particularly carefully. After all, if things turn sour, they'll be left holding the bag.

So the firm decides that one of their portfolio companies will buy another of their portfolio companies, but who decides the price? Negotiating with yourself can be exhausting, but I bet the price has something to do with the price they paid for the company originally. Just a guess.