Koch Brothers Fill Wall Street’s Void in Private Equity Lending

  • Internal group of 20 dealmakers steps into void left by banks
  • Identified ‘market need’ after seeing Buffett back big buyouts

Some big corporate buyouts are quietly finding two unusual backers: Charles and David Koch.

When credit markets froze at the end of last year, private equity firm Vista Equity Partners turned to a unit of the Koch empire to help finance its $6.5 billion buyout of software provider Solera Holdings Inc. Koch Equity Development kicked in $800 million in March. Two months later, Koch Equity provided $750 million to enable Apollo Global Management LLC to complete the $12.3 billion acquisition of home-security company ADT Corp.

Charles and David Koch

Source: Getty Images

For the billionaire Kochs, who made their fortune in the energy business, the deals mark a sharp expansion in financing private equity deals. Modeling itself after Warren Buffett’s Berkshire Hathaway Inc., Koch Equity, or KED, has the advantage of access to capital from parent Koch Industries Inc.’s considerable balance sheet.

The timing is no accident. Direct lenders like Koch are stepping into a void left by regulated banks, whose lending has been hampered by tougher capital requirements since the financial crisis.

“We saw that Buffett was deploying capital in ways we thought were appealing and there weren’t a lot of folks doing it,” said Matt Flamini, KED’s president, in a rare interview. “As regulations have evolved, affecting the credit markets, our willingness and capability to invest capital in this manner have grown. We identified what we believed to be a market need.”

Buy Outright

The Kochs, known these days for their conservative political activism, aren’t new to private equity. They first formed the unit in 2002. Its mission then was to find and finance so-called tuck-in acquisitions that fit companies owned by Koch Industries, today the second-biggest closely held company in the U.S.

In more recent years, Flamini said, KED has accelerated its activity in financing buyouts and has also started to partner with other investors to buy companies’ equity outright. The unit doesn’t deploy money from investors, meaning that unlike buyout firms it doesn’t face pressure to show returns in a specified time.

It also has shareholders who “want to reinvest 90 percent of the earnings back into the business,” Flamini said, referring in part to Charles, 80, and David, 76. Each brother has a net worth of $53.4 billion, according to the Bloomberg Billionaires Index, ranking them fifth-wealthiest globally.

Own Forever

“We don’t run 3-year or 5-year models, we run 20-year models” Flamini, 51, said of the transactions in which KED acquires a new business. “Our expectation is that when we’re buying a company, we’re going to own it forever.”

KED’s financing side has gotten busier as private equity firms seek alternatives to banks to pay for their deals. Alternate lenders like KED don’t come cheap. Their terms are typically more expensive than traditional bank loans.

“When the market is sort of frozen, our capital is very valuable,” said Andre Bourbonnais, chief executive officer of Canada’s Public Sector Pension Investment Board, which contributed $1 billion to the ADT buyout.

But some buyout firms have stuck with them, in part because they provide the option to lock in borrowing costs even if credit markets worsen, a protection that banks typically don’t offer. As a result of their popularity, funds that buy private debt raised $85 billion last year, the most since 2008, according to research from Preqin.

“We were able to, in the case of many transactions, lower the prices that we paid and then be very creative about arranging financing,” Josh Harris, Apollo’s billionaire co-founder, said at a conference last month. With the ADT deal, Apollo was willing to accept KED’s “quite expensive” financing, he said, because it allowed the deal to be completed.

‘Sweet Spot’

KED, which has about 20 dealmakers, typically structures its financing by buying preferred equity positions, which are senior to holders of common equity and junior to debt investors. The group’s “sweet spot” is to invest $300 million to $600 million, Flamini said, though it will put significantly more behind a transaction if Koch can reap strategic benefits from the investment, including the potential of later owning the business.

“If we look at the business and see that even with just a preferred equity investment we could learn from this business, or we could pick up some capabilities, or maybe they could learn something from us, then we’re willing to get to the roughly $1 billion range,” he said.

KED’s brand in the market for buyout financing has grown with its deals this year, Flamini said, adding that the group now gets calls from multiple players on the same deal.

“We’re looking at deals of similar size to Solera and ADT,” said Flamini. “Whether we get them across the finish line remains to be seen.”

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