At the recent Davos forum Stephen Schwarzman, Chairman of Blackstone Group, related an anecdote of a CEO of a $125 billion market cap company wistfully wishing Blackstone could buy his company, but speculating it might be too big. Although the discussion centered on the size and theoretical upside limit on future private equity deals, it was the wrong focus. There is no deal too big, as the subsequent Equity Office Properties and TXU deals demonstrate. The more useful focus should be on how a purchase price could be fairly set, should the unnamed company and CEO decide to pursue the deal. Private equity deals are a nightmarish scenario for little guy individual investors, whose interests in these deals are sold out to modern-day equivalent of robber barons. Now is the time for closer scrutiny by the media, Congress, and the SEC; as well as for private equity to demonstrate wisdom, address legitimate concerns, while acting in their own self-interest.

A bedrock principle for individual stock market investors has been to invest in companies with great managements and financials, and over time reap the benefits of solid, consistent share price growth. But the tremendous availability of global liquidity, resulting in the tremendous size and rewards built into private equity transactions; and human frailty (aka greed) short-circuits this process. They undermine traditional market forces and adversarial relationships that might once have been relied on to reach a fair price. Investors receive the equivalent of token rewards for their patience and get taxed on any gains to boot.

To illustrate, assume a CEO of a major pharmaceutical company has endured 6 challenging years, with blockbuster drugs coming off patent, a lackluster pipeline, and a sea of lawsuits. The company's long standing-shareholders have invested based on the safety of the industry, the decent dividend yield and the proverbial promising pipeline. When that CEO approaches a private equity firm to offer up the undervalued company, what's the sales pitch, and whose interest does he/she represent? The sales pitch is likely a mix of the pipeline's value being underestimated, legal liabilities overblown, potential to pare expenses, and opportunity to heavily leverage the balance sheet that would result in a huge payday in relatively short order. This begs the question why all of this can't occur under the auspices of and benefits to the existing public shareholders. The principle difference is the CEO could make out much more doing this for private equity. But at whose expense?

Sam Zells Equity Office Properties transaction being the extraordinary exception, clearly neither the pharma CEO nor the compliant board of directors can be assumed objective negotiators. After all, the CEO wants the deal completed, remain CEO, and receive the reportedly huge compensation private equity is willing to pay. Nor have directors in general glorified themselves as stewards of shareholder interests in recent years.

Institutional investors, the major shareholders of corporate America, could in the past be relied on to act in their own interest and hold out for a fair price. But they are now major investors in private equity, and might even be benefiting from a successful private equity takeover of their share holding.

Unlike their fellow institutional shareholders, few individual shareholders of target companies have the necessary resources to invest directly in private equity. Gone are the days when individual investors can rely on valuations by "impartial Wall Street firms", a contradiction in terms. Let's also stipulate government cannot decree a fair takeover price. Yet, a mechanism for achieving a trusted fair price is essential for private equity takeovers of ever-larger companies to continue.

Currently the little guy individual investor's only option is to accept the private equity terms - much like AES and Verizon in their negotiations with Hugo Chavez over the takeover of their local subsidiaries, or Royal Dutch Shell and its partners in their Sakhalin Island project negotiating with the Russian government - albeit more velvet gloved. The common denominator in these examples is that, after bearing the major risks, patient investors are foreclosed from participating in future ownership and benefits at what amount to arbitrary prices. In the current "Two Americas" environment, now even acknowledged by President Bush, would private equity really want such comparisons drawn?

A Modest Proposal

To avoid the inevitable calls for government action, here is a relatively simple solution: If the buyer is not a public company whose listed shares can be purchased by the selling shareholders, the sellers should be allowed the option to participate in the private equity deal proportionately, and on the same terms with the private equity investors. Sellers would have the option of accepting the private equity cash offer or remaining as participants in an investment vehicle that represents their interest in the private equity transaction. If a fair price were offered, many shareholders would likely accept it. Having the option to remain in a potentially lucrative deal would eliminate suspicion and rancor. If shareholders opt to remain in the deal, the private equity firm would still make its profits, and would save the buyout cash for use in future deals.

Alternatively, private equity can remain shortsighted, and wait for questions from a hostile Congress and public, such as:

• If the reason to go private is to avoid the costs and aggravations associated with operating as a public company, why is the final payoff the reselling of them back to the public, a reshuffle with much higher debt burdens, and most of the value sucked out?
• With the exception of "efficiencies" gained from asset sales, lowered head counts, offshored jobs, and the replacing of equity with debt, please name other value-added activities contributed by private equity?
• Are there any examples of new products and services resulting directly from private equity stewardship that are commensurate with the financial rewards? What is the correlation between risk and reward in such transactions?
• What exactly have managements achieved under private equity, other than huge payoffs, they couldn't have been achieved as public companies, with benefits shared with the original stockholders?
• How is all this activity good for the American economy?

*A graduate of Wharton, Ernie is a Founding Partner of Catalytic Group, Inc., a Technology consulting and execution firm. A former banker he enjoys writing on business topics and can be reached at ernie@catalyticgroup.com.