Money Stuff: Buy Low, Sell to Yourself

If you run a private equity fund, and you buy a company for $2 billion, and you do a good job sprucing it up and you sell it for $3 billion, then you get paid. Customarily you collect 20% of the increase in value, or $200 million, as a performance fee (or “carry”) for your work: The investors (or “limited partners”) in your fund made $1 billion, and you get 20% of their gains.

On the other hand, if you buy a company for $2 billion, and you end up selling it for $1 billion, then you generally collect about $0 in carry. You don’t starve or anything — you collect various other fees along the way, and presumably other companies in your portfolio did better and earn you carry — but this one gets you nothing.

If you buy a company for $1 billion, and then sell it for $1.5 billion, you collect $100 million in carry.

If you:

• buy a company for $2 billion,
• sell it for $1 billion,
• buy it back for $1 billion, and
• sell it again for $1.5 billion,

How much carry do you collect? A possible schematic answer is “$100 million”: You collect zero for buying at $2 billion and selling for $1 billion, and then $100 million for buying at $1 billion and selling for $1.5 billion, and zero plus $100 million is $100 million. Notice that in this scenario your limited partners have collectively lost money — they bought at $2 billion and sold for $1.5 billion — and you have made money, oops.

This analysis is rarely correct, for various important reasons. One is that I am assuming that you never get “negative carry” — you don’t pay $200 million when you buy at $2 billion and sell at $1 billion — and in the case of a diversified private equity fund that is not really the case. You don’t write investors a check for $200 million when you sell the company at a loss, but you generally earn carry on your fund, not on individual investments, so if you lose money on one that offsets the profits you make on others. [1]  (In particular, in my example, if you do all the buying and selling within a single fund, then it collapses into “you bought at $2 billion and sold at $1.5 billion,” earning no carry.)

Also you are not actually in the business of constantly trading in and out of the company at different prices. Much of the point of private equity is that you do not constantly mark your assets to market; you (try to) buy when assets are cheap and sell when they’re expensive, without worrying about fluctuations along the way. Selling at the lows to reset your carry is not really how private equity works.

Also, you have fiduciary duties to your limited partners to treat them fairly, and this seems pretty sketchy. In particular, in my schematic trade, if you replace “$1 billion” with “$500 million,” or “$0” for that matter, you make even more money for yourself (by resetting your carry threshold to an even lower level). You have an incentive to price the company as low as possible for your near-simultaneous sale and buyback. But you can’t just do that; you will need to persuade your limited partners that the selling price is fair.

Still the schematic trade is something to keep in mind. It used to be that the business model of private equity was (1) buying companies low, (2) sprucing them up for a few years and (3) selling them high (back to the public markets in an initial public offering, or to a strategic buyer). Increasingly, though, companies have stayed in private-equity hands for longer periods, and private equity sponsors have raised “continuation funds” to buy companies from themselves. That is, the sponsor raises a fund, it buys a company, it holds the company for five or seven or 10 years, everyone gets kind of antsy, and the sponsor raises a new fund — at least partly from different investors — to buy the company from the old fund. 

What is the price that the continuation fund pays the old fund to buy the company? Well, it depends. But the private equity sponsor has some obvious conflicts of interest. Every extra dollar that the old fund gets comes out of the continuation fund. Which way does that cut? Again, it depends. A high price might crystallize a big gain (and a big performance fee) for the old fund; it might reward favored investors in the old fund; it might allow the sponsor to report good results when it raises its next fund; the sponsor might have a lot of its own money in the old fund and want a high price. A low price might usefully reset the carry on a losing investment; it might reward favored investors in the continuation fund; the sponsor might put a lot of its own money in the continuation fund and want a low price. The point is that it would be weird in general for the sponsor to have no bias, to be completely indifferent about the price at which it sells a company to itself.

There are ways to mitigate this conflict — getting fairness opinions, getting outside bids for the company, giving limited partners a vote to approve continuation deals, letting limited partners in the old fund roll over into the new fund without resetting their carry hurdles, etc. — but, still, there is perhaps a trade here.

At the Financial Times, Antoine Gara reports:

One of the world’s largest sovereign wealth funds is suing a US private equity firm, accusing it of attempting to short-change investors on the sale of a portfolio company to another one of its funds.

The Abu Dhabi Investment Council is seeking to block Energy & Minerals Group from selling its stake in Ascent Resources, one of America’s largest private gas drillers, to one of the private equity firm’s sister funds. The sovereign fund alleges the deal undervalues Ascent while generating a windfall for the new fund managed by EMG.

The wealth fund said in a court filing unsealed on Wednesday: “Defendants are trying to force a conflicted sale of EMG fund assets to a continuation vehicle to reap a massive benefit for themselves at the expense of ADIC and the other investors to whom defendants owe fiduciary duties.” …

An investor in Ascent Resources told the FT they believed the gas driller was worth more than $7bn when including debt. But EMG’s continuation fund plans to buy its over 30 per cent stake in Ascent at roughly a $5.5bn valuation, leaving investors with lower proceeds than what they believe they could get from an initial public offering or a sale to a third party. EMG is also asking to pay its investors over a two-year time period, further lowering the present value of the proceeds, they said. …

A continuation fund deal would increase EMG’s ownership in Ascent and restart its ability to earn management fees and potentially lucrative performance fees if the driller’s value rises in the coming years.

Here is the (redacted) complaint. The gist of it is that, in this case, EMG had incentives to make the price as low as possible. For one thing, “the proposed CV Transaction involves EMG rolling over … its own capital into the CV and investing … additional capital,” so the lower the price the continuation vehicle pays, the better for the sponsor. (“CV” stands for “continuation vehicle.”) For another thing: 

If existing investors elect to rollover (and are not caught by the cap on rolling investors), the CV Transaction will require them to pay fees and carry to EMG, despite EMG currently being entitled to little or no fees or carry because investors have already lost substantial amounts on their EMG investments. This again departs from customary industry practice, where a continuation vehicle transaction would not typically impose substantial new carry requirements on existing investors who have lost significant value already.

One general problem in selling a company (or, here, a big stake in a company) is that you want to tell the buyers that the company is very valuable, while also telling the sellers that it isn’t. A few months ago, we talked about that problem in public-company mergers: A shareholder of a public company sued its board of directors, alleging that they used one set of (optimistic) projections to entice the buyer and another set of (pessimistic) projections to get the shareholders to agree to sell. Something like that allegedly went on here too:

ADIC continued to seek additional information about the CV Transaction, including access to the virtual data room (“VDR”) that EMG’s advisor … maintained in connection with EMG’s solicitation of potential CV investors. ...

EMG did not make and has never made the materials in the VDR generally accessible to investors in the current Funds. Most, if not all, other Advisory Board members, including those who have purportedly approved the CV Transaction, never received access to the materials contained therein. …

ADIC gained access to two Confidential Information Memoranda (“CIM”) that EMG had prepared for potential CV investors in March 2025 and September 2025. Both CIMs contained important information about the valuation of Ascent and the possibility of strategic alternatives that were not disclosed to (and directly contradicted what was disclosed to) the Advisory Boards. Together, the March 2025 CIM and September 2025 CIM painted a drastically different picture of Ascents’ prospects, as compared to the materials that EMG had disclosed to Advisory Board members in late October and continued to produce through mid-November, which offered bleak commentary on Ascent’s prospects.

In particular, EMG allegedly told investors in its existing fund that an initial public offering of Ascent was “not the immediate path to monetization,” and estimated a low price for any potential IPO, but it “was far more optimistic about a potential IPO when speaking with potential investors in the CV Transaction,” describing an IPO as the “expected case” and with a higher valuation.

I assume we’ll see more of this? We talked the other day about a portable toilet continuation vehicle, which is “poised to suffer a total loss” because in hindsight it paid too much for a toilet company. Pretty much every continuation vehicle will buy a company from an old fund at a price that is, in hindsight, (1) too high or (2) too low. There will always be conflicts of interest, and there will always be at least some difference in emphasis in how the asset is described to the old investors and how it is described to the new ones. And whoever loses will have some reason to sue.

We talked yesterday about an alleged antitrust conspiracy. The classic antitrust conspiracy is, like, a handful of fat-cat chief executive officers of widget manufacturers meet in a smoke-filled room and agree not to sell widgets for less than $100 apiece, immiserating widget consumers to increase their own profits. But a lot of antitrust conspirators don’t see themselves that way. What we discussed yesterday was:

• Companies with cash-flow problems often play their creditors against each other, cutting favorable deals with some creditors that hose other creditors.
• The creditors feel threatened by this and band together to avoid being picked off: They agree that none of them will accept a sweetheart deal with the company at the expense of other creditors.
• Is that a price-fixing conspiracy? Does that reduce competition in the credit market? Kind of? The creditors will say that it reduces destructive competition, that it prevents some creditors from getting unfair prices for their debt. But unfair is in the eye of the beholder.

Antitrust law is kind of a mystery to me, and I often find myself sympathizing with alleged antitrust conspirators while also thinking “well yes I guess this does keep prices high.”

Anyway the Wall Street Journal reports:

Amazon.com is facing a new labor challenge, this time from small-business owners who run the company’s package-delivery network.

A group calling itself DSPs for Equitable and Fair Treatment, or Deft, went public on Black Friday, saying its goal is to organize the company’s roughly 2,400 delivery-service providers to fight for better terms and reverse policies they say wipe out their profits.

The founders, who haven’t yet revealed their identities in public, are aiming for Amazon to increase pay for package deliveries and reimbursement for van usage, and loosen the criteria for bonus payouts.

If you are an employee of Amazon, and you think that Amazon is underpaying you, and you get together with a bunch of your fellow employees to talk about it, and they all agree, you can work together to demand higher pay. (This is called a “union.”) But if you are a small business that has Amazon as a customer, and you think that Amazon is underpaying you, and you get together with a bunch of other small businesses to talk about it, and they all agree, can you work together to demand higher prices from Amazon? I don’t know, man!

We have talked about this before. In particular, drivers for rideshare companies are often in an ambiguous legal situation: They are technically independent business operators, so if they band together to demand higher pay is that an antitrust problem? Maybe? DEFT “is a chapter of the American Association of Franchisees and Dealers,” and there is some history of franchisees — independent businesses — collectively bargaining against their monolithic franchisor. There are risks, though. In a gig economy in which everyone is an independent business operator rather than an employee, it’s trickier for the independent business operators to do collective bargaining. Even if they are bargaining against the giant corporation that is the customer for all of their services. 

I don’t know if that exactly explains DEFT’s opsec, but there is a lot of opsec. The Journal notes:

In building Deft’s membership, the founders are taking steps to shield members’ identities and communications from Amazon. The group is in the initial stages of vetting applicants to ensure they won’t relay information to the company, according to a post in the DSP Signal chat. After consulting with a military veteran, the founders decided to create a structure of five-person “cells” to keep members of the larger organization anonymous in the event one cell is compromised. It remains uncertain whether the organization will gain enough momentum to effectively negotiate with Amazon.

Maybe it’s not an antitrust conspiracy if no one knows who anyone is.

Here’s a press release from N3XT, a new crypto-flavored bank:

N3XT, a new bank built on blockchain technology to leverage break-through innovation in finance, officially launched today, enabling clients to make instant, programmable business-to-business payments in U.S. dollars any hour of the day. …

“The financial system is being re-wired to be internet native, 24/7/365 and global,” said Alana Palmedo, Managing Partner of Paradigm, an investor in N3XT. “N3XT’s blockchain-powered bank embodies that shift and we’re proud to back them as they establish a new standard for how dollars move globally.”

Sure. One general thing I will say about the US banking system is that it is a system, and if you bank at a bank that is open 24/7 and talks a lot about the blockchain, that doesn’t necessarily mean that you can send dollars to someone at 2 a.m. over the blockchain. What if the recipient uses a regular bank? 

Still, there are potential network effects. We talked once about the Silvergate Exchange Network, a crypto-flavored 24/7 payments network run by Silvergate Capital Corp. If you were on the SEN, and your counterparties were on the SEN, you could merrily send each other dollar payments any time you wanted, without touching the rest of the US banking system. How likely was it that you and your counterparty were both on the SEN? Actually pretty likely, if you were a crypto hedge fund or exchange in 2022; Silvergate did a good job of signing up a lot of crypto firms to its crypto-flavored payments network. (It shut down in 2023, for reasons.) Maybe N3XT will do the same. “N3XT launches with inaugural clients across crypto, shipping and logistics, foreign exchange, and other sectors,” says the press release.

But that’s not the point. Here’s the point:

N3XT is a full-reserve bank — every dollar of deposits is backed one-to-one by cash or short-term U.S. treasuries, making N3XT the first “narrow bank” in the United States. The bank does not lend, and it publishes its reserve holdings daily. It operates globally under a Wyoming Special Purpose Depository Institution charter and is regularly examined by state banking authorities.

The point is that the US dollar payment system is dominated by banks: A “payment” basically means “telling my bank to decrease my account and increase your account,” so it is natural that banks — which are where the accounts are — process the payments. And for a long time the fundamental business of banks was to take deposits (that is: create accounts) and issue loans. There are some natural historical reasons for that combination, but it is not an obvious combination from first principles. “What if we took deposits, parked the money in Treasury bills or interest-earning accounts at the Federal Reserve, and didn’t make loans” is a perfectly natural thought to have, as is “what if we didn’t take deposits, raised money from investors looking for returns, and made loans with that money?” The first thought is called “narrow banking,” the second is called “private credit,” and we have talked a lot about the move in recent years toward narrow banking.

But “the move toward narrow banking,” in the US, has often involved non-bank forms of narrow banking. A US government money market fund is sort of a narrow bank. A stablecoin is sort of a narrow bank. These are not banks, though; they do not have bank charters. Actual banks have gotten narrower — retreating from some risky lending businesses — but they have not become pure narrow banks, and they have faced resistance when they tried. We have talked a few times about the Federal Reserve’s rejection of a bank called TNB USA Inc., which wanted to take deposits, park them at the Fed, earn interest on reserves, pass the interest on to customers, and do nothing else. For various macroeconomic and systemic-stability reasons, the Fed was skeptical.

But there are a lot of narrow-bank-type things out there; if Tether can take customer money and park it in Treasury bills, why shouldn’t a bank? It was kind of inevitable that eventually a chartered bank would get into the business, and now one has.

I kind of just want to push fast-forward on this and get straight to my 2027 column about putting private credit and crypto into Trump accounts:

All manner of financial institutions are vying for a role in the program, from banks such as JPMorgan Chase to brokerages such as Charles Schwab and Robinhood Markets to money managers including BlackRock.

The U.S. will seed each of the “Trump Accounts” with $1,000, costing $15 billion through 2034, and tech billionaire Michael Dell and his wife, Susan Dell, said Tuesday they would donate $6.25 billion to expand the reach of the initiative.

Participating financial firms likely would earn lower management fees than their typical rates, but the program would be a potential gateway to acquire millions of new customers the companies hope will stay with them into adulthood and grow their accounts over time. ...

Many of the largest banks, brokers and asset managers plan to make pitches to the Treasury Department. The agency already is seeking proposals from firms including Schwab and Robinhood to oversee the Trump accounts’ records and perform administrative tasks, people familiar with the matter said.

I don’t know what will go in the Trump accounts to begin with. “The Treasury Department is considering choosing an exchange-traded fund or working with firms to potentially create a market-tracking fund with no fees,” reports the Wall Street Journal, which makes sense. By the time they launch, will they actually be filled with, like, Trump Media & Technology Group stock? World Liberty tokens? Various other crypto-y Trump personal projects? Stakes that the US Treasury has taken in various national-security-sensitive companies? Shares of Fannie Mae? Who knows. The point is that lots of people in the US, even now, do not have brokerage accounts, and if more of them got brokerage accounts then surely the brokers could make some money.

I always feel so stupid when I write this, but when I started in financial journalism, I assumed that the point of financial markets was to allocate capital to real-world economic uses, and by now I know that the point of financial markets is to create fun opportunities for gambling. What changed my mind was crypto. The fundamental lesson of crypto, it seems to me, is “if you create an electronic token whose price goes up and down, people will have fun betting on it, so its price will go up a lot, period, the end.” The electronic token doesn’t have to have “fundamentals,” it doesn’t need to be tied to anything else, just the act of online electronic gambling is enough to get people interested.

This lesson is extremely generalizable, though, and lots of people have found lots of ways to give people what they want, which is electronic gambling. There are meme stocks, and zero-day options on meme stocks, and sports gambling, and prediction markets. Most of those ways are … more fun than crypto? Like, betting on the price of Dogecoin or whatever is purely self-referential. Betting on a football game involves football! You can watch the game! Seems more entertaining. Meme stocks have a business.

Crypto, for a long time, had a couple of big advantages over other forms of electronic gambling:

1. Crypto had a better ecosystem for gambling: It offered wild bets that you couldn’t get elsewhere, because the US legal-sports-betting and prediction-market and zero-day-options ecosystems were not particularly advanced, while crypto offered tons of unregulated casinos and memecoins.
2. Crypto mostly went up, so everyone could make money. This is not true of sports betting, which is inevitably zero-sum.

But now crypto has gone down a lot, and the other gambling ecosystems have evolved a lot, and Bloomberg’s Muyao Shen reports:

The retail tide that once lifted everything from Trump-branded coins to dog-theme tokens is no more. In past cycles, altcoins would surge alongside Bitcoin and then fall harder. This year, the cohort largely missed the rally — and when the downturn hit, they cratered afresh, sending once-popular tokens like Dogecoin 50% lower since the September high.

One reason: competition for retail dollars has become far more crowded. Zero-day options, speculative tech stocks, leveraged ETFs and prediction markets can offer faster upside, better thrills, and less chaos. And with thousands of small coins — from joke tokens to half-abandoned blockchain experiments — the question is how far the shakeout runs. …

Part of it comes down to something simple: many of the new places to speculate feel safer or easier to understand. … Apps that once funneled retail money into altcoins now offer other ways to bet.

Crypto led the way to our modern gambling markets, but it might be losing its lead.

I guess that, if you run a quantitative hedge fund, the ideal design aesthetic for your offices is “escape room.” Like, your employees come to work, and they solve puzzles to get into the office, and they solve puzzles to log into their computers, and then they are nice and warmed up to solve the puzzles that are the business of quantitative finance. Maybe this is wrong. You don’t want them to spend so much time solving the get-into-the-office puzzles that they have no time to, like, find signals that predict stock price returns. But a little time. You want to select for people who love puzzles, and who are good at them, and who will seek out new puzzles to solve, and then you want to train them on more puzzles. Bloomberg’s Justina Lee reports on PDT Partners’ new offices:

When quantitative hedge fund PDT Partners moved into its new headquarters in New York City after the pandemic, Chief Executive Officer Pete Muller wanted to entice employees back into the office. So he designed a puzzle. “I wanted to give them a reason to look around,” he says.

About 80 artworks are displayed around the three-floor office in Columbus Circle, five of which contain cryptic clues to a phrase. …

One diptych, for instance, hangs in the office’s hidden “speakeasy,” a room that features books and games and is open to all employees through a secret entrance. 

If the employees are spending hours tunneling into the secret room to find the art clues to solve the puzzles, is that good for the firm’s profitability? I mean, indirectly, probably yes.

Meta’s Zuckerberg Plans Deep Cuts for Metaverse Efforts. Sam Altman Has Explored Deal to Build Competitor to Elon Musk’s SpaceX. Bond investors warned US Treasury over picking Kevin Hassett as Fed chair. Two Sigma Starts New Funds, Raises Cash Despite Internal Turmoil. When Finance Needed More Math, It Turned to the Card Players. How Brendan Nelson became HSBC’s stop-gap chair. Hedge Funds Get Jittery on Prospect of UK’s Non-Compete Ban. Citadel debuts new AI tool for equities investors, CTO Subramanian says. Manhattan Luxury Apartment Market Surges in Month After Mamdani’s Win. The World Has More Billionaires Than Ever. Flying taxis. Adversarial poetry.

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