The credit crisis and an ensuing economic downturn have led to a shrill outcry against Wall Street and, generally, any participant in the financial services industry. But now that many companies sitting in private-equity portfolios are going bankrupt or are on the brink of a court-supervised workout, will the broader public aim its ire at the PE industry?

There are plenty of examples of PE portfolio company messes, and one credit rating agency estimates that just over half of the 140 companies defaulting between January and May alone were private-equity owned.

Chrysler and GMAC, for example, were Cerberus Capital Management investments, while retailer Linens 'n Things was an Apollo portfolio company. Mervyn's, another retailer, was a Sun Capital company, and Star Tribune, the newspaper publisher, was a Vista Capital Partners company.

Improved credit conditions may have offered breathing room for some companies this year, but a recent report published by Fitch estimates $800 billion of debt in the form of leveraged loans and high-yield bonds comes due in the next five years. The rating agency warned that not all corners of the credit markets will be readily open for borrowers in coming years and it may be tough for some to pay down that debt, setting the stage for more defaults and bankruptcies.

To date, much of the vitriolf against private equity has been directed by an employees union, and their protests actually predate the credit crisis. But some questions have cropped up about fees the private-equity sponsors levy on their own investments, which, in some cases, added a burden on already troubled businesses.

Interestingly, PE sponsor-investors have protested these fees and some succeeded in doing away with them, suggesting that if any changes are imposed on the industry they'll come from investors managing what is often public money.

Take, for example, Jay Fewel, senior equities investment officer for the Oregon State Treasury. Fewel could not stomach the practice of levying transaction and management fees on portfolio companies and found that the current economic climate gave Oregon some leverage. He says he has been able to force general partners in private-equity funds Oregon invests in to fork over a larger shares of management fees to limited partners.

Over time, Fewel says, these fees could actually shrink, reducing the burden on companies that now need every bit of available capital to pay employees, vendors and suppliers as well as to make debt payments.

Fewel has found that most limited partners feel strongly that, if general partners are going to impose these fees, "the majority should go to the limited partners. And we're in a much better position to negotiate that now."

Charging target companies a one-time transaction fee when they are acquired is standard practice for buyout firms. The fees are meant to cover the costs connected with raising debt, due diligence and strategic planning.

Buyout funds also charge portfolio companies a fee if they buy other companies, and when the companies are subsequently returned to public markets. They also generally charge portfolio companies monitoring fees for the financial and operational guidance that buyout executives give corporate managers.

Limited partners, meanwhile, have pushed for a bigger slice of these fees for some time.

Fewel recalls that when Oregon first invested in private equity 20 years ago, general partners pocketed all the fees.

Gradually, limited partners began demanding an equal share, and now it's not unusual for general partners to fork over 80% of the fees to limited partners. But support is growing for limited partners to get 100% of any fees — an arrangement Oregon recently negotiated with a private-equity firm that Fewel declined to name.

To be sure, Oregon's size gives it more muscle than many other limited partners.

The state Treasury oversees $65 billion of public retirement funds, about $8 billion of which has been placed in private equity and other alternative investments. Commitments to individual funds can reach several hundred million dollars. This puts it in a much stronger position than investors committing tens of millions of dollars.

Another factor determining how much negotiating power a limited partner has is how early it commits itself to invest in a fund.

For this reason, Fewel says, Oregon aims to get into a fund at the first closing rather than the last. "And guess what? When limited partners take all the fees, the funds tend to charge less," he says. "Ideally, that's what we're looking for."

For some critics, a strong case can be made that the transaction and management fees charged by sponsors are not justified, since sponsors already earn a return on the capital they put to work in portfolio companies when they eventually sell them.

These fees "do not drive value-creation at portfolio companies," according to John Adler, who works in the Service Employees International Union's capital stewardship program. The union has been a vocal critic of the private-equity industry and protested some of its practices prior to the credit crisis. In recent years it has staged protests in front of some prominent fund firm offices.

Adler pointed out that the management fees are not imposed by all private-equity firms. "There are PE firms that either don't charge fees or rebate 100% to limited partners," he says, "and we think that's a better approach."

Steven Kaplan, a professor at the University of Chicago's Booth School of Business, admitted that he's no fan of management fees, either, but he doesn't think the financial crisis has much to do with the way they are split among limited partners and general partners. "The market is already moving, or has already moved, toward 100% for LPs," he says.

And though the size of transaction and management fees may fall in some cases, Kaplan is skeptical that they will ever go away. "Sponsors will keep charging them because it provides current return," he says.

Of course, the 1.5% to 2.0% management fees that private-equity shops charge investors, and the 20% share of investor profits they keep, are also points of tension between limited and general partners.

However, there does not seem to be much movement on this front, even though one of the industry's largest firms, TPG Capital, is refunding $20 million of management fees investors paid on an $18.8 billion fund this year.

TPG told investors at its annual meeting this month that the refund was intended as a gesture of goodwill to make up for the fact that it was not able to put much money to work in the first and second quarters.

Oregon's Fewel, who attended the meeting, recalls that the gesture was appreciated: "I didn't hear anyone saying they didn't want [the money] back."

Meanwhile, Josh Lerner, a professor at Harvard University's business school, has been surprised by how fee structures have remained intact. "I've been more or less predicting for the past 10 years that the crazy level of fees had to adjust down, but clearly over time there's been a very powerful force working in the other direction," he says.

Beyond the tug-of-war over fees, it is hard to see much potential for a backlash against private equity. Apart from the service employees union, which has warned for some time that private equity poses big risks to the economy, relatively few people are connecting the dots between buyout funds and the rise in the corporate default rate the past couple of years.

Standard & Poor's took a stab at it in a May report. The credit rating agency found that at least 79 — or just more than half — of the 140 companies that defaulted in the first five months of the year were private-equity owned.

The rating agency said it expects another 200 U.S. companies to default in the coming year and that it expects these casualties' exposure to private equity to remain high.

The Private Equity Council, an industry trade group, says S&P's data is flawed because it includes as "private-equity-related" many transactions in which private-equity investors never controlled company operations, financing or management.

"The list, for example, includes debtor-in-possession and rescue financing of ailing businesses, noncontrolling stakes and already exited companies," spokesman Robert Stewart notes in an e-mailed statement.

S&P has not updated its projections in the past five months, though it has since cut its default forecast for all junk-rated companies — private-equity-related or not — to take into consideration credit market improvements that make it easier for troubled companies to refinance debt. The rating agency now expects the default rate to decline to 6.9% 12 months after September's 12-month trailing rate of 10.8%.

In July, S&P had forecast that the default rate would escalate to 13.9% by June 2010.

As the University of Chicago's Kaplan sees it, companies are filing for bankruptcy for the same reason so many homeowners are defaulting: When credit was cheap, they borrowed too much.

"A lot of deals were done that in retrospect shouldn't have been done, and some of those companies will go Chapter 11," Kaplan says. But he adds: "That's capitalism — you have winners and losers. It's silly to blame private equity."

And Kaplan points out that bankruptcy, painful as it is for investors who are wiped out and employees who lose their jobs, is not necessarily the end of the road.

Plenty of companies — like Federated Department Stores, which went bust in the early 1990s after the previous boom-and-bust cycle — have restructured and are still in business.

But how the private-equity industry is viewed by the broader public may be shaped by how sponsors handle the downturn. For example, if a company is taken to bankruptcy court to shed its debt and the sponsors invest more money to keep the business moving forward and sustain development, they may be viewed in a better light.

"Defaults and bankruptcies happen all the time, especially when the economy turns south with precipitous force. [But] people liquidating companies quietly rather than restructuring would be something that would create more ire. The most important thing any business leader can do is to sustain and create employment, " says Lynn Tilton, chief executive officer of New York-based private-equity firm Patriarch Partners.

"Main Street is angry. It has a reason to be angry. I think they'll shoot at anything they consider Wall Street. At the same time, you have to be careful what you're blaming people for."

Allison Bisbey Colter is a freelance writer in Maplewood, N.J.

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