Disputing private equity’s home ownership analogy

May 31, 2012, 7:41 PM UTC

FORTUNE — Yesterday I spent some time chatting with Geoff Rehnert (Audax Group, ex-Bain) and Mike Ascione (Berkshire Partners) about the dedictability of corporate debt interest. More specifically, the whole value proposition of debt vs. equity on a company’s balance sheet.

As I’ve written previously, I believe that companies are better off with less debt than more debt, all else being equal. Geoff and Mike didn’t think it much mattered, and that government shouldn’t take a position one way or the other.

They made some good points, but let me take issue with one that I’ve heard from a lot of readers: The homeowner analogy. Basically: Imagine I buy a $1 million house (I did, it’s awesome). Geoff and Mike argue that the house’s value isn’t changed if I take out a $200k mortgage compared to an $800k mortgage.

But here’s the problem: In the homeowner analogy, the home’s value isn’t affected because the home isn’t taking out the loan. I am. It’s my financial situation that suffered if I have to pay 15 or 30 years of interest on $800k compared to $200k. In the case of an LBO, the debt is taken on by the actual asset (the company), while the “homeowners” only contribute the “cash.”

Yes, it is possible that the extra leverage means the homeowner can make asset improvements, just like PE firms try to do with their companies. But PE firms don’t make fewer operational improvements at a portfolio company for which they paid a higher equity ratio.