How Private Equity Causes More Harm Than Benefit to Economies
Part 4 of the Economic Series
Part 1- Economics as a Political and Control Weapon
Part 2 - Money, The Ultimate Weapon
Part 3 - Central Banks, Global Economic & Political Control
What is Private Equity (PE)?
The Private Equity concept can be either a blessing or a curse.
It is terrific when used with win-win intentions that benefit the most people, and if genuine, successful expertise and management skills are applied by PE partners and senior managers.
It can also be disastrous for companies and cause significant harm to a nation’s economy, as outlined in this article.
I write from personal experience with Private Equity (PE). My business partners and I owned a private equity company that was very successful - for the partners, for the companies we purchased and managed, for the people who worked for those companies, and for our customers and clients. We enhanced the quality and health of every company we purchased and operated, and increased their real value and profitability by 2-4X.
Unfortunately, like many good systems or intentions, the PE concept is all too often distorted and warped and used to satiate extreme greed by a tiny number of individuals at the expense of (literally) tens of millions of other people. This has been a growing problem, and is affecting entire economies in negative ways.
So what is Private Equity (PE)?
“Private equity describes investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.
“Private equity firms buy companies and overhaul them to earn a profit when the business is sold again.
“Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.
“An acquisition by private equity can make a company more competitive or saddle it with unsustainable debt, depending on the private equity firm's skills and objectives.
“Private equity funds may acquire private companies or public ones in their entirety, or invest in such buyouts as part of a consortium. They typically do not hold stakes in companies that remain listed on a stock exchange.
“Private equity is often grouped with venture capital and hedge funds as an alternative investment. Investors in this asset class are usually required to commit significant capital for years, which is why access to such investments is limited to institutions and individuals with high net worth.”
“In contrast with venture capital, most private equity firms and funds invest in mature companies rather than startups. They manage their portfolio companies to increase their worth or to extract value before exiting the investment years later.”
- Investopedia
“What REALLY is Private Equity? What do Private Equity Firms ACTUALLY do?”
“Why the name private equity? What companies are targeted by private equity funds? What type of strategies are used by private equity funds when investing and exiting investments?
“How long is the typical investment horizon of a PE investment?
“Which are the different fund structure private equity firms use in the US and in Europe? How are private equity companies remunerated for their investment efforts by investors? What is the typical lifecycle of a private equity fund?
“Private equity firms comprise a diverse range of investment strategies and focus areas.”
The business idea is simplicity itself. A group of people get together and form a PE company. This PE firm then purchases existing, profitable, mature companies, with the intention of building up their value, to be sold at a high profit within a few years. The PE firm gets most of the money needed to purchase other companies from outside investors and bank loans; the partners of the PE firm put up a tiny percentage of the needed funds from their own pockets - around 1-5% on average. So the partners have little skin in the game; their investors and banks assume 95-99% of the financial risk.
Think of Flip This House - buying a house, fixing it up a little or a lot to improve it, then selling it within a short time period for a nice profit after all expenses and loans are paid off. That’s essentially what most PE firms do.
What PE firms do used to be called Leveraged Buyouts (LBOs), a term that is no longer used for some reason (maybe Private Equity sounds so much sexier and cooler, I’m not sure). LBOs were made famous by the movie Barbarians At The Gate, which depicted (in an entertaining but mostly factual way) the highly-leveraged purchase of RJR Nabisco in 1998 by KKR for $25 billion. (KKR is the world’s 2nd largest PE firm.) That was an insane purchase price at that time, and the massive debt RJR Nabisco was saddled with hurt the company badly and on multiple levels.
This 4-minute video gives an excellent explanation of how PE firms use leverage to purchase companies:
“Private equity funds are groups of investors that flip companies for a profit. This works exactly like flipping a house. It's the technique they use that makes them special.”
The Good, the Bad and the Ugly
The idea - and the ideal intended outcome behind PE investments - are supposed to be that the PE firm adds real and significant value to the companies they purchase; real value as measured in healthy growth, prosperity, productivity, improved working conditions and profitability.
The purpose should be for the companies being purchased to be better than before:
to be run even more efficiently and productively;
to produce even higher-quality products and services than before;
to become more profitable;
to grow in a positive, healthy and sustainable direction;
to maintain and even add jobs instead of cutting jobs and laying off people;
to provide excellent compensation and working conditions to its employees and staffs;
AND earn a nice income and profit for the PE partners and investors as a result of this all positive growth.
The intention shouldn’t be to bleed the purchased company dry, to strip it of its most valuable assets, to cease the operating procedures and principles that made it successful before the purchase, to lay off a percentage of its employees ‘to improve profitability,’ possibly drive the company into bankruptcy, and then sell the remaining carcass just to earn a nice profit for the PE partners and their investors and no one else. Yet this is the result that occurs more often than the ideal intended outcome when PE firms purchase successful companies.
Here is a terrific, 18-minute video describing the downside of PE:
“How Private Equity Secretly Broke The Economy”
“642 US companies went bankrupt in 2023, the highest number since the great financial crisis. But what’s more surprising is that companies owned by private equity are 10 times more likely to go bankrupt.
“The problem is, 1 in every 14 workers in the US collect paychecks from companies owned by private equity.
“But what is private equity? How do they have more money than Apple, Microsoft, Amazon and Tesla combined? And what are they doing to the US economy?”
“How did private equity firm KKR take an extremely profitable and successful company like Houdaille [the largest auto parts manufacturer in the US], and drive it into bankruptcy and then wipe it off the face of the economic map in just 2 years?”
“The problem is, when a PE firm buys a business, they’ll [usually] raise prices, cut expenses, lay off workers, cut salaries and lower quality.”
This 15-minute video also gives an excellent description of how PE works, and the problems associated with the way in PE firms operate:
“There has been a lot of talk about how the US real estate market is in a bubble. But people are getting it wrong. The real bubble is in a little corner of the finance industry that is unknown to the average person.
“This industry has trillions of dollars in assets, and the companies it owns employ millions of Americans. The industry that I’m talking about is Private Equity.
“In this video we are going to cover how this bubble in private equity formed, when it could burst, and most importantly what this means for the economy.”
“Private equity is driving up costs while lowering quality in all industries - to include health care.
“Private equity is also shutting out millions of people from buying their own homes. In 2021, private equity investors bought nearly 1 in 7 homes in top metro areas. This drove up home sale prices by double digits, and also increased rents by almost 40% on average.”
PE firms produce an overall net decline in the quality, productivity, working conditions and morale of the companies they purchase. All too often, the purchased companies drown in the massive debt created for them by the PE firms. There are exceptions of course; there have been success stories - but these are in the minority.
“Private Equity is a great idea... in theory. Funds take investor money, buy a bunch of fledgling or faltering companies, shuffle around their structure and leadership and operating model, grow their worth, then sell them a few years later for a profit. What's wrong with that?
“. . . On average, headcount [number of employees] at companies bought by private equity shrinks by 12% over the following two years, translating to thousands upon thousands of layoffs. PE-owned nursing homes see 11% higher mortality rates than the non-PE owned counterparts, summing to a total of 1,000 excess deaths per year.
“Companies acquired by private equity firms through leveraged buyouts are found to be 10 times more likely to go bankrupt in the following ten years than those that are not.”
The video below is too dramatic for my taste, and I disagree completely with their recommendation to unionize as a ‘solution’ to the PE problem. But if you can ignore those two aspects and their comparisons with the Mafia (like I said, a little too dramatic), there is a lot of good and accurate data here about the negative impacts generated by PE firms:
“Have you ever wondered why so many major retail chains have filed for bankruptcy or closed locations recently? Toys r Us, Baskin Robbins, J Crew, Hertz, 24 Hour Fitness, Dunkin Donuts. . .
“There’s a shadowy mafia that has been ripping off the entire US economy while making themselves rich. Really rich. This group is responsible for bankrupting hospitals, your favorite retail chains and even ripping off Taylor Swift. They’re called Private Equity. And your company might be next. We took a deep dive into the shocking strategies that the Private Equity Mafia uses.”
“20% of companies taken over by private equity go bankrupt within the first 10 years, compared to just 2% otherwise.
“Private equity is destroying jobs and making workers’ lives worse.”
Here’s another good description of how PE works, using the Simmons mattress company as an illustration (Simmons filed for bankruptcy after being purchased by a PE firm):
“Inside the Private Equity Game. NY Times documentary about how Private Equity works and explores the Simmons Mattress deal.”
“What surprised me most about this story is the degree to which private equity touches our lives in ways that we're not aware of. A shopper at Albertsons probably doesn't know that it's private equity owned or someone who eats at Outback Steakhouse would have no idea.
“Many people don't realize the scope and influence of the private equity industry. The number of brands is astonishing, and what most people don't realize is we all of us in one way or another actually are invested in many private equity deals.
And another:
“Buyout Of America: How Private Equity Is Destroying Jobs and Killing the American Economy”
“Few people realise that the top private equity firms such as Blackstone Group, Carlyle Group and Kohlberg Kravis Roberts [KKR] have become America's largest employers through the businesses they own.
Journalist Josh Kisman explores private equity's explosive growth and shows how its barons wring profits at the expense of the long-term health of their companies. He shows how excessive debt and mismanagement will likely trigger another economic meltdown within the next five years, wiping out up to two million jobs.”
Warren Buffet doesn’t care for Private Equity, and would rather have Treasury bonds yielding 1-1.5% than be involved with PE:
“We have seen a number of proposals from Private Equity funds where the returns are really not calculated in a manner that - well, they're not calculated in a manner that I would regard as honest.” - Warren Buffet
Buffet is always diplomatic and tactful; he never says in public what he really thinks when he doesn’t like something. His public criticisms are always muted and softly worded. For Buffet to say publicly that “returns are not calculated in a manner that I would regard as honest” is equivalent to most people screaming that PE firms are dishonest crooks.
Gretchen Morgenson, author of These Are the Plunderers: How Private Equity Runs—and Wrecks—America, gave several interviews in which she goes into great detail how PE firms generate more harm than benefit more often than not:
“Private equity firms are buying up the US economy and stripping it for parts. From healthcare to education, utilities and more, massive firms like Blackstone and the Carlyle Group have acquired vast holdings across critical industries essential to the health and well-being of everyday people. Instead of seeking to make these ventures more profitable, private equity firms are more likely to orchestrate to bleed their assets for short-term gains—even if those assets are univerisites, hospitals, or nursing homes.”
Gretchen Morgenson Interview 1 here
“We sit down with Pulitizer-prize winning and NY Times best-selling investigative journalist Gretchen Morgenson. Gretchen is renown for her groundbreaking reporting on the financial markets, with a particular focus on the way in which they are too often abused by Wall Street power players.
“Today, we'll discuss the key takeaways from her new book These Are the Plunderers: How Private Equity Runs―and Wrecks―America. Gretchen, along with her co-author Joshua Rosner, expose the world of private equity as ‘insidious’, claiming that a small cohort of elite financiers -- and their government enablers -- use excessive debt and dubious practices to undermine our nation’s economy for their own enrichment.”
The problems associated with PE aren’t limited to the United States. Great Britain is experiencing similar negative impacts:
“Next month’s UK election will likely be a reckoning for Prime Minister Rishi Sunak and the Conservative Party.
“High Street [same as Main Street in the U.S.] retailers like Morrisons, Byron Burgers, Wagamama and others have all been scooped up by US private equity firms in recent years. And the debt they owe, compounded by high interest rates may be endangering their financial resilience while putting employees at risk.”
And in Finland:
“Almost everything we consume has been touched by private equity at some point in the value chain.
“I criticize the magic sauce that private equity firms use to create ‘value.’ This magic sauce - on dubious grounds - transfers wealth from investors, such as our pension funds, into the pockets of a few private equity partners.
“. . . how private equity makes portfolio companies focus more on financial engineering and consumer exploitation, and less on actually improving their products and services.
“. . . how private equity seeks to reduce market competition, right under the nose of our competition regulators.”
So far, the Bad and the Ugly sides of Private Equity buyouts have been presented. Unfortunately, that’s because the Bad and Ugly sides outweigh the Good that could come from leveraged buyouts by PE firms.
There are enormous, untapped potential benefits that can come out of the PE industry: higher employment, higher wages, increased prosperity for millions and millions of people, increased productivity and profitability, positive and healthy growth - all of which contribute significant boosts to the overall economy and prosperity of a nation.
Using my own example of the potential good from PE: My business partners and I bought 12 companies over a 20 year period. In 10 of those companies, we increased their profitability and productivity by 2-4X. The other 2 companies increased by 1.2-1.5X.
We NEVER laid off a single individual over that 20 year span - not one job was lost or cut. Just the opposite; we were so successful in growing these companies that we had to hire more and more people. We created additional jobs, instead of causing unemployment. And, we paid our people higher wages than were paid before we took over, and gave them all profit-sharing plans that gave them significant bonuses every year.
We improved the quality of products and services produced by these companies. As a result, we increased market share and demand for our products organically.
We added value to every company we purchased, made them more successful, higher quality and healthier than they were before we stepped in, and were able to sell these for a nice profit.
Our philosophy was that we were in it for a longer haul, not a quick buck. We intended to make these companies better in every way, knowing that profits from sales would follow naturally and for all the right reasons.
This is the optimum way for the PE industry to operate. And some PE firms do operate this way, and some company purchases have produced successful outcomes as described above. Unfortunately, negative outcomes from PE purchases have outnumbered ideal, optimum outcomes.
The Difference
What is the difference between a PE firm achieving ideal, optimum outcomes with their purchased companies vs producing effects and results that are more harmful than beneficial? There are two driving factors:
the intentions of the PE partners when purchasing a company, and
their leadership and management expertise and skills (or lack of)
Too often, the partners - and investors - of a PE firm are looking for a quick ‘flip-this-house’ type of transaction to earn millions or tens of millions or even billions of dollars as fast as possible. ‘Get in and get out quick’ is the attitude and intention with the majority of PE acquisitions. This attitude and intention result in the negative outcomes and disasters described in all the videos above.
The vast majority of individuals within PE firms lack genuine expertise and skills in leadership and management - although this vast majority think they’re ‘leadership and management experts.’ The proof is always in the pudding; it doesn’t matter what anyone thinks he or she knows and is skilled at. The outcome tells the tale.
Even if the partners of a PE firm have a ‘get in and get out quick’ attitude and intention, they can still achieve a successful, optimum outcome for the most people if they’re actually skilled in leadership and management. ‘Cost cutting’ alone doesn’t constitute ‘skilled, expert management.’ But cost cutting is the primary tool used by most PE managers. Cutting costs are sometimes vital for survival, but if that is the main tool and skill applied, then negative and disastrous outcomes will result.
I’ve written an entire book on this topic; there’s too much to cover for this article. But I wanted to address these two vital factors, even if only cursorily.
Top PE Firms
PE firms are ‘ranked’ one of two ways: (1) by the amount of capital raised from investors over a specified time period, or (2) total Assets Under Management (AUM) over a specified time period. AUM means the total market value of the companies, real estate and other assets purchased but not yet sold, under the control of the PE firm.
Because PE firms buy and sell companies so quickly, and are always raising and investing funds from investors, these values constantly shift, they are highly fluid. So PE firm X could be the top firm based on total AUM today, and drop to number 20 the next month if it divests some of its companies.
With this fluidity in mind, here are the top PE firms. Blackstone and KKR are the kings of the PE world, perennially #1 and #2, while the other companies fluctuate up and down these rankings. If not specified otherwise, companies are based in the U.S.
Blackstone
KKR
The Carlyle Group Inc
CVC Capital Partners (Luxembourg)
Thoma Bravo
TPG Capital
EQT A.B. (Sweden)
Vista Equity Partners
Warburg Pincus LLC
Neuberger Berman Group LLC
Advent
General Atlantic
Apollo Global Management
Bain Capital
Hg (London)
Goldman Sachs Capital
Silver Lake
Clayton, Dubilier & Rice
Hellman & Friedman
Clearlake Capital Group
Leonard Green & Partners
Insight Partners
Permira Advisers (London)
Cinven (London)
Brookfield Asset Management (Toronto)
Nordic Capital (Saint Helier)
Genstar Capital
Francisco Partners
Tiger Global Management
Blue Owl Capital
Partners Group (Switzerland)
Ares Management
Hillhouse Capital Group (Singapore)
L Catterton (UK)
Neuberger Berman Private Markets
PAI Partners(Paris)
TA Associates
Apollo Global Management
Stone Point Capital (UK)
BC Partners (London)
Adams Street Partners
BlackRock
BDT & MSD Partners
Veritas Capital
Bridgepoint (London)
Ardian (Paris)
HarbourVest Partners
China Reform Fund Management Corp (Beijing)
Andreessen Horowitz
Thomas H. Lee Partners
Summit Partners
PSG Equity
Collectively, these firms control several trillion dollars worth of companies. This gives the PE industry a great deal of financial and political power.
It’s unfortunate that PE firms in general lack the proper intention/attitude and requisite leadership/management skills to consistently produce the enormous potential benefits.
Wonderful!!
Another great article!
I love the series. It gives me sooo many realizations about life and how to better it.
What I would love to also see, is what you would do to create a more ideal world than the one we are currently experiencing, and why you think those are the best solutions for our current world problems.
Thanks mate!