We’ve spent a lot of time delving into the who, what, where, when and whys of corporate concentration because the impacts are not only felt over the bridge and in far off lands, but also right here on our local businesses and the Cape Cod community. One form of corporate power that deserves a closer look is that of private equity.
You may have heard the term “private equity” – as elusive a term to many of us as day trading, rocket science or brain surgery – you’ve heard it used but couldn’t explain what it really entails if asked.
So, what is private equity, really?
Private equity firms – which has grown from a $1 trillion industry in 2008 to $4.5 trillion today – are owned by their founders or a small group of investors (meaning they are not public or traded on the stock market) and they buy companies using money raised from places like pension funds and insurance companies.
The general idea behind private equity firms is that they acquire companies that are struggling slightly or that they believe have a high potential for growth, repackage them or speed up their growth, and then sell them to another firm, take them public, or find some other sort of exit for them, usually in about 3 to 5 years.
This may leave you with the impression that private equity is a good thing – PE companies swoop in and save companies just as they are about to go under, or they take businesses to the next, and much more efficient, level. The data show another story.
Scratch beneath the surface and you’ll find most deals involving private equity firms are leveraged buyouts, where private equity firms buy companies basically by loading them up with debt.
What does that mean and why is it a problem?
A leveraged buyout is the process of acquiring a company using debt, rather than cash and stock. So, the private equity company essentially invests very little money (think 2%) for the purchase, and essentially uses the company’s assets as collateral for their own loan being used to purchase the business.
Then they take out additional loans or sell off assets like real estate through their leveraged companies to pay dividends to themselves and their investors (the companies are now responsible for those additional loans too). And because they control the company, they can transfer money to themselves through management and consulting fees.
The extensive use of debt increases the risk that the portfolio company will experience financial distress (usually after the general partner, who has put up 2 percent or less of the equity, has successfully exited the company).
What’s more, to free up more money for themselves, they cut costs like technology and development, workers, and pension plans and other long-term investments.
All for short-term gain. In the long-term many of these acquired companies end up suffering.
According to researchers at California Polytechnic State University, roughly 20 percent of large companies acquired through leveraged buyouts go bankrupt within ten years. And research published by worker groups claimed that, over the past ten years, private equity firms were responsible for 1.3 million lost jobs.
Oh, and unlike public companies, they are very lightly regulated by the Securities and Exchange Commission (SEC), and they pay no corporate tax or capital gains from the sales of the businesses.
Wait, this is happening on Cape Cod?
Toys R Us, Payless, Radio Shack, iHeart Radio, KB Toys, Blockbuster – firms like the Carlyle Group, Bain Capital, KKR, and the Blackstone Group have acquired them and run them into the ground.
And firms like these have come for small local businesses and communities too. Groups like Gatehouse have bought up local newspapers stripped them to the bone, while others have turned their attentions toward the food supply: farmland, fishing quotas and grocery stores. Still others are purchasing as many single-family homes and apartment buildings as they can, charging incredibly high rents and investing very little in upkeep and maintenance. And recently, the Provincetown Independent reported on the shocking disregard for human life at nursing homes owned locally by private equity firms, as well as the PetVet Care Centers, owned by a private equity firm out of Connecticut and giving a local veterinarian a hard time.
Why should you care?
Short term gains might help money managers and investors, but don’t do much for a community like Cape Cod built on longstanding, strong local businesses.
Josh Kosman, author of The Buyout of America, refers to private equity firms as “zombie companies” because they are not creating anything. They are not investing in technology, people, innovation, and they are not moving the economy forward. They are buying existing companies and sucking the life out of them. He says, “small businesses are the backbone of the country and then you have these 300 firms employing one out of ten of us, that’s a problem…and should disturb a lot of people.”
According to Lisa Donner, executive director of Americans for Financial Reform, “private equity and hedge funds now wield enormous influence over the American economy, often with terrible consequences for workers and communities. We need effective rules of the road to stop predatory practices by these Wall Street giants.”
What can we do about it?
We always encourage consumers to think local first. And this is no different. Make sure the company you are doing business with is locally operated, where the people who bring their energy and effort running the business day-in and day-out are Cape Codders. A simple search on DuckDuckGo will generally give you the answers to the question of ownership.
We also encourage people to be aware of these issues when they head to the ballot box.
Washington has done little to examine private equity or to ensure that their incentives align with the best interests of the economy (perhaps it’s because at least four former Secretaries of the Treasury now head private equity firms and PE firms donate a lot of money to political campaigns). In other words, the current system allows private equity firms to buy companies, weaken or destroy those same companies, and still make money for the Wall Street executives.
However, Elizabeth Warren did introduce the Stop Wall Street Looting Act of 2019. Her proposal would overhaul how private equity collects fees, who’s responsible for an acquired company’s debt, and how stakeholders are paid in the event a company does go bankrupt. It would also close the carried interest loophole that keeps private equity’s taxes so low.
Passing legislation like this on a state or federal level would go a long way long way in reining in the sector, protecting small businesses and local communities, and strengthening the economy.