Private equity, eli5
February 1, 2025 4:16 AM Subscribe
I keep hearing about the role of "private equity" in enshittifying various parts of the commercial landscape these days. Can anyone recommend good, incisive sources digging into how this works and why/if it's happening more now?
Some specific questions I've had:
Some specific questions I've had:
I'm sympathetic to the obvious angles of critique, but I'd prefer sources that lean academic and focus on elucidating systems rather than polemic. Apologies if any or all of these questions are very dumb and off-base, as I'm just starting to explore this.
Thanks so much!
I like a lot the book The Unaccountability Machine by Dan Davies. It's not just about private equity, but he covers it in some detail. I think a good outline of some of it is in this interview he gave in the FT (ungated)
posted by ambrosen at 6:06 AM on February 1 [2 favorites]
posted by ambrosen at 6:06 AM on February 1 [2 favorites]
Emily Stewart did good reporting on this, and summarizes the 101 of it pretty well on the Vox "Explained" podcast, including defenses of the industry, criticisms of leveraged buyouts, etc.
Also, unironically recommend (re)watching the movie Pretty Woman to anyone who truly wants an ELI5 of PE.
posted by windbox at 7:06 AM on February 1
Also, unironically recommend (re)watching the movie Pretty Woman to anyone who truly wants an ELI5 of PE.
posted by windbox at 7:06 AM on February 1
I think that a defense of PE in theory would be that turning around an underperforming company is a specific skill that is not necessarily related to the skill of managing a well-performing company.
An analogy would to someone buying rundown properties and fixing them up for resale, as opposed to a homeowner. In theory PE firms can be specialists in turning around underperforming / poorly managed houses(companies), without requiring them to be specialists in every business or manage houses(companies) indefinitely. There is a real niche for people who buy "underperforming" assets (deferred maintenance, rundown, etc), renovating them, and reselling them. The reselling is key, since it allows those people to re-use their capital in their area of specialization, as opposed to having to manage a portfolio of properties.
There can be economic value in this for everyone (assuming that the 'renovations' are done well) since in theory the 'PE firm' is an expert in this type of thing. House flipping - doing this without actually adding significant economic value, cutting corners, cosmetic fixes only - would be equivalent to a PE firm simply loading a company with debt and cutting costs below a sustainable level in order to to flip it, leading to the enshittification you describe.
posted by true at 7:21 AM on February 1 [7 favorites]
An analogy would to someone buying rundown properties and fixing them up for resale, as opposed to a homeowner. In theory PE firms can be specialists in turning around underperforming / poorly managed houses(companies), without requiring them to be specialists in every business or manage houses(companies) indefinitely. There is a real niche for people who buy "underperforming" assets (deferred maintenance, rundown, etc), renovating them, and reselling them. The reselling is key, since it allows those people to re-use their capital in their area of specialization, as opposed to having to manage a portfolio of properties.
There can be economic value in this for everyone (assuming that the 'renovations' are done well) since in theory the 'PE firm' is an expert in this type of thing. House flipping - doing this without actually adding significant economic value, cutting corners, cosmetic fixes only - would be equivalent to a PE firm simply loading a company with debt and cutting costs below a sustainable level in order to to flip it, leading to the enshittification you describe.
posted by true at 7:21 AM on February 1 [7 favorites]
Megan Greenwell has written about this and even has a book coming out that addresses some of it, Bad Company
posted by Carillon at 7:27 AM on February 1
posted by Carillon at 7:27 AM on February 1
Plunder: Private Equity's Plan to Pillage America by Brendan Ballou is a good primer. Brendan Ballou is a federal prosecutor and served as Special Counsel for Private Equity in the Justice Department's Antitrust Division.
posted by saturdaymornings at 7:43 AM on February 1 [6 favorites]
posted by saturdaymornings at 7:43 AM on February 1 [6 favorites]
House flipping - doing this without actually adding significant economic value, cutting corners, cosmetic fixes only - would be equivalent to a PE firm simply loading a company with debt and cutting costs below a sustainable level in order to to flip it, leading to the enshittification you describe.
Came to say something similar, but perhaps with a more glum assessment overall. Because while sure, it's possible to develop expertise in house-flipping in a way that isn't gross (i.e. doing quality renovations of falling apart houses), the problem is that when you have a short term relationship to something - whether a house or a company - there are little incentives to care or be emotionally attached to its long-term future - or to value something about it beyond its monetary value. People who own a home for decades value the home beyond the market rate - that's why sellers regularly will sell a house for less than they could to a buyer that clearly values the house as it is, rather than someone who plans to flip it. Likewise, CEOs often care about their company's reputation or the quality of the product - Steve Jobs cared about Apple being profitable, but obviously he cared about much more than that and wasn't driven by purely maximizing profits, and was emotionally invested in what happened in the company. Even if PE doesn't make a company go bankrupt, there is little incentive for them to make the company better.
This Guardian article is a good overview, (cites work by Ballou), and includes this key evidence: "Private equity takeovers have been blamed for the terminal declines of dozens of well-known businesses, and the associated job losses, including J Crew, Kmart, Sears and BHS. According to one frequently cited analysis, one in five private equity-owned companies go bankrupt within 10 years of acquisition – a rate 10 times higher than that of publicly owned companies. And it’s not because private equity tends to target companies that are already weak; often these businesses were thriving before being consumed."
posted by coffeecat at 10:04 AM on February 1 [6 favorites]
Came to say something similar, but perhaps with a more glum assessment overall. Because while sure, it's possible to develop expertise in house-flipping in a way that isn't gross (i.e. doing quality renovations of falling apart houses), the problem is that when you have a short term relationship to something - whether a house or a company - there are little incentives to care or be emotionally attached to its long-term future - or to value something about it beyond its monetary value. People who own a home for decades value the home beyond the market rate - that's why sellers regularly will sell a house for less than they could to a buyer that clearly values the house as it is, rather than someone who plans to flip it. Likewise, CEOs often care about their company's reputation or the quality of the product - Steve Jobs cared about Apple being profitable, but obviously he cared about much more than that and wasn't driven by purely maximizing profits, and was emotionally invested in what happened in the company. Even if PE doesn't make a company go bankrupt, there is little incentive for them to make the company better.
This Guardian article is a good overview, (cites work by Ballou), and includes this key evidence: "Private equity takeovers have been blamed for the terminal declines of dozens of well-known businesses, and the associated job losses, including J Crew, Kmart, Sears and BHS. According to one frequently cited analysis, one in five private equity-owned companies go bankrupt within 10 years of acquisition – a rate 10 times higher than that of publicly owned companies. And it’s not because private equity tends to target companies that are already weak; often these businesses were thriving before being consumed."
posted by coffeecat at 10:04 AM on February 1 [6 favorites]
Best answer: I spend a large amount of my professional time as an adversary of private equity firms in the realm of bankruptcy creditor rights, and as such think I can have a decently unbiased view of the picture. And from this I can say that most people writing about private equity for popular or political audiences are so lacking in basic premises that their conclusions aren't even so much wrong as they are non-sequiturs. Vegan teetotalers reviewing steakhouses, really.
Private equity arose as an investment strategy from two things: the tendency of public equity markets not to reflect the true value of many companies, and the willingness of the debt markets to lend to buyers (private equity firms) of such companies on a non-recourse basis, enhancing returns when the buyer was right about the value of the company, and limiting losses when the buyer was wrong about the value of the company (because the buyer only loses its initial equity investment, and doesn't have to pay back the debt). This creates a structural "cheapness" to portfolios of leveraged private investments, from which the historical returns of the better private equity firms have been very good over (by now) a very long period of time.
"Vampirism" fails almost entirely as a description of bad private equity investments. Trades like Red Lobster and Joann's (in both of which my firm was involved on the creditor side) reflect the fact that markets are mostly efficient and as such a fair share of private equity acquisitions will simply be wrong about the value trend of the company. The private equity investors lose their entire equity investments in those failures, with dividends and fees they took out between the trade and its failure being somewhere between zero and a very small part of that investment. In other words, whatever PE firms may be, good vampires they are not.
PE investors are mostly you - pension funds, charitable endowments, university endowments, (if you're a non-American) sovereign wealth funds. To a modest extent they are extremely rich people who directly invest a portion of their portfolios in PE funds. To an even lesser extent, they are their own founders and senior partners, who have most of their economics in their own junior ownership stakes in deals ("carried interest"). The gains of investors in the second and third categories flows back to the middle class and working-class (or don't) in the the ways the money of wealthy people does or doesn't generally: taxes and spending.
In modern regulatory states (like the US, UK and EU jurisdictions) every industry lobbies avidly. PE is no different, and PE bigwigs have good friends in DC just like ag and pharma and defense bigwigs do. PE, like FIRE ("finance, insurance, and real estate") generally, tends to be very bipartisan in its political approach - unlike industries that are mostly Democrats (law, media) or Republicans (natural resources, e.g.). All sizeable PE shops will have at least one major Democrat and one major Republican donor in their partnership ranks. I can't speak well to EU or UK law, but US law is broadly accommodating to PE strategies, as it has preserved the two things without which it would not work (limited liability of controlling shareholders, and the ability to deduct interest upon debt from taxable income) and the capital gains rules without which it would be much less attractive.
No one would or should defend private equity as being for "everyone's good." Nothing can ever satisfy that, and when it comes to business, there are always going to be losers. Companies will be poorly managed, and even well-managed companies will find themselves on the wrong side of changes in demand for goods and services and efficiency in meeting those demands. The intelligent questions to ask are whether the public policies that support private equity lead to structural misallocation of capital in a way that decreases national wealth, and, if so, whether those policies can be changed in a manner where the cure is not worse than the disease. There is no (serious) doubt that national wealth is enhanced by shareholders' liability for corporate debt being limited, which is not to say that there are not specific cases (which I often pursue avidly!) where veil piercing, alter ego and direct co-liability are entirely proper. There is a lot more debate about the tax deductibility of interest corporate debt, and the academic and policy work on that front is very interesting. The debate on capital gains rules is spirited, but less interesting because it tends to be more overtly political.
posted by MattD at 10:27 AM on February 1 [21 favorites]
Private equity arose as an investment strategy from two things: the tendency of public equity markets not to reflect the true value of many companies, and the willingness of the debt markets to lend to buyers (private equity firms) of such companies on a non-recourse basis, enhancing returns when the buyer was right about the value of the company, and limiting losses when the buyer was wrong about the value of the company (because the buyer only loses its initial equity investment, and doesn't have to pay back the debt). This creates a structural "cheapness" to portfolios of leveraged private investments, from which the historical returns of the better private equity firms have been very good over (by now) a very long period of time.
"Vampirism" fails almost entirely as a description of bad private equity investments. Trades like Red Lobster and Joann's (in both of which my firm was involved on the creditor side) reflect the fact that markets are mostly efficient and as such a fair share of private equity acquisitions will simply be wrong about the value trend of the company. The private equity investors lose their entire equity investments in those failures, with dividends and fees they took out between the trade and its failure being somewhere between zero and a very small part of that investment. In other words, whatever PE firms may be, good vampires they are not.
PE investors are mostly you - pension funds, charitable endowments, university endowments, (if you're a non-American) sovereign wealth funds. To a modest extent they are extremely rich people who directly invest a portion of their portfolios in PE funds. To an even lesser extent, they are their own founders and senior partners, who have most of their economics in their own junior ownership stakes in deals ("carried interest"). The gains of investors in the second and third categories flows back to the middle class and working-class (or don't) in the the ways the money of wealthy people does or doesn't generally: taxes and spending.
In modern regulatory states (like the US, UK and EU jurisdictions) every industry lobbies avidly. PE is no different, and PE bigwigs have good friends in DC just like ag and pharma and defense bigwigs do. PE, like FIRE ("finance, insurance, and real estate") generally, tends to be very bipartisan in its political approach - unlike industries that are mostly Democrats (law, media) or Republicans (natural resources, e.g.). All sizeable PE shops will have at least one major Democrat and one major Republican donor in their partnership ranks. I can't speak well to EU or UK law, but US law is broadly accommodating to PE strategies, as it has preserved the two things without which it would not work (limited liability of controlling shareholders, and the ability to deduct interest upon debt from taxable income) and the capital gains rules without which it would be much less attractive.
No one would or should defend private equity as being for "everyone's good." Nothing can ever satisfy that, and when it comes to business, there are always going to be losers. Companies will be poorly managed, and even well-managed companies will find themselves on the wrong side of changes in demand for goods and services and efficiency in meeting those demands. The intelligent questions to ask are whether the public policies that support private equity lead to structural misallocation of capital in a way that decreases national wealth, and, if so, whether those policies can be changed in a manner where the cure is not worse than the disease. There is no (serious) doubt that national wealth is enhanced by shareholders' liability for corporate debt being limited, which is not to say that there are not specific cases (which I often pursue avidly!) where veil piercing, alter ego and direct co-liability are entirely proper. There is a lot more debate about the tax deductibility of interest corporate debt, and the academic and policy work on that front is very interesting. The debate on capital gains rules is spirited, but less interesting because it tends to be more overtly political.
posted by MattD at 10:27 AM on February 1 [21 favorites]
Best answer: There's a fantastic old paper by Larry Summers and Andrei Shleifer (I know lol but stick with it for a second) that makes a very trenchant criticism of private equity, all in economic theory terms. Along the way they explain what the positive economic theory rationale for those strategies is supposed to be. It's a short paper, I recommend it. What follows is a mix of what they say and my own thoughts.
In a nutshell: think of the anti-PE epithet of "vulture capitalists." Ew, yuck! But actually vultures are wonderful buddies who play a vital role in many ecosystems: they clean up the trash. They take resources that are locked up in low-performing niches (toxic corpses) and they liberate them so they can be recycled into the rest of the system. I love vultures (real vultures). Similarly, the value provided by vulture capitalists is that some businesses are over-capitalized. They picked up a lot of investment when they used to be more productive, and now management and other stakeholders don't want to give up those resources. The magic of the leveraged buyout is you get a big cash payout to loosen the grip of those stakeholders, but it comes out of the business instead of your pocket. So it's (notionally) a win-win: old stakeholders get cashed out, and resources get liberated from their low-performing uses.
So the idea is that it's a painful but useful niche in the economic ecology. They're like the Schumpeterian euthanasia squad. Of course, you can acknowledge all of that and go, What a disgusting way to think about something with a human cost! Valid! But Summers and Shleifer's criticism goes beyond that. They point out that, when new private equity owner-management comes in, they may be bound by the explicit legal obligations of the old company, but they are not bound by any implicit understandings the business may have had with stakeholders like their workers. The private equity premium partly comes from the ability of the new owner-managers to violate the trust of old stakeholders who didn't solemnize their rights in a binding way. But that's not an economic efficiency, that's a rent that you capture by screwing over people who are less savvy and capable of defending their rights.
posted by grobstein at 10:38 AM on February 1 [10 favorites]
In a nutshell: think of the anti-PE epithet of "vulture capitalists." Ew, yuck! But actually vultures are wonderful buddies who play a vital role in many ecosystems: they clean up the trash. They take resources that are locked up in low-performing niches (toxic corpses) and they liberate them so they can be recycled into the rest of the system. I love vultures (real vultures). Similarly, the value provided by vulture capitalists is that some businesses are over-capitalized. They picked up a lot of investment when they used to be more productive, and now management and other stakeholders don't want to give up those resources. The magic of the leveraged buyout is you get a big cash payout to loosen the grip of those stakeholders, but it comes out of the business instead of your pocket. So it's (notionally) a win-win: old stakeholders get cashed out, and resources get liberated from their low-performing uses.
So the idea is that it's a painful but useful niche in the economic ecology. They're like the Schumpeterian euthanasia squad. Of course, you can acknowledge all of that and go, What a disgusting way to think about something with a human cost! Valid! But Summers and Shleifer's criticism goes beyond that. They point out that, when new private equity owner-management comes in, they may be bound by the explicit legal obligations of the old company, but they are not bound by any implicit understandings the business may have had with stakeholders like their workers. The private equity premium partly comes from the ability of the new owner-managers to violate the trust of old stakeholders who didn't solemnize their rights in a binding way. But that's not an economic efficiency, that's a rent that you capture by screwing over people who are less savvy and capable of defending their rights.
posted by grobstein at 10:38 AM on February 1 [10 favorites]
MattD, I'd read somewhere that a legal change (maybe during the Reagan years? or more recently?) made current private equity strategies possible. Is it changes to capital gains law?
posted by Vegiemon at 2:49 PM on February 1
posted by Vegiemon at 2:49 PM on February 1
Mod note: One removed. Please just go ahead and give your own response rather than commenting on someone else's. Thanks.
posted by taz (staff) at 9:47 PM on February 1
posted by taz (staff) at 9:47 PM on February 1
I seem to recall that taxation changes for how the income arrives to the profiteers - pass-through structures for example - has made it more lucrative. Maybe MattD can say more here.
posted by Dashy at 6:35 AM on February 2
posted by Dashy at 6:35 AM on February 2
Best answer: (The tax reforms Reagan signed were marginally negative for PE strategies, as they reduced and then temporarily eliminated the difference between ordinary income and long-term capital gains tax rates, and introduced a concept ["AHYDO"] that somewhat impaired the deductibility of interest on certain corporate debt.)
In terms of the current impact of tax policy upon "profiteers," tax rules, other than deductibility of interest on corporate debt, have only modest impact. Done well, private equity is so lucrative that people would still pursue those strategies even if their income from them were more heavily taxed.
* Endowments would still do PE investments if their income became taxable, rather than tax exempt like all other charities' income.
* Foreigners would still do US PE investments if their capital gains became US taxable (as they are presently not, excepting certain real estate related gains).
* Ultra-rich Americans would still do PE investments if capital gains rates went up.
* People would still want to be working partners at PE firms even if they had to realize their share of gains on successful trades as ordinary income bonuses rather than carried interest capital gains. We financiers in other disciplines have to take our upside in bonuses, dividends and distributions half of which we share with our friends at the IRS and the New York State Department of Finance, and yet we still come to the office every day despite that.
Put another way, the Laffer Curve is very moderately convex at the point where PE activity sits.
posted by MattD at 7:25 AM on February 2 [2 favorites]
In terms of the current impact of tax policy upon "profiteers," tax rules, other than deductibility of interest on corporate debt, have only modest impact. Done well, private equity is so lucrative that people would still pursue those strategies even if their income from them were more heavily taxed.
* Endowments would still do PE investments if their income became taxable, rather than tax exempt like all other charities' income.
* Foreigners would still do US PE investments if their capital gains became US taxable (as they are presently not, excepting certain real estate related gains).
* Ultra-rich Americans would still do PE investments if capital gains rates went up.
* People would still want to be working partners at PE firms even if they had to realize their share of gains on successful trades as ordinary income bonuses rather than carried interest capital gains. We financiers in other disciplines have to take our upside in bonuses, dividends and distributions half of which we share with our friends at the IRS and the New York State Department of Finance, and yet we still come to the office every day despite that.
Put another way, the Laffer Curve is very moderately convex at the point where PE activity sits.
posted by MattD at 7:25 AM on February 2 [2 favorites]
In 2023, private equity portfolio companies accounted for 16% of all US bankruptcy filings.. Across all sectors, private equity-owned companies are twice as likely to go bankrupt compared to public companies, mainly due to the high levels of debt associated with typical private equity deals. The private equity model prefers short-term profits and rapid value extraction in exchange for the long-term stability of the companies in their portfolios.
Source
posted by lalochezia at 3:31 PM on February 3 [1 favorite]
Source
posted by lalochezia at 3:31 PM on February 3 [1 favorite]
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posted by raccoon409 at 4:34 AM on February 1