Explaining the con that is private equity

Emily Stewart's private equity explainer for Vox is a great explainer on how the PE con works: buy up businesses, load them with debt, sell off their assets, slash their costs, then walk away as the house burns, leaving society to put out the fire -- all while enjoying special tax status on your gains.

It's a great companion-piece to Matt Stoller's "Why Private Equity Should Not Exist." Stewart's got a delicious opener, though: she notes that in 2010, Doug Lowenstein -- the top US private equity lobbyist -- wrote a letter complaining about a PBS special on the problems of PE, touting Toys R Us as PE success story.

But by 2017, the private equity looters who took over Toys R Us had looted the company into ruin, paying themselves hundreds of millions in bonuses, stealing their workers' pensions and severance, and leaving their workers' private data sitting behind in ruined stores for anyone to find and steal.

To explain leveraged buyouts in easier-to-understand terms, let’s say you buy a house. Under normal circumstances, if you can’t pay for the mortgage, you would be in trouble. But by the LBO rules, you’re only responsible for a portion. If you pay for 30 percent of the house, the other 70 percent of the asking price is debt placed on the house. The house owes that money to the bank or creditor who lent it, not you. Of course, a house can’t owe money. But under the private equity model, it does, and its assets — its factories, stores, equipment, etc. — are collateral.

The idea, in theory, behind private equity is that the endeavor will be worth it — for both you and the house. “There are many companies that, if not for private equity, would not be able to get access to the kind of capital they need to scale, to transform, to turn around, and to have succession planning,” said one industry source, who requested anonymity to speak candidly for this story.

But because of the debt companies end up owing creditors as part of a deal, they sometimes find themselves with such high interest payments that they can’t make the investments necessary to be competitive or even stay afloat. Plus, companies often take out additional loans to pay private equity investors dividends, and then they pay a fee if and when they are sold. If they can’t pay off the debt, the companies are on the hook, and their employees and customers are the ones to suffer the consequences.

And private equity’s No. 1 priority isn’t the long-term health of the companies it buys — it’s to make money, and as is the case in so many facets of investing today, to make money fast.

What is private equity, and why is it killing everything you love? [Emily Stewart/Vox]

(via Naked Capitalism)

(Image: Mike Kalasnik, CC BY-SA, modified)