I added a new, longer-than-normal entry to the glossary that I publish in association with this blog yesterday. The entry is on private equity, which is such a deeply inequitable and dangerous feature of the modern neoliberal economy, as I explain as follows:
Private equity is a form of investment in which funds, typically controlled by specialist financial firms, buy ownership stakes in companies that are not publicly traded, or take publicly listed companies private.
It is often presented as a source of entrepreneurial dynamism, managerial expertise and long-term investment. In reality, much private equity activity is better understood as a mechanism for financial extraction.
That does not mean every private equity investment is harmful. Some firms do provide patient capital to growing businesses. But the dominant model in many markets, particularly in the UK and US, has become closely associated with financial engineering, debt loading and short-term extraction.
Private equity is therefore best understood as a product of financialised capitalism.
Its key features include the following.
First, leveraged buyouts.
The classic private equity model involves borrowing heavily to buy a company. The acquired company is then often required to carry the debt used to purchase it. The debt-to-equity ratio is often at least 4:1.
This is the defining absurdity of much private equity activity: a company can be bought using borrowed money, and then be left responsible for repaying debt it did not choose to incur.
The result is often:
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Reduced resilience
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Pressure for rapid cash extraction
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Lower investment
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Increased bankruptcy risk
The company becomes a financial instrument rather than a productive enterprise.
The collapse of Toys “R” Us is often cited as an example of this model in practice.
Second, asset stripping.
Private equity firms frequently extract value by selling property, intellectual property, subsidiaries or pension assets owned by acquired companies.
A common strategy is a sale-and-leaseback arrangement, in which a company sells its property assets and rents them back, generating short-term cash but imposing long-term costs.
This often weakens the productive core of businesses.
Third, fee extraction.
Private equity firms frequently charge substantial fees for matters such as:
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Acquisition fees
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Advisory fees
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Management fees
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Refinancing fees
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Exit fees
These fees are often paid regardless of whether the acquired company performs well.
The investors win first.
Others bear the risk later.
Fourth, short-term exit strategies.
Private equity funds typically aim to sell companies within a relatively short period, typically 3 to 7 years.
This encourages behaviour designed to maximise resale value rather than long-term productivity, meaning the following are prioritised:
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Workforce reductions
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Underinvestment
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Financial engineering within accounting
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Aggressive cost-cutting
Long-term stewardship is rarely the priority.
Fifth, tax advantages.
Private equity frequently benefits from highly favourable tax treatment.
Interest on debt incurred to buy a company is often tax-deductible.
Carried interest income of private equity partners who arrange these deals has often been taxed more favourably than employment income.
Complex international structures can reduce effective tax rates.
This is state-enabled financial extraction.
Sixth, opacity.
Private equity operates with far less transparency than public companies.
Disclosure requirements are weaker.
Ownership structures are often complex.
Workers, suppliers, pensioners and even regulators may struggle to understand who controls a business and why decisions are being made.
Seventh, expansion into essential services.
This is where private equity becomes especially dangerous. Private equity has increasingly moved into:
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Care homes
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Health care
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Veterinary services
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Housing
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Essential infrastructure
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Education
These sectors depend on long-term trust, stable staffing and patient investment.
Private equity frequently imposes the opposite incentives.
The collapse of Southern Cross Healthcare remains a warning of what happens when financial engineering is applied to care.
From a Funding the Future perspective
Private equity represents the triumph of extraction over production. It often creates the illusion of wealth creation because transactions generate fees, asset price gains and accounting profits, but much of this “value” reflects:
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Increased debt
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Reduced resilience
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Weakened labour conditions
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Lower long-term investment
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Higher systemic risk
In accounting terms, private equity often resembles the failure to maintain capital whilst pretending profits have been earned.
It consumes future resilience for present gain.
That is not an investment. It might properly be called liquidation by instalment, or, as the process was once called, asset stripping.
There is a role for genuine long-term private investment in productive enterprise, but that requires:
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Stronger tax reform
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Tighter regulation
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Limits on excessive leverage
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Worker protections
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Pension protection
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Much greater transparency
And in essential services, there is a strong case for private equity to be absent altogether. Care, housing, health and critical infrastructure should not be treated as chips in a casino.
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There’s an excellent book just out about MMT
https://www.amazon.co.uk/You-Just-Print-Money-Taxes/dp/1394375255/
Yes, it acknowledges that money printing could create inflation, but also looks in detail at underused resources such as land, labour and materials. They might just be lying around in the sense of not being used at all.
You can write a summary of your arguments to post here, if you wish
I will respond. I have ordered a copy. I will warn you – I think you have argued with a straw man
But I cannot ba fairer than making you the offer
But you need to stop claiming your own book is excellent or I might think you are doing hype not argument.
There are a lot of questions as you have said in the past about the treatment of interest for tax purposes.
May I suggest that we need some sort of ‘National Investment Fund’ whose role might be to pick up some of the business’s that have fallen into or might fall into the hands of Private Equity?
Possibly in some cases to give them right of first refusal in certain sectors
As you say, quite long for a glossary piece – but a pretty good summary.
An iniquitous equity – the abuse of language that actually means privilege through leverage. In short, legalized theft.
🙂
Thank you, Richard.
With regard to fee extraction, the investment firm often sets up a company to provide services to its portfolio companies. When the portfolio companies are sold, they are often bound to uneconomic contracts, e.g. facilities management, IT support, supplies, recruitment etc, with the former owner. This can cripple the former portfolio company and prevent it from being independently viable.
A better known example than Toys R Us is Manchester United. Even this Gooner feels sorry for them.
Agreed
Too old an example, but one we looked at in Sheffield
I should have first said this is a splendid post.
Thank you
A lot of hours are going in right now
More haste, less speed as I’m running around.
With regard to systemic risk, some banks are desperate to get into these deals and some bankers are desperate to fraternise with people they perceive to be magicians. The banks overexpose themselves to such risk.
The investment firms often flatter the dumb money, especially pension funds, when offloading the faltering portfolio company.
Much to agree with
Back in mid 80’s I was trained and sponsored to attend University by a company that could trace it’s roots back to 1819 and had steady grown over the years to a point where it employed several thousands of people locally and globally and had an apprentice scheme seen as being second only to that provided by Rolls Royce. While away at University, during my first year, the business was agressively purchased by Private Equity. What you have outlined is in a short space of time exactly what happened. The first thing to go was the apprentice school which said a lot about their long term ambitions. It still leaves a bitter taste in the mouth.
I am sure it does
Did you get to finsh?
I was one of the lucky ones as I got to finish my training. Many of those I started training with or were in the following year’s intake were let go. The social club along with the apprentice school were the first things to go as obviously long term investment in human capital was not seen as worthwhile. What followed was brutal. Yearly rounds of redundancies, selling off of substancial assets (land, buildings, machinery, know how) and renting them back, hollowing out and selling off of various divisions to the highest bidders, usually other private equity outfits, decimated pension schemes. Personally, I managed to secure (if that is the right term), a role with one of the weaken and sold off divisions only for the new company to suffer the same fate. Much to dislike
The water companies were also subjected to the processes you describe. With predictable and highly deleterious results. Deep capital built up over many decades providing multidimensional societal benefits liquidated leaving hollowed out organisations devoid of resilience, continuity, institutional memory, strategic purpose. Not creative destruction but structural collapse leaving everyone poorer but the private equity predators. The tax regime that supports this economic vandalism must be terminated.
Thank you Richard for taking the time to explain private equity so clearly. I’ve found your writing genuinely helpful in improving my understanding, and I suspect many others have too. It’s not always easy to make complex topics accessible, but you do it very well. I appreciate the effort you put into educating readers like me.
Thank you
Extraction in one of its worst forms: water companies granted monopoly status, asset stripping ,move as much money as possible offshore to tax havens, allowing foreign companies to own what should belong to us, undermining public health with polluted water, flooding people’s homes
All the while what is Ofwat doing? Water should be nationalised