How Private Equity Consumed America
Summary
TLDRThe video script discusses the concept and practice of private equity, highlighting both its potential for revitalizing companies and the risks it poses. It uses the example of Yahoo, which after a decline was bought by Apollo Global Management and revitalized under new leadership. The script also contrasts this success story with the failure of Marsh Supermarkets, which went bankrupt following a private equity takeover. It delves into the structure of private equity firms, their fee models, and the use of leveraged buyouts. The narrative criticizes the industry for its focus on short-term gains over long-term sustainability, leading to job losses, reduced service quality, and even bankruptcy for acquired companies. The script concludes with a reflection on the human cost of private equity practices and the emotional detachment that allows for exploitation in the name of profit.
Takeaways
- 💼 **Private Equity Basics**: Private equity (PE) firms invest in companies, restructure them for growth, and then sell for a profit.
- 📉 **Yahoo's Decline**: Yahoo, once worth more than Amazon and Apple combined, declined after rejecting Microsoft's bid, eventually being sold to Verizon and then Apollo Global Management.
- 🔄 **Transformation Strategy**: Apollo Global Management, under Jim Lanzone's leadership, focused on Yahoo's core assets like Yahoo Finance and Yahoo Sports, selling off other assets to refocus the company.
- 📈 **Growth and Profitability**: Through strategic sales and focusing on successful divisions, Yahoo reportedly became profitable, with an IPO potentially in the future.
- 🤵 **General Partners**: PE firms are typically led by experienced individuals known as general partners, who use their connections to raise funds and invest in companies.
- 💰 **Firm Earnings**: PE firms earn money through a 2% annual fee on all money and a 20% performance fee on returns above a certain benchmark, often resulting in significant income for general partners.
- 🏢 **Leveraged Buyouts**: PE firms often use leveraged buyouts, where they borrow money to buy companies, amplifying potential earnings but also increasing risk.
- 🛒 **Asset Sales and Leasebacks**: PE firms may sell and lease back company assets to generate immediate cash, which can be used for further investment or to pay down debt.
- 📊 **Consequences of PE Ownership**: The pursuit of efficiency and cost-cutting by PE firms can lead to negative outcomes like job losses, reduced service quality, and even bankruptcy for acquired companies.
- 🛍️ **Impact on Local Communities**: Closure of local businesses, like Marsh Supermarkets, after PE ownership can have significant social and economic impacts on communities.
- ⚖️ **Tax Advantages**: The income of general partners from performance fees is often taxed at the capital gains rate, which is lower than the rate for traditional income, further incentivizing aggressive growth strategies.
Q & A
What is the basic premise of private equity investing?
-Private equity involves funds taking investor money to buy companies, restructuring them, growing their worth, and then selling them for a profit after a few years.
What was Yahoo's market capitalization at its peak in the early 2000s?
-Yahoo's market capitalization reached a high watermark of over $125 billion.
Why did Yahoo reject Microsoft's purchase bid in 2008?
-The script does not provide a specific reason for Yahoo's rejection of Microsoft's bid, but it mentions that the decision led to a decade of decline for Yahoo.
Which private equity firm bought Yahoo after its sale to Verizon?
-Apollo Global Management, a large private equity firm, bought Yahoo after its sale to Verizon.
What was Jim Lanzone's previous experience before being appointed to lead Yahoo's turnaround?
-Jim Lanzone had previously worked at Ask.com, CBS's digital business, and briefly as CEO of Tinder, which gave him experience in turning around and leading digital businesses.
What were the two key assets that Apollo and Yahoo's new leadership team decided to focus on?
-The two key assets that Yahoo decided to focus on were Yahoo Finance and Yahoo Sports, as they had maintained a strong reputation in their respective fields.
How does the private equity firm make money from its investments?
-Private equity firms typically charge a 2% annual fee on all money invested, regardless of performance, and a 20% performance fee on any returns above a predetermined hurdle rate.
What is a leveraged buyout and how does it amplify potential earnings for a private equity firm?
-A leveraged buyout is when a private equity firm uses a combination of its own money and borrowed money to purchase a company. This strategy amplifies potential earnings by allowing the firm to acquire larger companies and increase the value of their investments.
What was the fate of Marsh Supermarkets after its acquisition by Sun Capital?
-Marsh Supermarkets filed for chapter 7 bankruptcy in 2017, closing all locations and liquidating assets. The company struggled to keep up with rent payments and pay vendors under Sun Capital's ownership.
How does the private equity model potentially impact employees and consumers?
-The private equity model can lead to layoffs, reduced service quality, and increased prices for consumers. Employees may face underfunded pensions and job losses, while the focus on short-term returns can lead to long-term negative consequences for the companies involved.
What are some of the negative outcomes associated with private equity ownership?
-Negative outcomes of private equity ownership can include company bankruptcies, increased mortality rates at nursing homes, and a higher likelihood of layoffs. The focus on efficiency and cost-cutting can lead to a decline in the quality of products and services.
Why is the general partner in a private equity firm incentivized to maximize firm gains?
-The general partner is incentivized to maximize firm gains due to the compensation model, which includes a significant share of the performance fee from investments that exceed the hurdle rate. This fee is treated as capital gains, leading to a lower tax rate and potentially substantial personal income.
Outlines
📈 The Concept and Challenges of Private Equity
Private Equity involves taking investor money to buy, restructure, and sell companies for profit. However, it’s not always successful. For example, Yahoo's market value plummeted from over $125 billion to $4.8 billion before Apollo Global Management bought it. Apollo, known for its controversial history with figures like Leon Black, aimed to revitalize Yahoo with new leadership under Jim Lanzone, who had prior success with Ask.com. Yahoo's transformation involved selling off non-core assets like Yahoo! Japan and Edgecast, focusing on core strengths such as Yahoo Finance and Yahoo Sports, which saw significant growth and new leadership. This restructuring has reportedly made Yahoo profitable again and poised for an IPO.
🔍 Understanding Private Equity Firms
Private equity firms are centered around General Partners (GPs) who leverage their networks and expertise to raise funds and invest in companies. Notable GPs include Mitt Romney of Bain Capital and Steven Schwarzman of Blackstone. These firms make money through a 2% management fee on all funds and a 20% performance fee on returns above a set hurdle rate. Leveraged buyouts (LBOs) amplify potential earnings by using borrowed money, but also increase risks. The tax structure favors GPs by taxing their earnings as capital gains rather than income. This system incentivizes GPs to maximize firm gains, often through aggressive strategies.
📉 The Downfall of Marsh Supermarkets
Marsh Supermarkets, a regional grocery chain, expanded rapidly in Indiana and Ohio before being bought by Sun Capital Partners. Under private equity ownership, the chain faced significant changes, including asset sales and store renovations. However, these moves, including sale-leaseback arrangements, strained the company’s finances. Despite initial sales boosts, long-term strategies failed, leading to bankruptcy and the closure of all Marsh locations in 2017. This example highlights the detrimental impact private equity can have on regional businesses, employees, and local communities.
🏬 Consequences of Private Equity Ownership
Sun Capital’s ownership of Marsh Supermarkets resulted in bankruptcy and significant financial losses. Despite failing to recoup their investment, Sun Capital still profited from management fees and asset sales. The closure of Marsh locations had severe effects on communities, turning areas into food deserts and undermining employee pensions. This case exemplifies a broader pattern where private equity firms prioritize short-term gains over long-term stability, often at the expense of employees and consumers.
💼 The Dark Side of Private Equity
Private equity’s focus on efficiency and cost-cutting often leads to negative outcomes, including layoffs and reduced service quality. Industries like healthcare, regional groceries, and casual dining chains are particularly affected. PE-owned companies see higher bankruptcy rates and, in the case of nursing homes, increased mortality rates. The drive for profit, enabled by leveraging and incentivized by favorable tax treatments, encourages practices that prioritize short-term financial gains over sustainable business health. This system benefits a small number of individuals at the top while often harming employees and consumers.
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The script transitions to a sponsor message, promoting Brilliant as a learning platform that simplifies complex STEM subjects through interactive exercises. Highlighting a course on large language models, the ad emphasizes Brilliant’s approach to breaking down topics into small, manageable chunks that can fit into daily routines. This method makes learning more accessible and practical for users, encouraging continuous self-improvement. The ad offers a free 30-day trial and a discount on an annual subscription, encouraging viewers to explore Brilliant’s educational resources.
Mindmap
Keywords
💡Private Equity
💡Leveraged Buyout
💡General Partner
💡Management Fee
💡Hurdle Rate
💡Performance Fee
💡Yahoo
💡Marsh Supermarkets
💡Sale-Leaseback
💡Artificial Intelligence
💡Brilliant
Highlights
Private equity firms operate by investing in struggling companies, restructuring them, and aiming to sell for a profit.
Yahoo's decline after rejecting a Microsoft acquisition offer led to its eventual sale to Verizon for a fraction of its peak value.
Verizon's merger of Yahoo with AOL resulted in a significant loss, eventually selling to Apollo Global Management.
Apollo Global Management, under the leadership of Jim Lanzone, focused on Yahoo's core assets like Yahoo Finance and Yahoo Sports.
The strategic sale of Yahoo's non-core assets allowed Apollo to recoup its initial investment.
Yahoo's transformation under Apollo included cutting off non-essential assets and focusing on profitable divisions.
Private equity firms typically operate through a General Partner who raises funds and manages investments.
General Partners in private equity firms are incentivized by a 2% management fee and a 20% performance fee.
Leveraged buyouts are a common strategy where private equity firms use borrowed money to magnify potential returns.
The case of Marsh Supermarkets illustrates the potential negative outcomes of private equity ownership, including bankruptcy.
Private equity firms often focus on industries like regional grocery chains, casual dining, and healthcare.
The consequences of private equity involvement can include job losses, increased costs for consumers, and reduced service quality.
Private equity ownership has been linked to higher mortality rates in nursing homes and increased likelihood of bankruptcy.
The general partner's compensation model encourages growth at all costs, which can lead to exploitation and negative human impact.
The distance between decision-makers and those directly affected by their decisions allows for easier exploitation in private equity.
U.S. tax authorities treat the general partner's earnings as capital gains, resulting in a lower tax rate compared to traditional income.
Artificial intelligence is a growing focus in finance, with potential implications for how private equity and other sectors operate.
Brilliant.org offers courses on complex subjects like large language models, making them accessible through intuitive teaching methods.
Transcripts
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?
For example: do you remember Yahoo? In the early 2000s, it was an icon of the early internet. It
was consistently worth more than Amazon and Apple combined. Its market-cap reached a high
water mark of over $125 billion. But today, it’s known for what it isn’t—after rejecting a $44.6
billion purchase bid by Microsoft in 2008, a decade of decline led to its eventual sale to
Verizon for a humiliating $4.8 billion. Verizon then merged the company with AOL, previously
bought for $4.4 billion, but after the downward trend continued Verizon finally sold the combined
company for just $5 billion—an enormous loss. The buyer was Apollo Global Management—a behemoth
private equity firm previously headed by Leon Black until his $158 million in payments to
Jeffrey Epstein emerged in the media. Through the years, Apollo has owned and transformed
companies like ADT, Chuck E. Cheese’s, Qdoba, and AMC Theaters, but this time,
they believed there was value to be had in the beleaguered web services company, Yahoo.
For their strategy to work, they needed a leader, and for that they turned to
experienced businessman Jim Lanzone. Part of the reasoning was surely that this wouldn’t
be the first time Lanzone attempted to turn around a faltering internet business. He made
a name for himself while working at Ask.com. This company started as Ask Jeeves—an early
and promising competitor in the search engine space focused on natural-language processing,
much like today’s AI-driven chatbots. Google, of course, won that competition, so the company
pivoted its business model to center on questions and answers, rather than search,
and correspondingly rebranded as Ask.com. It was around then that Jim Lanzone was appointed CEO,
and while always overshadowed by the company’s fall from its promising early days, Lanzone was
recognized as having finished his term as CEO with the company on a firmer footing,
and is therefore credited for its continued survival. In the years that followed,
Lanzone went on to lead CBS’s digital business leading up to its massive merger with ViaCom, and
then was briefly CEO of Tinder in 2020, so Apollo believed he had all the experience for the job.
This new leadership team, CEO Lanzone and investor Apollo, started by selling off extraneous yet
valuable assets Yahoo had acquired through the years—they wanted to focus on the company’s core,
rather than just acting as a collection of random revenue-creating resources that managed
to survive through time. So the key assets of the comparatively strong and independently
operated Yahoo! Japan were sold off to its other owner, SoftBank, for $1.6 billion, then Edgecast,
a streaming technology company that the former owner had grouped into the Yahoo/AOL merger,
was sold for $300 million. With just those two sales and the $2 billion they brought in,
Apollo was reportedly able to more-or-less recoup what it had borrowed to finance
the purchase of Yahoo in the first place. The key next step was facing reality—recognizing
that Yahoo was no longer truly a search engine, it was no longer an internet homepage, and it
was hardly even an email provider anymore—really, Yahoo was simply just whatever still worked. And
what worked was clear: Yahoo Finance and Yahoo Sports. Through the years, each had maintained
and gained a reputation as the best places to go for investing and sports news and data.
So to double-down on success, they once again hired from experience—Ryan Spoon’s time at ESPN
and BetMGM gave him context into the fantasy sports audience that drives so much of Yahoo
Sports’ traffic, so he was tapped to be that division’s president. Tapan Bhat’s time as
Chief Product Officer of NerdWallet informed his experience in the wants of the newest generation
of retail investors, so he was appointed general manager of Yahoo Finance. Structurally,
within Yahoo, each of these core divisions was given a high degree of autonomy to build out
unique product offerings for their specific customer-bases—Yahoo Sports started work to
bolster its sports betting offerings, including acquiring sector-startup Wagr in 2023. Yahoo
Finance focused on growing its subscription-based offerings, and its Yahoo Finance Plus platform,
offering advanced trading tools and data, is reported to now have more than two million
customers and double-digit year-over-year growth. The details of what Apollo and this new leadership
team are doing go on and on, but in short, Yahoo has gone through a transformation marked
by cutting off its appendages, reinforcing its core, and it’s working—while obscured by the lack
of reporting requirements due to its private ownership, all indications suggest that the
company is, while smaller, as healthy as its been in decades, and the CEO has said that it’s on the
path towards IPO and is “very profitable.” However Apollo exits this investment,
it will almost certainly yield them a tremendous return. And it’d be fair to argue they will have
deserved it—they came in, took a risk, found a new leadership team, developed a viable
strategy, then shepherded the company through a transformation. They took an obsolete institution
and brought it back into relevancy. And this is exactly what the private equity industry
would like you to believe private equity is. Structurally, private equity firms are not
complicated. Their cores are the General Partner. General partners typically know
the right people—it is not an entry level job. To take the example of a rather random,
rather unremarkable firm, J.W. Childs Associates was founded by general partner John W. Childs
after a long and successful stint at Thomas H. Lee Partners, founded by Thomas H. Lee.
Thomas H. Lee founded his firm after a long stint at the First National Bank of Boston,
where he rose to the rank of Vice President. Other examples of private equity general partners
include Mitt Romney of Bain Capital, who was also the 2012 Republican nominee for president,
and Steven Schwarzman of Blackstone, the 34th wealthiest person in the world.
These connections are crucial thanks to step two in the process—raising money. Typically
general partners start by throwing in a couple million of their own money, to set the stakes,
then they’ll go around pitching investors on why they’re the best person to manage the investors’
money. Often it has something to do with having particular experience in a particular industry
that is particularly attractive for particular reasons—in the case of J.W. Childs, he likely went
around arguing that he had a particular knack for investing in consumer food and beverage companies
since at his prior firm he had helped arrange the buyout of Snapple for $135 million in 1992, which
his firm sold two years later for $1.7 billion after massive revenue-growth. And he’d likely
argue that food and beverage companies are great for investment since people have to eat and drink,
and therefore the sector is less subject to the cycles of the market than something like tech.
This sort of stability is particularly attractive to the massive institutions that make up the core
of private equity investors—in John W. Childs’ case, insurance companies like
Northwestern Mutual or employee pension funds like the Bayer Corporation Master
Trust. Individuals can theoretically invest in PE funds, but only if they hold enormous
wealth—it varies dramatically, but many funds have minimum investments upwards of $25 million.
Meanwhile, the way private equity firms themselves make money is remarkably consistent—they just take
two percent of it. Two percent, of all money, each year, is taken as a fee, regardless of whether or
not the firm actually grows the investment. But then to incentivize returns, the firm also sets
a benchmark, called a hurdle, that they’re aiming to beat in year-over-year investment growth—say,
7%. Any money earned on top of that hurdle is then subject to a 20% fee that goes back to
the firm. So, say, if a fund was originally worth $100 million but grew to $110 million, $3 million
would be subject to that performance fee and so 20% of it, $600,000, would go back to the firm.
In practice, what’s earned from the 2% base fee is fairly consistent, since there are generally
restrictions as to when investors can take money out of the fund so the sum does not
generally fluctuate rapidly—therefore, firms typically earmark this base fee for covering
basic operating costs like office rent and analyst salaries. But how much is made from the 20% fee
varies enormously—some years it could be nothing, others it could be yacht money,
especially since the gains from that fee are generally distributed primarily to the general
partner. This is how general partners like John W. Childs become billionaires. And even better:
the money from these fees is not considered traditional income by the American tax
authorities—it’s considered capital gains. Despite the fact that these earnings do not
truly come from investment by the general partners themselves, the IRS treats them as if they do and
therefore only about 20% goes to taxes, versus the 37% they’d pay on traditional income.
So, considering it’s the primary source of their wealth, the general partner is massively
incentivized to maximize their firm’s gains, and to supercharge this to the next level they almost
all rely on one simple trick—they don’t actually invest their own money, at least primarily. Now,
if a $100 million fund bought a $100 million company and increased its value by 25%,
they’d gain $25 million. But, if a $100 million fund bought a $400 million company and increased
its value by the same multiple, they’d gain $100 million—they’d 2x the fund’s value. And believe it
or not, a $100 million fund can buy a $400 million company… as long as they have a friendly banker.
This is what’s referred to as a leveraged buyout—the fund puts in some of their money,
but primarily relies on borrowed money to pay the seller, just like a homebuyer with a mortgage.
This magnifies the potential earnings, but in turn, of course, the potential losses.
But it’s worth considering what this does for the General Partner. In a $100 million fund buying a
$400 million company with 75% borrowed money, very small margins of growth can make all the
difference for this one individual. With a 7% hurdle and 7.5% growth, 20% of the margin above
7% on that $400 million company would earn this individual $400,000 But if, instead,
the company reached 7.75% growth, the general partner would earn $600,000—because of this
amplifying effect, every quarter of a percent growth, a rather small difference, earns the
general partner another $200,000 in income. It’s also worth considering that it really
doesn’t matter exactly how this value is created. For every miraculous Yahoo-turnaround
story there’s a Marsh Supermarkets. At no point did Marsh reach the size
or level of national ubiquity as Yahoo—if you aren’t from Indiana or Western Ohio,
you’ve likely never heard of Marsh SuperMarket. Yet, while confined to just two states, Marsh
Supermarkets and its private equity takeover, exemplifies a pattern that spans all fifty.
The first Marsh opened here, a small local grocer catering to specific local needs in Muncie,
Indiana in 1931. The simple concept took. Weathering the Great Depression,
then outlasting World War II, the budding Indiana institution began to expand: by the 1950s there
were 16 Marsh locations across the state, by 1952 there was a Marsh distribution center in Yorktown,
Indiana, and by 1956, the store was expanding into Ohio. As demands changed in the ‘60s,
the company adjusted. Marsh Foodliners became Marsh SuperMarkets, growing in size to accommodate
one-stop shopping. Diversifying as decades progressed, the company also established its
own convenience store: The Village Pantry, its own bargain bin store: Lobill Foods, and eventually
purchased its own upscale grocers in O’Malia Foods and Arthur’s Fresh Market. Blanketing urban
and suburban Indiana and western Ohio, Marsh and Marsh properties were a mainstay through the ‘90s
and 2000s. And it was at about this time that Sun Capital became interested in the company.
Today, there are zero Marsh locations. In 2017, unable to keep up with rent payments
and struggling to pay vendors, the company filed for chapter 7 bankruptcy, closing
every last location and liquidating all remaining assets. Like an empire spread too thin, Marsh had
reached its territorial epoch before collapsing in on itself within just two decades—all on a
timeline that rather neatly lines up with the brand’s time under Sun Capital’s ownership.
Now, Sun Capital Partners didn’t instigate the regional grocer’s fall from grace. Prior to the
sale, Marsh had expensively failed to expand into Chicago; it had felt the revenue squeeze from
encroaching box stores; and it watched Krogers parade into its grocery market. In response,
the company began to fall behind, failing to modernize its stores or products, backing out of
sponsorship deals with the Indiana State Fair, and opening itself up to the possibility of selling.
In an atmosphere of supermarket consolidation, though, there wasn’t much interest in the
struggling chain… not until someone noticed in a footnote in the company’s financial report that
the company held a rather robust real estate portfolio. A $325 million purchase point then
became more palatable, and in early 2006, Sun Capital jumped, paying $88 million in
cash and assuming $237 million of debt. To Sun Capital, the deal was a can’t lose
proposition—either they’d turn around and flip a bloated business, or they’d sell the assets,
assets which just in real estate have been estimated to be worth $238 to $360 million.
Under new ownership, things changed quickly: they pared management, they sold the company jet, and
with the money saved, they renovated storefronts. Sales went up. Then came more maneuvering,
but less the kind that would help bump sales. Almost immediately after Sun Capital took over,
store locations went up for sale: this one for $750,000, this one for $2.15 million,
and this one for $1.2 million. They’d stay operating as Marsh stores, but they’d now
be paying a lease while Sun Capital would collect an unspecified commission on the sales. They even
went as far as selling the company headquarters for a reported $28 million before then straddling
the grocer with a 20-year lease increasing on a 7% clip every five years. This maneuver is
called a sale-leaseback, and it's quite common in private equity, because at least on paper,
it makes sense for both parties. Marsh Supermarket properties were no exception as they could boost
dividends or provide capital for another leveraged buyout for Sun Capital, while also
helping the grocer to pay down debt and provide investment flexibility in the short term. But
as for the consequences accompanying that long, escalating lease on company headquarters—along
with cost-saving moves like carrying name brand products, cutting staff, and contracting out more
and more services—well, Sun Capital just hoped it wouldn’t have to deal with them. As early as 2009,
news bubbled to the surface that they were trying to sell the grocery chain.
But to the dismay of Sun Capital, the new, leaner, streamlined Marsh just wouldn’t sell.
Ultimately, the new-owner business boost was short-lasted, and in 2017, the grocer would go out
of business with Sun Capital at the helm until the very day it filed for bankruptcy. To Sun Capital,
failing to sell was a missed opportunity in a company overhaul that they would deem a loss,
as the group ultimately came $500,000 short of recouping their investment
into the chain grocery store. But even in a loss the private
equity firm won. They still collected their management fee each year of ownership,
afterall. They also collected their commission on sold assets as the company spun off its property
at seemingly every turn. Really, the only loss was that they just didn’t win more.
The same couldn’t be said about the consumers or employees, though. Deeply embedded in Indiana
and Ohios’ urban areas, Marsh locations provided healthier, fresher alternatives in areas at risk
of fading into food deserts. Beyond nostalgia, residents who lost their local grocery and
pharmacy were mad, confused, and lost with the disappearance of a longtime local institution.
Then there were the people that worked for Marsh. According to Washington Post reporting,
at the onset of Sun Capital’s ownership only one of three retirement plans was agreed to be fully
funded by the new ownership—unsurprisingly, the executives’ plan. As for store employees,
their pension went underfunded by some $32 million dollars, which fell not on Sun Capital
to even out, but to the government insurer. As for warehouse workers, Marsh owed some $55 million at
the time of bankruptcy to their pension which was already struggling to pay out full checks.
Ultimately, Marsh Supermarkets as a business and Sun Capital as a private equity firm are
relatively small potatoes. But their ill-fated 11-years speak to a larger
pattern in American life. Private equity quietly maneuvers, takes over, reorganizes,
and moves on while consumers and employees grapple with the consequences. Private equity fixates on
industries: regional grocery chains like Marsh; casual restaurant chains like Red Lobster;
odd-end industries like animal retail and veterinary care; and, most unnervingly, the most
consequential industry of them all in healthcare. In most cases, only the sharpest-eyed consumer
notices the subtle changes, but frequently enough, private equity’s internal tinkering
turns things sideways. The local market goes out of business, the menu items track upward in price,
the understaffed and over-priced veterinary clinic’s care drops in quality, the elderly home’s
staff unintentionally neglects a call for help. All this happens in the name of efficiency gains,
cost-cutting, and corporate streamlining—bad outcomes not even private equity firms can deny.
On average, headcount at public 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.
Theories abound as to why a benign structure leads to such malignant results. But none are
surprising. They all have to do with what happens when one shrinks a conglomeration of hundreds or
thousands of people, their relations, their creativity, their capabilities,
their faults, their everything down to a deluge of figures on a spreadsheet. The stories of a private
equity firm going in, working on the human level, changing the fundamental culture of a
company in a way that strengthens collaboration, creativity, innovation towards the end of just
creating a stronger, more competitive product for their customers are tough to come by. The stories
of a private equity firm going in, hiking pricing after their analysts told them they could, hiring
lobbyists to create more favorable legislative conditions, initiating mass layoffs for divisions
that are not yet profitable, saddling companies with debt in complex financial maneuvers,
shuffling assets around to create the illusion of transformation, sacrificing future potential
for present-day returns—those stories, and their calamitous human results, go on and on and on.
Exploitation is easy without emotion. When the person making decisions is the same
person unlocking the door each morning, it is much more difficult for them to profit off of
their employees' suffering. They have to face the consequences of their greed face-to-face,
and that’s uncomfortable. When the person making decisions is the boss of the vice
president who’s senior associate manages the associate who sits on the portfolio company
board which appoints the CEO who’s direct report manages the division who’s vice president manages
the regional manager who oversees the branch manager that unlocks the door each morning,
exploitation in the name of profit is easier. And those small number of individuals at the top,
the general partners, have all the incentive in the world to exploit on the margins.
Because of the compensation model, the industry is focused on growth at all costs—after all,
without gangbusters growth, the person whose name is on the sign doesn’t get paid. And finally,
with a massive 20% of over-hurdle performance multiplied by leverage then paid out to the firm,
tiny margins of difference—say, outsourcing HR to a third-party firm that is less effective yet
cheaper—make all the difference on the general partner’s annual income. The incentives push
towards brutality, then this brutality is shielded by layers of bureaucracy, and finally the US
government rewards the brutality by subjecting the gains from it to a lower tax rate. It’s a great
system, assuming you happen to be the general partner of an American private equity firm.
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