Private Equity Should Not Exist
mattstoller.substack.com
mattstoller.substack.com
private equity, the financial model in commerce which more than any other defines the Western political landscape
That doesn’t seem accurate. Public companies controlled by the stock market, a board of directors, and a CEO are far more important, both politically and overall, than the small number of companies which have been taken over by private equity.
The point is, the PE landscape is infinitely more complicated than just saying it is good or bad.
One could make similar observations about the payday loan industry: most of the firms are predatory and their offers suck, but 1) because of high default rates, the loan offers will necessarily be poor, and 2) creating more alternatives to payday loans would be great. But banning payday loans would be a net negative, because the choice of "very high interest rate loan or nothing" is better than having "nothing" as the only option.
Were the alternatives better for the stockholders or the CEO? And, were the alternatives better for which stockholders?
The number of firms that have started public, gone private, and then gone public again seems to indicate that private equity doesn't seem to be adding business value.
In addition, a lot of private equity seems to be about stripping cash from companies in creative ways--effectively the endgame of the "hostile takeover and then partition the company" from the 1980's. Toys R Us, Sears, K-Mart sure didn't seem to benefit from private equity.
PE firms, once they own the company, can strip all the cash they want to from the company they own. There’s no law saying a company can’t be harvested for its assets if the shareholders believe that’s the most effective way to extract value from the asset.
[1] - https://corpgov.law.harvard.edu/2017/12/19/analysis-of-delaw...
No? It seems like the opposite to me, surely. The company couldn't go public again at a profit if it wasn't improved.
There's a public company. It has some core goodness to it, but the senior management from board on down are useless and damaging it. The shareholders are passive and don't know what to do. PE steps in, buys it, taking it over and thus taking it private. They then reorganise the firm, getting rid of the bad management and potentially, making hard decisions those managers were emotionally incapable of doing, like shutting down treasured but loss-making business units, slaughtering some sacred cows, quite possibly letting people go and so turning the business around.
Having gone in and done the hard stuff, they then take the company public again and profit from turning the firm around, because they don't really want to manage that company in perpetuity, they just wanted to make money by righting the ship and salvaging what was possible.
Sometimes maybe the business can't be saved. Maybe it's been cobbled together out of acquisitions that made no sense. Maybe it over-extended into new product lines where it had no real advantage over its competitors. In these cases breaking the firm up actually makes most sense from a macroeconomic perspective: the capacity the uncompetitive product departments had may be better utilised by more capable competitors, maybe the acquired firms make more sense to be separated.
The article is written from a leftist perspective that PE is bad and uses lots of perjorative and biased language as a consequence, e.g. "A private equity fund is a large unregulated pool of money run by financiers". What makes this pool of money "unregulated" vs any businesses pool of money? The question is left unanswered. The author knows that "unregulated" is a dog-whistle to certain types of reader and is blowing it as hard as he can.
Other things it says that just aren't true:
private equity is not business
Yes it is.
PE is a political movement
No it isn't.
I've read quite a few critiques of private equity over the years, and worked at a firm that received a major investment by one, albeit not a controlling stake due to the complex nature of that firm's privatisation from government. True to form one of the first things the PE guys did was come in and review every employee, firing a lot of them. "Dead wood", one of them apparently said. But they were right and the company has grown significantly through the privatisation and their involvement. Even the critiques I've read (like this one) usually admit there's positive outcomes to the work PE does.
It'll just sit there, along with the other huge pools of capital that can't seem to find great investment opportunities.
I think (?) that Toys-R-Us provides more value to the _country_, if nothing else in terms of employment for a few thousand people, than a few $b sitting in a bank somewhere.
If we were really effective at putting that $b to work, that might be the better option. Infrastructure somewhere might be worth more than TRU to society.
It's not like "but for Private Equity firms, these would be vibrant, competitive, going concerns". At most, PE was a specific acceleration of their demise, but it seems overwhelmingly likely that the reaper was coming for them anyway...
Sure. This downplays how poorly things were going for Toys R Us before the leveraged buyout. They significantly underperformed expectations the holiday season before the leveraged buyout. Private Equity bet big that they could help Toys R Us make the jump to e-commence as well as revamping stores (they were notoriously outdated compared to the competition at the time of the buyout) and improve operational efficiency. The added debt did make things worse, but Toys R Us was failing on multiple fronts before the buyout (which is why they became a buyout target). Given their underperformance in several strategic areas, it's unlikely that Toys R Us was going to magically turn things around if Private Equity never got involved.
I'm not arguing that Bain and KKR (the Private Equity companies involved) added any value. Both bet and lost $1.3B each on the idea that they could legitimately turn things around at Toys R Us. The rapid rise of e-commerce along with the economic downturn in 2010 meant that Toys R Us was likely doomed regardless of who tried to lead their turnaround. There are legitimate reasons to be critical of Private Equity, but it's not as simple as saying Toys R Us died only because of it.
The article makes it seem super obvious that these deals won't work out. But that is actually not the case. Many / most PE deals actually do work out, and end up making the sponsors a lot of money.
And why would banks allow this? Because private equity are huge profit drivers. They use lots of debt. They also acquire many companies, so there is an ongoing relationship.
if this were the true problem, i.e. if there were a profitable business that just wasn't making enough income to service its debt, then the enterprise would continue to exist after restructuring the cap table.
adding debt to the company just changes the cap table, it doesn't change the profitability of the underlying company.
"either way it would be coming out of the cash owned by the PE shops". They don't have to invest you know. After all, the company is now unprofitable. Obviously it's just inefficient. Why give money to an inefficient company from your core profitable business, when you can break the company up and use the profit from looting it in your core profitable business which you're good at?
It makes much more sense for PE finance to siphon funds for use in a field they have expertise in (more finance) than try to manage companies in various fields (like retail) they're so not expert on, especially when the companies are in the debt.
Perhaps you can do it for pension funds, although most pensions are government backed anyway.
But investors are taking a known risk. These are all sophisticated adults. If a bank wants to sign a contract that they will lose money if the company goes under, who is Warren to say they shouldn't? They're getting well paid for that risk, they know it's a risk.
If you ban debt-funded PE, you'll just have banks in-house the PE firms or any number of other structures that have the same result - people buying companies with other people's money and only sharing in the upside. Because that's a structure that benefits both sides (the banks and the PE companies) and they both want it to work.
There are no banks that failed due to defaults from LBOs.
Besides, the plan goes well beyond banks. If a private investor wants to lend money for an LBO, this still prevents it.
Of course LBOs are not significant enough to single-handedly cause a bank to fail. However, they can still cause companies to go bankrupt that would have otherwise survived.
In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs.
If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11.
>In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs.
What work is LBO doing in this sentence? Financing LBOs carry some risk of loss, as does everything except Treasuries. Why would LBOs be special as something banks shouldn't be allowed to finance? Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc?
Debt is wiped out after liquidation. Most companies do not survive this. Debt service can make the difference between profitability or unprofitability. Remember, this is debt that was forced on the company externally.
> Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc?
I never said they are bad at risk analysis, I am saying they do not truly carry the risk in the first place. The difference is in the outcome. An LBO that should never have happened is worse than a corporate loan that should not exist.
Nope. I get the feeling you don't know the difference between chapter 7 and chapter 11?
>An LBO that should never have happened is worse than a corporate loan that should not exist.
Why?
Same here.
Chapter 11 doesn't "wipe out debt", that's what Chapter 7 does. Chapter 7 implies liquidation.
Chapter 11 may reduce debt obligations, entail partial liquidation, and so on. It doesn't just wipe out the debt.
> Why?
Because of the moral hazard. If I can just get a loan for an LBO to buy a company and squeeze it out like lemon, that's highly destructive. Unlike when issuing a junk bond, I have no real interest in the companies long-term survival. I guess you can make an argument that debt-financed stock buybacks have similar issues, but that's a topic for another day.
In the short term, even a bad LBO looks good for both the bank and the PE firm. Meanwhile, the company has a debt burden that paid for nothing but the privilege of having been bought out, likely requiring them to charge higher prices, which is a strong competitive disadvantage. This leads the whole argument of "restructuring companies to be more efficient" ad absurdum.
Also true, but a key feature of bankruptcy is discharge of debt. Liquidation is not required for elimination of debt.
https://scholarship.law.nd.edu/cgi/viewcontent.cgi?article=1...
What hasn't changed is the fact that Chapter 11 doesn't discharge debt. The prospect of having the creditors repaid at least in part is a prerequisite to Chapter 11.
Page six has around 22% converted and 10% still open. The rest were either dismissed or confirmed, and constitute a majority of cases.
"Still open" means the case is ongoing, so those numbers are irrelevant.
"Conversion" means going from Chapter 11 to Chapter 7 right away.
"Dismissal" doesn't mean success or failure, it means the case is dismissed.
"Confirmed" means that the case will proceed as Chapter 11 instead of being converted or dismissed outright. That can still lead to Chapter 7 later on if the restructuring fails.
Sure, any company, including those that successfully emerged from Chapter 11, may file for Chapter 7 later. But generally once it's confirmed it's considered a success.
Of course confirmation implies that the company continues to exist in order to for the restructuring to actually take place, it doesn't imply that it will exist afterwards. Dismissal doesn't imply that the company will continue to exist for much longer either, it's simply the alternative to going straight to Chapter 7. In any event, dismissal is not a success. You are also ignoring all the cases that go straight to Chapter 7 for your hamfisted construction of a "majority".
No matter how you twist and turn it, the majority of companies that file for bankruptcy do not survive, and the companies that do succeed in Chapter 11 still have to repay debt. That's my whole point.
https://repository.law.umich.edu/cgi/viewcontent.cgi?article...
1) Confirmation rates are actually higher than commonly believed (= roughly one third)
2) If we carefully select for companies that are likely to succeed with confirmation, success rates are higher. Well, duh.
There's a valid argument there, saying that the value of Chapter 11 should not be measured in terms of confirmation rates, because hopeless cases are hopeless no matter how good the law is.
Yet, this doesn't support your view that most companies that file for bankruptcy will survive. If anything, it shows the opposite.
People don't want to run businesses for ever. Private equity allows them to, in some cases. An unmotivated entrepreneur who is only doing a half assed job after a while will also cause a company to go bankrupt. Better to sell then.
Banks generally have sufficient collateral (i.e. from the acquired business) to cover the outstanding principal in the event of a bankruptcy.
Well that was an impressively elaborate sales pitch
I’m in healthcare and they tear it apart.