Private equity piling on debt like never before
pionline.com
pionline.com
This scam, err, scheme, is simply a way for 'investors' to squeeze out all the company's speculative value in a quick cash lump sum, leaving behind a zombie corpse crippled by debt.
It’s a hole in regulation that’s too complicated to legislate against and one of the hidden ways wealth is shielded from tax.
There's no zero risk profit here. Getting a loan using an asset as collateral is not some loophole to evade tax. The loan isn't used for consumption with zero residual value - otherwise how do the lender expect the borrower to service the interest? The loan is used to produce more profit via investment, increasing overall wealth, which means it's correct to not tax it the same way you would tax profit or capital gains.
At the point of consumption is where the best place to tax occurs.
For personal investments it can work out the same way because the interest rate on the loan can be negotiated to a much smaller level than what is available to normal people if you have a lot of money. So as long as you make a reasonable bet that your fairly liquid investments (stock in a public company is really liquid) can return more value than your loan repayment. There’s some risk but it’s not that insane and it’s manageable.
> At the point of consumption is where the best place to tax occurs.
Keep in mind that sales tax still exists but it’s a flat rate and is thus what’s called a regressive tax (vs a progressive income tax). So a rich person using a collatorized loan against their stock portfolio is going to pay less relative tax than a normal person receiving income who paid both income tax & the same sales tax amount. Yes there can sometimes be a luxury sales tax but all that means is that goods that normal people wouldn’t even be able to afford in the first place have a marginally higher tax rate.
i'm not referring to sales tax regarding point of consumption. I am referring to personal income taxes (capital gain or otherwise).
As soon as the profits move from being re-used for investment to becoming personal wealth (intended for consumption), the taxation should occur.
(Maybe not of the firm that originally took the loan - but someone, eventually, because the alternative is economic collapse.)
Is there a reason why this isn’t so?
(I get that there are other reasons why we might not want to do this… I’m curious whether this would fix the issue in the first place.)
Private Equity is paying a ton of money to borrow. Startups don't raise at billion-dollar valuations on a dream and a white-paper. Monkey NFTs are worthless. Several crypto currencies that seemed like thinly veiled scams are basically dead. China has stopped building empty cities.
This all seems pretty good. If the US Government wasn't staring at a mushroom cloud of unsustainable debt without future interest rate decreases, I'd say things are down right peachy.
A bit unfair that you’re getting downvoted, it’s not your fault that the yield curve inversion is unfolding, and that this historically has been a strong leading indicator of a recession.
A decade ago their economies were similar size/scale...
I imagine immigration plays massive rolls in these economic projections (however local to larger Unions).
Let's take it one sub-section at a time, starting with Part D:
The most insane "free give away" of younger tax-payer money, which the first decade of beneficiaries effectively contributed <10% of received benefit (prescription drug subsidization, but only if you're retired/disabled).
I am ALL FOR SINGLE-PAYER HEALTHCARE SOLUTION — I dropped out of a US medical school over a decade ago (realizing the system then was broken, most-obvious-then with the passage of medical student / resident ~80hr/week MAX scheduling (ha ha ha)). Obamacare was doomed before it even passed, and I personally paid the IRS "fine" for the few years required.
Your wall of text is absolutely spot-on, breath-taking!, and yet I recommend to many to embellish their lives in facts, starting with the greatest book [1] on Modern US Retireeism's Upper Crust [certainly there are numerous more impoverished Boomers]; those that did from the "I got Mine!" Generation absolutely are detached from the reality of modern US Decline [opportunies aren't there, folks, for massive segments of population].
Some common examples I see in my part-time philanthropy work (medical focused, for underserved populations within US):
Rich, Well.Meaning Donor: "Yes, but I'd rather donate mother `internationally` because there is SO MUCH OPPORTUNITY FOR US CITIZENs to work and they `just aren't` working."
Donor coordinator (not wealhty; work is matching tax-writeoffs with approved local charities): "That is JUST NOT THE CASE, Friend [2]. I am happy to discuss the complexities of any of a variety of hindrances which keep the majority of Americans impoverished, renting, and unable to develop their own Generational Wealth — pick any topic"
Rich Phil./Legal Tax Avoider: "Why doesn't anybody want to be a non-traveling nurse anymore?!" [==contract nurses that rotate positions and are very. well. paid |VS| full-time staff nurse]
D.C: "Because working staff at a hospital doesn't pay very well, for all the emotional and physical BS that nurses have to deal with -- and the hospital gets gutted by some MBA/JD that works quickly to make each Fiscal Quarter more profitable, to the ultimate doom of the healthcare of patients and well-being of employees. By being short-term traveling contract, only, the MBA/JDs [at first] appear to be saving money [i.e. more shareholder value!] until ultimately the cost of mismanagement/lawsuits from overworked staff and misunderstood wards ends up destroying the entire healthcare system."
Rich Donor, less gratuitously: "???" "But USA has `best healthcare in the world!` ... `wait times` ... `yada` ..."
Me: "...if you can AFFORD IT."
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[1] book "A Generation of Sociopaths" A+
[2] e.g: RAM (Rural Access Medical?) started out as an international charity started by a US Physician... who then realized that underserved/uninsured US Citizens oftentimes face 3rd-world-like health crisis, particularly in rural Appalachia (for just one 5M+ example!).
In contrast, the Boomers entered the workforce in the late 1960s, paid only 6.5 percent of their earnings to Social Security and nothing to Medicare. For about half of their working years, the Boomers paid 10 percent or less to Social Security and less than 1.25 percent to Medicare. Only from 1990 on, when the Boomers had earned paychecks for a quarter‐ century, did they start paying 12.4 percent to Social Security and 2.9 percent to Medicare — the same percentage we Gen‑X/ Yers have paid our whole lives. Yet, Boomers are reaping the full rewards, rewards we will likely never see.
It's an absolute fucking joke and the final trick played by a generation that took solid foundation built on sweat and sacrifice, partied on them for 30 years, left their trash behind and sold what remained for parts. Every-time my conservative, gubmnt hating father lauds the wonders of Medicare and how wonderful his free healthcare is I want to kick him squarely in the balls.
My other older friend at least will read technical information on specific subjects; but his wife poopoos and moral inquisition on "fairness" (a bad word in Her house).
[1] youtube.com/watch?v=mK5TbGvvluk - a 4:49s clip by ClimateTown (Rollie Williams) citing every oil, insurance, and national agency which refutes this (spoiler alert: it's ALL OF THEM accepting global warming).
On the note of "selling": after certain Boomer family members were complaining about the cousin in NYC who won't renovate and get that sweet ABnBux cashflow from her brownstone, I pointed out that our family had let go of 8 figures worth of property in my lifetime (for about 6 figures in cash), and that they had no right to pin our landed gentry hopes on her. Like water off a duck's back; I don't even think they understood what I was trying to say, repeatedly misinterpreting, "It shouldn't be all on her," to mean, "We could swoop in and finance it if only she'd let us." No, I meant, "You squandered your portions of the pie Boomering around in the 90s and early 2000s; leave her be."
They just... don't listen.
Perhaps sadly, bored ape nfts still go for about $60k+ https://www.coingecko.com/en/nft/bored-ape-yacht-club
Traditionally, PE firms would obtain cheap financing from a bank or another finance provider to carry out a leveraged buyout - the PE firm pays a small percent of the acquisition cost using cash, the banks cover the rest, while interest payments to the bank are covered by cash flows of the acquisition target.
But with the higher cost of financing that is available for traditional collateral like the acquisition firm, the PE firms have had to resort to providing collateral using other sources, such as the cash flows of the PE management company itself, or the equity returns of the acquisition target. This could be the fees that are paid to the PE firms themselves to manage the money - it would have been very taboo to expose the management company to risk like that, but now PE firms don't care. Interest rates are skyhigh, around 20%, which is actually high for corporate, and usually the rate for consumer loans.
So yeah, PE is changing quite significantly, and the old model of doing business won't work.
(There's more than that, but I'm not an expert either.)
A private equity fund is an entity - usually a limited partnership - that is created by a “sponsor” (called a “manco” in that article for “management company”) and raises money from outside investors. The sponsor manages the fund and the investments it makes using that raised capital (and in exchange for various management fees paid by the fund to the sponsor). Note that, for a variety of reasons, those investments usually take the form of an investor (limited partner) agreeing to contribute cash up to a designated amount - but not upfront. Instead, the investor funds that agreement to invest cash in the fund when the sponsor asks for a portion of it to be sent to the fund so the fund can make an investment.
It’s been standard practice for a while for a private equity fund to borrow money secured by its assets, which are generally a combination of the ownership interests in the companies it has invested in and its right to cause its limited partners to contribute additional capital to the partnership. By using proceeds funded from debt, the fund can improve the way that its returns to its equity investors are measured, which results in the sponsor receiving enhanced incentive economics.
The main new development reported by this article is that private equity sponsors are now pursuing debt at the sponsor level that is secured by the sponsor’s incentive economics mentioned above as well as any management fees paid to the sponsors by the funds that it manages.
This doesn’t mean that the companies that private equity invests in are more indebted or more likely to collapse due to leverage - instead, the article is reporting that the overall structure of a private equity investment (an operating company owned by a fund that is managed by a sponsor) is seeing additional levels of debt at the top level of that corporate structure.
Is it more reasonable to understand this as:
a. Private Equity is running out of cheap sources of money, so it is resorting to risky high interest sources.
b. Private Equity sees a lot of present opportunity and are willing to take on even high interest debt because there are clear opportunities for higher interest returns.
c. Private Equity got into the pantry and their risk appetite is all messed up and self-destructive
?
To oversimplify slightly, assume that every investment is funded by 60% debt, 39% equity from limited partners and 1% from the private equity sponsor - that 1% representing their common equity participation in the deal (which they’re putting up both because they presumably think it is a good opportunity to invest their personal money as well as to demonstrate alignment with their limited partners). This article is describing how that 1% is getting funded. So instead of coming out of their personal checking accounts, the private equity investment professionals are getting a private capital provider to lend it instead at credit card rates.
So this article probably indicates that deals are in a bit of a lull right now (no exit proceeds from prior investments to fund new investments) and traditional banks have tightened up lending. A few years ago, traditional banks were making similar loans to sponsors at low, low single-digit interest rates (think SVB and their personal loan product portfolio), so now instead the sponsors are having to tap private credit providers, who are going to insist on a much higher rate of return.
Not sure why I was downvoted so much for this comment. The parent poster asked to have the article explained. I did my best to explain the article. I didn’t say I thought that PE firms doing this was a good or bad idea.
If you have a better explanation of the article then please comment yourself. I am here to learn from you too
Which is smart as markets come to the realization that PE's had been creating wealth by trading assets among themselves at articficial, ever higher valuations and now - with higher cost of money - could face reality check. Slowly first then suddenly.
For example I have purchased a dog for a million dollars last year and today I have exchanged that with PE for two cats valued at milion dollars each. So we both now have on our books assets that are valued at two million dollars. Which is great only as long as there is someone who wants to buy my cats and PE's dog at four million dollars next year.
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> This complicates true price discovery. Public markets, while not flawless, tend to be a stricter test of fair valuations. The private equity industry deserves credit for finding continuous ways to bypass the issue and keep their fee stream running.
Private equity: financial engineering prevents valuation check - https://www.ft.com/content/d6891146-f8ff-4c26-83e3-739e7793d...
> The firms that used the era of cheap money to become the new financial titans are wrestling with rising interest costs
> “Many of the reasons these guys outperformed had nothing to do with skill,” says Patrick Dwyer, a managing director at NewEdge Wealth, an advisory firm whose clients invest in private equity funds. “Borrowing costs were cheap and the liquidity was there. Now, it’s not there,” he adds. “Private equity is going to have a really hard time for a while . . . The wind is blowing in your face today, not at your back.”
Private equity: higher rates start to pummel dealmakers - https://www.ft.com/content/8b4a5df6-7f6d-480f-8d20-55793854c...
Of course, at 19%, even crappy investments look good. Unless they go to 0.
The Fed watches neither of those metrics; they watch inflation and unemployment, so I wouldn't actually make this bet, but it's a story people like to tell.
Sounds a bit like what some European football (soccer) clubs do (to their determent at times) selling future earnings to secure financing. I think Barcelona did something like this selling part of their future TV revenue income to secure financing.
I don't have much sympathy for banks speculating on companies and ending up loaning more than the collateral is worth.
Hopefully this won't be the next bailout
These PEs are the locusts of the financial world.
Life is positive-sum.
Fixing a clogged, depends on how they do it I guess.
Companies are all we have for a society in this country; decades of liberalization, mobile work forces, and commodification-as-identification have ensured that.
If the company is going under, it's value to society is questionable.
Sometimes no, but sometimes yes. What about employees, services the company provides to people, etc.? For example, is it no problem if a PE buys and runs into the ground businesses like nursing homes, hospitals, rental apartments and homes? What about in smaller communities where there is no substitute?
Nothing we do is in a vacuum, the domain where economic theories operate. We live in a community, economy, society, and all need to think about how we affect them. If not us, there's nobody else to do it. No person - or fictional corporate entity - is an island.
You cannot tell a private owner of a privately-owned nursing home that they should keep losing money year over year.
Considering that there are other, profitable nursing homes, maybe there is a systemic problem with this nursing home that cannot be fixed (for example too expensive real estate, bad company culture, ...). I this case, liquidating it and then re-using the assets (employees, buildings, ... ) in other economic endeavours is the right choice for the individual and also for society at large.
That's the theory (or one theory among many), but it doesn't always work that easily in practice. If you own any for-profit business, you have obligations beyond making money. If you own a nursing home, you have obligations to the residents, their families, the community, etc.
> You cannot tell a private owner of a privately-owned nursing home that they should keep losing money year over year.
Nobody tells them that. First, the choice isn't follow the (stereotyped) PE route or lose money. Second, your job as a business owner is to make money no matter what the conditions. If as a business owner you accept excuses from yourself (or others) about circumstances, you won't last a month - there are always reasons it can't be done. Your job is to balance and solve all those problems, and make money.
Beyond the perversity of using a company's own full faith and credit to eat it dead from the inside out (essentially admitting that the PE firms themselves are not respectable enough to be granted the credit directly), we have multiple instances of the government preempting the purchase and liquidation (and presumably the accompanying halt or even dissolution of production within) of certain companies for antitrust or even national security reasons.
Um, I disagree—there's a lot wrong with that mindset.