Private Equity: Your Ears Will Bleed

The history of private equity and leveraged buyouts reveals an aggressive form of capitalism that reshaped how companies are bought and sold, with a considerable emphasis on investor profits at potential human and financial costs.

Emergence of Private Equity in 1970s

The strategy of private equity, which became popular later, traces its origins back to the 1970s, although leveraged buyouts are most strongly associated with the 1980s.

Private Equity: Buy, Restructure, and Sell Companies Profitably

The concept of private equity involves firms buying controlling interests in companies or buying them outright, restructuring them to be more efficient, and then selling them for a profit. Milton Friedman, an influential economist, argued that corporations should only prioritize shareholder profits, thus setting the ideological stage for what would become the operational model of private equity.

The conversation points out the early activities of Kolberg, Kravis, Roberts & Co. (KKR), which conducted leveraged buyouts of smaller, often family-owned businesses during the 1960s. KKR's significant early buyout occurred in the mid-1970s when they acquired Houdaille Industries in 1979 for $380 million, with only about $1 million paid directly and the remainder financed through large amounts of debt placed on the acquired company.

Private Equity's 1980s Rise: RJR Nabisco Buyout & Job Losses

The noted leveraged buyout of RJR Nabisco in the 1980s stands out as a key event. The deal, described as a significant and early leveraged buyout, was so noteworthy that it inspired the book and film "Barbarians at the Gate." This event marked an era in ...

The article describes how private equity firms have mismanaged various companies across different industries, often leading to massive job losses, increased debts, and deteriorating services.

Private Equity Takeover Closed 800 Toys "R" Us Stores, Impacting 30,000 Jobs

Kkr Loaded Toys "R" Us With Debt and Drove It Into Bankruptcy

Toys "R" Us was taken over by private equity, resulting in the closure of 800 stores worldwide. This takeover impacted 30,000 jobs and drove the beloved toy company into bankruptcy. The private equity firm's management decisions put significant debt onto Toys "R" Us, leading to its eventual downfall.

Sears Holding, Formed by Kmart's Acquisition of Sears, Was Dismantled by Eddie Lampert, Costing Thousands of Jobs

Lampert Used Buybacks and Asset Sales to Enrich Himself and Investors, Neglecting Sears

Edward Lampert, a former Goldman Sachs employee and chairman of ESL Investments, took charge of Sears after Kmart's acquisition created Sears Holdings. Lampert was accused of devaluing Sears, enabling its purchase at a discounted price. Under his direction, the company underwent a steep decline over seven years, closing down from 3,500 Sears and Kmart stores to only eight. The Wall Street Journal estimates roughly 200,000 job losses during Lampert's tenure.

Lampert's management practices enriched himself and investors at the company's expense. He initiated stock buybacks valued at $6 billion, which significantly exceeded capital expenditure, resulting in declining store conditions and company performance. ESL loaned Sears Holding nearly $2.6 billion, ensuring ESL collected around $400 million in interest and fees. This mismanagement led to Sears Holdings filing for bankruptcy with tens of thousands of jobs cut and $11 billion in unpaid debt to creditors.

Moreover, the profitable parts of Sears were spun off, with ESL investing in these smaller entities. In 2015, Lampert's Seritage Growth Properties purchased hundreds of Sears and Kmart buildings, then rented them back to Sears Holdings, further siphoning funds from the already struggling retailer.

Private ...

The article delves into how private equity firms can negatively impact companies through strategies aimed at boosting short-term profitability, often at the expense of long-term investment and stability.

Private Equity Firms Use Layoffs and Closures to Boost Short-Term Profitability

Private equity's approach to management often includes mass layoffs and company break-up as they struggle to pay back substantial loans used for leveraged buyouts. To service these debts, private equity firms may resort to selling off a company's assets, leading to increased operational costs and impaired company performance.

Impact on Communities and Iconic Brands

One example is Red Lobster, whose expenses soared from $16 million in property taxes to $158 million in lease costs after their properties were sold and leased back to the firm. This change drastically affected Red Lobster's operations but benefitted the equity firm through increased lease revenues.

The discussion also touches on the management of Sears Holding during bankruptcy restructuring, which resulted in severe cost-cutting measures: employee layoffs and store closures. These closures, particularly of Sears and Kmart stores, led to a significant loss of jobs and affected the surrounding communities, highlighting how private equity decisions can reverberate beyond the boardroom.

Private Equity Financing Leaves Companies Vulnerable

Private equity financing makes companies vulnerable because managers often prioritize their earnings through fees, insulated from adverse outcomes like bankruptcy or job loss. This practice contributes to the negative perception of private equity, as managerial profit can be disconnected from the success of the company or the well-being of its workers.

Struggling Companies Imp ...

The private equity industry faces critical scrutiny over its lack of transparency and resistance to heightened regulation compared to public companies.

Private Equity Firms Face Less Oversight Than Public Companies

Following the 2008 financial crash, Congress had considered ramping up the regulation on private equity firms but ultimately found that these firms still operate under significantly less oversight. Private equity, categorized as an alternative investment, tends to be riskier with less transparency and is subject to less scrutiny. The government's lighter regulatory approach stems from the idea that only certain types of investors, such as accredited investors, are allowed to participate in private equity, and thus, the need for transparency seen with traditional stocks and bonds is not as pressing. Consequently, private equity firms continue to engage in opaque practices without the accountability that is required for publicly traded companies.

Opaque Practices Hinder Accountability of Private Equity Firms

Although there have been increased reporting requirements, private equity firms remain less transparent than their publicly traded counterparts. This lack of oversight allows them to utilize compensation formulas like "2 and 20," which enable private equity managers to earn from the total assets and profits of the companies they handle, sometimes through maneuvering asset prices. This arrangement fosters an environment where practices remain clouded and managerial accountability is less straightforward.

Private Equity Managers Structure Compensation for Lower Tax Rates

Private equity managers often reap substantial profits, as mentioned in the context of Edward Lampert running companies aground. These earnings are taxed at a capital gains rate of around 20%, which is far less than the nearly 37% one might expect from personal income tax rates. The fees charged by these managers classify as capital gains rather than personal income, leveraging what's known as the "carried interest" loophole to benefit from lower tax rates.

"Carried Interest" Loophole Taxes Private Equity Managers At 20% Capital Gains Rate, Not Higher Income Rate

The carried interest loophole r ...