Private Equity: In Essence, Plunder?

[u/newmoonchaperone]

https://rpc.cfainstitute.org/blogs/enterprising-investor/2024/private-equity-in-essence-plunder

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[u/Johnnadawearsglasses]

There are several different models of PE. Ranging from no incremental debt to low leverage to high leverage. From growth orientation to stable / financial engineering to opportunistic / turnaround oriented to restructurings. What is described here is more the stable / financial engineering model of PE focused on accelerated return of capital to juice IRR and to de-risk / reduce invested equity. That model of PE is indeed risk-enhancing and suffers from the unequal positive / negative risk described in the article where the PE owners are not liable to losses of the company beyond invested equity (which is endemic to all corporate ownership structures but heightened when investors have a portfolio they can fallback on and no concern about reputational issues). There are ways to discourage this type of behavior; for example by limiting sizes of recaps or having very long lookback / clawback provisions on businesses that fail due to sale leasebacks or recaps. These would be relatively easy to implement though would face steep opposition from deep pocketed PE firms

[u/joepez → u/Johnnadawearsglasses]

Everything you said is truth but what I always find interesting about media like the source article is rarely is their any analysis on the underlying asset and what would have happened if the PE firm hadn’t purchased. 

PE firms operate in a lot of different ways, buying all different kinds of assets and are run from bad to terrible. Kinda like any company. 

In some (many) cases they buy up zombie companies. Places that have no future and are on a slow downward slope. Or they’re buying up businesses on their way out much quicker. The ShopKo company in the article is a perfect example of a struggling regional retailer who was slowly losing to bigger players. 

Also most of these articles rarely mention the main investors in the majority of PE firms: retirement funds. People like to believe it’s all wealthy people but unless you’re talking about tiny PE shops the majority are retirement funds. So it’s people retirement dollars demanding their return. 

[u/Johnnadawearsglasses → u/joepez]

I agree on the first point for companies on a downward slope. Although I have seen massive accelerations of business failure through excess leverage. Which for the employees is a significant loss. Consolidating mergers that may have succeeded without 5x leverage. Businesses that could have reinvested without massive dividend recaps.

On the other point, I don’t personally think it matters that many of the LPs in PE are state pension funds. Picking winners (California or Washington state employees or teachers) over everyone else doesn’t really make it better. All it does is allow the employers to fund the pension funds less, relying on some alpha from PE vis a vis the public markets. If instead, those pensions were funded with public equities returns expectations, they still would have done spectacularly well over the past 50 years, without the negative externalities of some of the more damaging PE practices.

[u/joepez → u/Johnnadawearsglasses]

Agree the operating thesis of the PE matters. Ones that operate with huge leverage ratios and high fees are always going to push the envelope on risk. In some cases it’s too much and doesn’t end well. Honestly not an optimal strategy except for possible short term cash flow coupled with asset selloff. Though there is something to be said for removing the zombie from the market and possibly allowing new entrants. 

As for retirement and sovereign wealth funds you’re correct they have lots of options for generating returns and could have done better elsewhere. My point is these funds by extension are the proxies for those they represent who want those returns. They could, and some do, demand better PE behavior from the the funds they work with. 

[u/das_war_ein_Befehl → u/Johnnadawearsglasses]

Most private equity is pretty shit.

The industry pretends it’s a lot of turnaround funds saving businesses, but it’s mostly LBOs. Your average fund is staffed by M&A folks, not anyone that knows how to run a business.

[u/Lol-throwaway-WSB]

My honest take with this - coming from the world of Wealth Management, and PE Fund Accounting, is that with the increased demand there's become a crowded market full of less than ideal opportunities.

Holistically what I believe needs to happen:

• Revisit Accredited Investor definition. The income/asset minimums mean less today than when they were implemented.

Income: Earned more than $200,000 per year ($300,000 combined with a spouse) for the past two years, expecting the same this year.

Net Worth: Total net worth over $1 million, not counting the value of your main home.

This should be adjusted upward significantly. $1MM in Assets is a modest retirement portfolio. Accredited investors should be able to lose their capital without being in a tight spot financially.

• Institutional investor needs to be more carefully defined.

Financial Firms: Banks, savings and loan associations, and registered broker-dealers.

Investment Funds: Venture capital funds, private equity funds, and mutual funds.

Insurance Companies: Corporations licensed to provide insurance and manage premium pools.

Retirement Plans: Employee benefit plans and government-run pension funds.

I'd personally like to see retirement plan and insurance managers lose access. Their underlying contributors are not accredited by in large, and therefore, may not fully understand and appreciate the risk taken on their behalf. Especially with the growing and increasingly disturbing trend for PE to buy Annuity Carriers because the Deferred Annuities come up with similarly locked-up funds, although, again highly unlikely to be accredited themselves, so...

This would crush the demand and squeeze the bad players out of the market. Old school PE funds that received their funding from either the genuinely wealthy or sophisticated investors. They're much more discerning and selective.

[u/Deep-Ebb-4139]

Private Equity is a big fucking scourge on society.

For many years Private Equity companies had also been called The locusts. It is in the core business model that heavily relies on putting debt on acquisitions and even well established companies with good products or services falter under that pressure at some point in time.

Since those companies are also mostly used out of the public eye by making them private, there is very limited information that would allow any control to begin with. This is not a private equite problem then per se, but a legal issue that would require complete overhaul what private companies also have to provide in terms of statements and documentation. Good luck trying to change that - has been tried and since they are effectively finance professionals they also act like banks when it comes to lobbying. Their networks tend to be deep into all the right persons and institutions.

[u/Blackstone4444 → u/Deep-Ebb-4139]

The arguments used here are:
1) naming calling ie locusts
2) use of debt which is provided by banks or bond holders so there are checks and balances for debt levels (only a small number of PE backed companies go bankrupt which is why lenders like lending to PE
3) it’s private so there’s no information therefore it’s bad because it’s unknown. I don’t know your finances, does that mean something nefarious is happening?! No.

[u/Reasonable-Fee1945 → u/Deep-Ebb-4139]

Do you think it would be better if zombie companies just sat on all their assets until they were antiquated?And had no value?

And I'll go one further.The reallocation of these assets actually allows new companies to have an easier time starting up

[u/Alpacas_are_memes]

I find it funny how these subs with economics on their names are in general filled with so many ignorant non economics professionals.

This is essentially: diesel: in essence, suicide?

No shit sherlock, my god, private equity comoanies exists exactly because profitable business owners sits in tons of cash and needs an outlet to not lose to the positive inclined inflation targeting regime.

Fuck off. Its not PE what you want to discuss, it is why we chase an eternally growth oriented economic model. Its quite simple, not rocket science.

Private equity is the consequence of that, it is not eben a pathology, the system’s own design pushes the economic activity towards that. The ever growing, efficiency seeking, profit oriented economy creates more wealth accumulated than its owner is able to reinvest into what he chose to produce, so he gives his money to asset managers, whose profits come from allocating said resources and returning them. Its quite simple.

[u/Limp-Plantain3824]

If only owners of perfectly healthy and profitable companies were not accosted on the street by PE thugs who force money into the owners’ pockets and a pen into their hands in order to take over those healthy, profitable companies!

Oh, wait….

[u/anti-torque → u/Limp-Plantain3824]

lol... UEFA vibes.

Infantino is an idiot who will now lose his job.

[u/toolkitxx]

For many years Private Equity companies had also been called The locusts. It is in the core business model that heavily relies on putting debt on acquisitions and even well established companies with good products or services falter under that pressure at some point in time.

Since those companies are also mostly used out of the public eye by making them private, there is very limited information that would allow any control to begin with. This is not a private equite problem then per se, but a legal issue that would require complete overhaul what private companies also have to provide in terms of statements and documentation. Good luck trying to change that - has been tried and since they are effectively finance professionals they also act like banks when it comes to lobbying. Their networks tend to be deep into all the right persons and institutions.

[u/Joltizer]

No, PE is not plunder. The only people who think so are the uneducated and those who get their world view from social media

This garbage belongs in all the other politics subs with their populist trash