The private equity (PE) industry has faced its fair share of public scrutiny over the years. However, recent high-profile PE acquisitions of popular retailers like Payless Shoes, Deadspin, Shopko, and RadioShack have revived criticisms of the controversial industry. The industry swallows healthy companies while prioritizing short-term gains over long-term value, and because of this, reform through legislation is necessary.
The term private equity is itself ambiguous, used to categorize an array of different activities from venture capital firms to hedge funds. Big-name companies include the Carlyle Group, Bain Capital, and the Blackstone Group. Just as the name indicates, private equity firms are private, owned by their founders, managers, or investors. Typically, such firms buy companies that are struggling or have underutilized growth potential, with the stated intent of repackaging them, speeding up their growth, and making their business models more efficient. In theory, acquired companies are expected to either be sold to another firm, taken public, or offloaded in some other way.
However, this outcome rarely manifests in practice. Often, private equity companies are more concerned with maximizing short-term returns than they are with the long-term health of the companies they acquire. The quicker firms can yield a return on their investment, the quicker they can move on to acquiring a new company. Often, PE-acquired firms find themselves unable to pay back their high-interest debt receipts. As a result, they struggle to stay competitive without the necessary capital to make continued investments.
Nearly two-thirds of retail bankruptcies in 2016 and 2017 were private equity-owned or controlled companies. A 2018 report comparing Albertsons, a grocery chain managed by the PE firm Cerberus Capital Management, to the Kroger Company revealed that Kroger had been better able to sustain itself in the current economic landscape compared to Albertsons because it had less debt.
In another report by the American Investment Council, 20 percent of public companies that go private through leveraged buyouts were found to declare bankruptcy within 10 years. That’s in contrast to a two percent bankruptcy rate among companies not controlled by PE firms over the same period. Furthermore, once acquired, investors often liquidate any real-estate assets that acquired companies own, while keeping the proceeds. Consequently, businesses are forced to pay rent on the properties they once owned, further adding to their substantial financial burdens.
Regardless of whether a company goes bankrupt or not, private equity firms are largely immune to the financial burden of poor investments. If an investment goes well, PE firms usually yield a 20 percent return. But even if their investments end in bankruptcy, PE firms still make two percent of the money they are managing altogether. Instead, everyday Americans who work for these retailers end up bearing the brunt of bankruptcy.
An industry-friendly study found that two years after companies are bought by private equity, employment shrinks by 4.4 percent and workers’ wages fall by 1.7 percent. For example, when the hedge fund SL Investments took over Sears in 2005, workers lost their 401(k) benefits and were shifted to commission-based salaries. Consequently, workers experienced hourly wage reductions of nearly fifty percent.
A lack of transparency hides the role of private equity in the bankruptcy of acquired companies. Many argue that if private equity firms cannot be held socially responsible for the effects of their speculative blunders, then Congress ought to pass legislation keeping the industry in check. Last year, Senator Elizabeth Warren (D-MA) proposed a piece of legislation titled “Stop Wall Street Looting Act of 2019.” The legislation would transform how private equity firms collect fees and make new rules dictating how acquired companies’ debt burdens are distributed. This would force private equity firms to take on more responsibility for their role. Another proposed piece of legislation involved taxing the advisory and other fees that private equity investors profit off of.
PE firms like Blackstone defend themselves by arguing that they are not to blame for the demise of traditional brick-and-mortar retailers. Rather, they insist that the inability of such retailers to keep up with new technology and the competition that e-commerce poses has led to their ultimate demise. Moreover, private equity groups say that their activities promote growth in the companies they acquire by providing them with access to the necessary capital for scaling and transformation.
Yet the data shows a clear correlation between private equity acquisition and bankruptcy. In order for any substantive change to occur, intervention from Congress is necessary to ensure that the PE industry operates with greater transparency and accountability in the United States.
Photo: Image via Flickr (Virginia Retail)