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Being told to “suffer through 2 years in investment banking and then to move onto private equity” is advice likely heard by most people who are interested in getting into finance. A clearly sought-after profession- undeniably due to the pay- is known remarkably little about. Perhaps the infamous term the invisible hand more accurately describes private equity than capitalism as the true cogs of the economy. Your secondary school to your dog’s veterinary practice, are all institutions likely owned by a PE firm. So, we ought to ask ourselves: what do these firms really get up to?
What private equity does is very simple; a firm will take some of its own money, some of the investors’ money and a lot of borrowed money to buy up a company. The company is then flipped, by making operational or financial changes in the hopes of making a profit later down the line. This is what a PE firm does, however, the issues lie in the underlying business model of the profession. In 2007, Carlyle acquired the US nursing home chain Manor Care. It was bought up with lots of debt, which resulted in staff cutbacks, healthcare violations and a whole load of complaints. This led to the death of a particular individual and when the family tried to sue Carlyle their defence that held up in court was that the firm never really owned Manor Care. Carlyle’s position was that they “merely advised a series of funds whose limited partners who through shell corporations own assets of Manor Care”. Not only did the PE firm load up the nursing home with all kinds of debt which resulted in the death of an individual, but because of legal reasons, Carlyle was free of any responsibility.
Previously, a PE firm would buy the noncore business units of a company, the parts that were unused or suffered from neglect. However, from 2004 onwards, PE has thrived on the basis of purchasing an entire public company. This growth is obvious from the value of PE buyouts which grew from $28 billion in 2000 to $502 billion in 2006. This success is due to the standard practice of ‘buying to sell’ that follows from a transition in performance improvement that a company undergoes. The longevity of a company and its sustainability are not the primary goals of a PE firm.
Why do people want to get into the profession? Money is the obvious answer. This gives rise to the notion that PE incentivises bad people or money grabbers. Critics and defenders of PE focus on the people in the field- if you change the people then you change the business. Perhaps this is a greater sociological question, though, what is known for certain is that the laws around private equity have created a business model that incentivises a great many poor outcomes. All of these factors impact everyone but the private equity firm.
With this in mind, PE has many positive impacts on not just a company’s financial security but also the overall economy. When PE firms help companies increase efficiency and save costs, they are also boosting competition, driving innovation and creating jobs. Luxembourg is regarded as the hub of private equity with 19 out of the top 20 PE firms operating out of the country. Out of the 51,000 people working in the financial services industry, it is estimated that 8,000 are related to private equity, outlining the job creation from the sector. Consequently, Luxembourg is viewed as a ‘business friendly’ hub, which has encouraged the government to protect the field, which is said to be part of the problem.
There are a great many things that private equity does for our economy and the financial sector, and with its mounting growth, it is safe to say that the industry is here to stay. However, there is far too much that private equity firms can get away with, due to the unregulated legalities of its business model.
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