Is private equity, the polite name for the spreading ecosystem that developed out of the corporate raiding and leveraged buyouts of the 1990s, the best thing since sliced bread – ‘a purer form of capitalism’, as some have argued? ‘Who can argue with a new model of enterprise that aligns the interests of owners and managers, improves efficiency and productivity, and unlocks hundreds of billions of dollars of shareholder value?’ enthused Michael Jensen in a 1989 HBR article. Or is it a monster, an evil mutant draining the life and livelihoods out of companies, communities, workers and customers?

Prompting the question is the transformation that has swept global capital markets since the Great Crash of 2008. Although the decade and a half of zero interest rates that has just ended did little to stimulate wage growth or productivity, it was viagra for financial assets.

And it wasn’t just public stock indices that soared. Less well appreciated is the explosive rise of the unregulated private markets – private equity, hedge funds, venture capital and the shadow lenders that fuel them with credit. In the US and UK, the number of publicly-listed companies has halved this century while money has surged into PE like an incoming spring tide. Global stock market capitalization still dwarfs private equity. But the latter is growing much faster: in the same timeframe PE has mushroomed more than sixfold, with assets under management now standing at $12.7tr, according to McKinsey. More firms are owned by PE than are quoted on the New York Stock Exchange, and PE-owned companies now employ 11 million Americans,  up by one-third on four years ago. Accounting for around 7 per cent of the mighty US economy, PE is now firmly mainstream.

Could the uncomfortable reason be that private equity is, in fact, the superior way of managing that boosters claim? Investors certainly have drunk the Kool Aid. With interest rates effectively at zero, the promise of yield, even at the cost of locking up an investment for the seven or 10 years of a fund’s life, has been catnip to investment managers. Following Harvard and others, university and other endowment and pension funds have poured cash into PE – including pension funds for whose members Jensen’s ‘improving efficiency’ frequently translates as reduced pay, worse conditions and lost jobs, nor only intentionally: PE-owned companies are 20 per cent more likely to fail than publicly-owned counterparts. 

This contradiction has been brushed aside during the apparently good times for investors – ‘apparently’, because lack of transparency makes the claimed superiority of PE’s returns over the long term moot. (Berkshire Hathaway’s Warren Buffett and the late Charlie Munger are/were notable sceptics.) But it is one that will get more glaring as today’s challenging conditions bring PE’s ugly side into full view. And ugly means repellent. Two recent books about private equity with tellingly similar titles (Plunder: PE’s Plan to Pillage America, by Brendan Ballou, and These Are The Plunderers: How Private Equity Runs – and Wrecks – America, by Gretchen Morgenstern and Joshua Rosner) spell it out without compromise. 

Over a wide spectrum of industries, they charge, PE firms have played out repeated variations on the same theme: debt-propelled acquisitions and restructurings that strip companies of their assets, load them with debt and prioritise profits over people. Workers and customers bear the brunt of operational cost-cutting as product and service quality plunges. Healthcare, a sector favoured by PE for its assured payments and the reluctance of customers to complain, has been particularly corrupted: the imposition of ‘surprise’ billings as different services – emergency rooms, for example – are hived off into separate ownership has become notorious, while the ‘carnage’ in US care-homes during the pandemic is put down to perfunctory or sometimess non-existent care in short-staffed and ill-equipped PE-owned units. Meanwhile, ‘activist’ hedge and PE funds have taken to targeting companies with extensive CSR programmes that can be repurposed into dividends and stock buybacks. Others have no hesitation in buying out orphaned fossil-fuel companies and running them at full tilt, while also investing in environmental clean-up specialists. 

Another tactic under fire is the PE ‘rollup’, an under-the-radar way canny funds create local or regional monopolies by buying up and merging dozens of standalone businesses in the same industry (funeral homes, hospitals, caravan parks, GP and veterinary practices, care homes, local press, even garage doors..). They then run through the monopolist’s playbook, hiking prices, reducing choice and imposinge drastic conditions on users. Not before time, rollups are now attracting the attention of regulators. The FTC is currently investigating a cluster of transactions and wants to reform antitrust laws to make it easier to challenge other anticompetitive mergers and acquisitions.

Of course, not all private equity is totally vile, just as public corporations aren’t exclusively run by saints. While PE’s record in the UK is by no means glorious (care homes, water companies…), as usual it is a pale shadow ot its counterpart in the US. But there’s no doubt that PE’s combination of disproportionate personal gain and lack of scrutiny has attracted individuals whose greed, lack of scruple and recklessness might make the original robber barons flinch. Thanks to the ‘insanity of 2&20’ (as Roger Martin described the infamous PE and hedge fund charging formula¹) private markets have become ‘flat out… the greatest wealth producer of our lifetime’. In the current Forbes 400 rich list, 69 are PE or hedge fund executives, with a combined net worth of an eye-popping $465.7bn. The seven highest-paid PE executives currently pocket (I can’t bring myself to use the word ‘earn’) more than $1bn a year under a ‘heads-I-win-tails-I-don’t-lose’ formula for a job that generates little or no net value for society at large.   

What do we make of all this? One conclusion might be, yes, PE is a purer form of capitalism – if ‘pure’ is relieved of any connotation of virtue and taken to mean business stripped back to the single-minded pursuit of profit without acknowlegement of the existence, let alone claim, of any other stakeholder, unrestrained by regulation or public scrutiny. This is management as Friedman’s ‘business of business is business’ on steroids, treating the company as an abstract ‘nexus of contracts’ and people as rational utility maximisers motivated only by self-interest, both of them vehicles for and instruments of the sole end of short-term financial gain. Greed rules, absolutely.

Cynics believe that PE’s share of the investment – and management – markets will continue to grow regardless – a chilling prospect. For now, though, interest rates at a 20-year high have put the funds on the back foot. Headlines calling ‘the end of an era’ and ‘a reckoning for PE’ are a daily occurrence in the financial press, as several things have become clear through the clouds of hype: many firms overpaid for targets, appetite for IPOs has dwwindled, and panicky investors are beginning to head for the exits, even at a discount. At the same time, refinancing debt in portfolio companies at vastly higher interest rates is driving managers to all manner of esoteric, not to say dubious and certainly riskier forms of financing. As noted, US regulators are hovering in the wings.

What might stir them into action is a crash triggered by defaults rippling out from the unregulated non-bank lenders where PE increasingly raises its money – many of them owned by those same PE outfits. That is a distinct possibility: currently no one knows the extent of the loans or how they are connected to the real economy. If that house of cards collapsed all bets would be off – indeed, it is currently the only realistic route to bringing the funds to heel. The cost of a PE-induced crunch would be high, and it’s a racing certainty that, as in the 2008 crisis, none of the real perpetrators would go to jail. But everyone else in the world would still have good cause to cheer.

1. The 2 of 2&20 is a fixed annual management fee of 2 per cent charged on the assets under management. The 20 is the 20 per cent share – known as ‘carried interest’ or just ‘the carry’ – levied on any profits made on the capital (a charge that is taxed at the lower rate of capital rather than income). ↩︎