Private equity bought out your doctor and bankrupted Toys“R”Us. Here’s why that matters, on this week’s DecoderPod
The short answer on leveraged buyouts is no. It’s the same basic idea, which is buy a company with a fair amount of debt, try to make some changes, and sell it for a profit. That basic business model is the same that it’s always been. I think private equity firms have very successfully rebranded themselves and, in some ways, pulled themselves up by their bootstraps in terms of reputation. And part of that is that private equity firms have just expanded far beyond private equity.
The really interesting part about that is, as I understand it, the private credit market is just significantly less regulated, almost by definition, than the public market, and there are voices out there saying that private credit, in large part led by private equity firms, could lead to a bubble simply because of how little transparency there is in it.
And what that means is it tends to lead to risky short-term strategies that, if they blow up in somebody’s face, it’s not the face of the private equity firm. And so, I think it’s not that private equity leaders are more greedy or anything like that. It’s that the legal structures that we’ve got around it mean that they just have a different set of incentives.
They’re different on the margin, but it’s some variation of “I know what I’m doing, and then I try to make decisions to get there as fast as I can.” That absolutely cuts against what you say private equity companies do, which is that they’re hyper short term. One of the arguments that I hear from PE companies is, “We’re going to pull you out of the public market.
This is one of the first claims you make in the book that stood out to me: private equity companies, when it comes down to it, are pretty bad operators of businesses. Which strikes me as, one, a pretty huge claim, but also counterintuitive. This is a group of people that go, they buy companies, they do whatever they’re going to do, try to make them better, sharper companies.
that sells to KKR or a small one like a veterinary clinic or a dermatology clinic whose doctor wants to retire, selling to a private equity firm can make a lot of sense because you’ll get a large payout because you’ve got a lot of equity. The challenge that you’ve got, typically, is for the people that remain.
I can’t get into too much of the details because of my work, but I will say one of the interesting challenges that you’ve got with private equity roll-ups is when you’re looking at antitrust potential cases, when it’s one big company planning to buy another big competitor.
Just to set a baseline on the sorts of tactics that we’re talking about, and we’ve already referenced this a little bit, a sale-leaseback is where the private equity firm directs the company to sell its assets — the Shopko store, the factory, the hardware that it has — and then lease it back to itself. And that gives you a short burst of cash from the sale, but then you’re shouldered with the ongoing obligation to pay back the things that you once owned.
I’m going to just ask you a very silly first-year law student question. I was not a great law student, but–I wasn’t great at that, either, but this thing you’re talking about where the private equity companies actually operate the companies they’re invested in through their funds, they direct their operations, they roll them up, they have preferred supplier agreements, I think you have the example of Talbots in the book where they forced them to change clothing suppliers and Talbots folded.
But the reason that they do that is it allowed them to push off the company’s pension funds from their books and onto the quasi-government agency, the Pension Benefit Guaranty Corporation. It meant that Sun Capital and Friendly’s would no longer be responsible for the pension debts, the PBGC would. And that’s one of the ways that they can use bankruptcy to their advantage.
And that seems like a problem that we can see expressed right now. In the private markets, you’ve got a handful of PE companies; in the public markets, you’ve got a handful of index funds, and they might as well just be controlling the economy. That seems like a problem that should cut across party lines. We should have functional markets. Everyone agrees that competition is good for consumers and that having new firms enter lowers prices and makes better stuff.
That’s a great point, and I’m always adamant about pushing back slightly on the story of Toys“R”Us. Toys“R”Us was profitable the last year before it declared bankruptcy. The challenge was that it had so much debt that it was servicing that rather than being able to expand its operations, and it had advantages that Amazon didn’t have in terms of physical stores. But that’s a rant perhaps for a future podcast.
Yeah, well, maybe this isn’t quite responsive to your question, but the other interesting possibility is that venture capital firms become more like PE firms. It’s like Andreessen Horowitz is just becoming such a massive entity that, eventually, they might be looking at more the leverage buyout model than the traditional “bet and hope you win the lottery” or something like that.
I have to say, I was reading the book, and I was struck by how many extremely sensible, well-meaning cases you discuss, and then at the end the caveat is: and then they lost the case. And it just seems like a recurrent theme throughout this book: people have a great legal theory and, again, to the innocent bystander, the case makes a lot of sense, the problem seems obvious, and then they lose on a technicality of standing or corporate structure or funding sources or whatever.
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