Private Equity is Everywhere. Should we be concerned?

By Rachel Phua

Private equity is everywhere. It owns the coffee shop you get your donuts and coffee from every morning. It sells you your pet’s favorite treat. And it runs the clinic you hope you never need to visit because of the horror stories about astronomical bills. It even rules over you when you die.

On its own, private equity isn’t bad. These are pools of money run by finance professionals who believe they’re making the best use of the trillions entrusted to them by taking over businesses and improving the way they’re run so they make more money and spend less. Investors — rich families, pension funds, insurance funds, sovereign wealth funds, endowments, and more — who handed them their money earn a tidy sum from the profits these businesses make or when they’re sold at a higher valuation.

And the finance professionals who made those smart choices get rewarded too, typically with 20% of the profits (sometimes only after meeting a certain performance/profit level) and a 2% annual fee on the value of the businesses they manage, regardless of how the businesses are performing.

Private equity has grown significantly. There is about $11.7 trillion worth of assets under private equity management globally, as of end-June 2022, up from $9.8 trillion the year before. In fact, it has been growing by 20% every year since 2017.

On average, four of the largest publicly traded private equity firms have more than doubled the value of private equity assets under their management in five years, according to company filings.

State-owned institutional investors such as pension funds and sovereign wealth funds, which invest workers' and taxpayers' money, have increased their allocations to private equity over the years. In 2008, about 10% of their assets were put in private equity. In 2020, that swelled to 22%, researchers from the University of Oklahoma and data tracker Global SWF found.

This is even though private equity offered lower returns than the S&P500, which you can buy passive index funds in. Private equity returned a median 15.1% annualized return over 10 years between 2012 and 2021, the private equity lobby group American Investment Council reported. Investing in the S&P500 would have given a 16.96% annualized return over the same period, based on calculations of historic returns compiled by Aswath Damodaran, a professor of finance at New York University.

But private equity has gotten a bad rep in the recent decade, and it’s mostly from the leverage buyouts private equity firms have done, which resulted in thousands of job cuts and once-beloved companies going under.

Leverage buyouts are when a company — the private equity firm — buys another company using a huge loan and saddles the company they bought with the debt. The company is forced to find ways to repay the loan and the interest on it, often by slashing costs through layoffs, suppressing wages, store closures, fewer product choices, and service cuts.

When the company still can’t afford to keep up with the debt, they file for bankruptcy. This is what happened to Toys R Us in 2017, 12 years after it was bought by KKR, Bain Capital, and Vornado Realty Trust for $6.6 billion. The toy store said it was struggling to pay off its $5 billion debt while having to find ways to compete against Amazon, Walmart, and other toy retailers. About 33,000 people lost their jobs. Initially, they weren’t given a severance, until their months of protest led to Bain and KKR setting up a $20 million severance fund (Vornado did not contribute). The three private equity firms made $250 million from Toys R Us during the 12 years they owned it.

Private equity firms also take out loans on the backs of their target companies to pay themselves billions, a practice called dividend loans.

Despite the problems private equity has caused, the industry is still lightly regulated and firms do not have to disclose how they’ve made their investments, their fees, and how their returns are calculated. Fund managers also manage to pay lower taxes because of a loophole both Republican and Democratic presidents have failed to fix.

Many private equity firms also own chain stores that are able to offer consumers lower prices with economies of scales. For most people, they are inescapable. Can you buy everything you need with $50 and still avoid spending at private equity-owned businesses?