Is Private Equity Benevolent or a Conundrum or Both?

Is Private Equity Benevolent or a Conundrum or both? What is Private Equity?

Approximately 6.5 percent of the American economy, based on the limited concept of GDP, is in private equity. That is 6.5% of the $29.35 trillion dollars, the current GDP, or, $1.90775 trillion dollars.

When involved in individual business investments, private equity capital is invested into a target company either by an investment management company (private equity firm),
a venture capital fund, a hedge fund, or an “angel” investor, a wealthy individual who invests personal money in early-stage companies. Angel investors expect to take ownership positions in the companies they buy into because their capital is unsecured—they have no claim on the company’s assets. There are 11,218 Private Equity, Hedge Funds & Investment Vehicles businesses in the US as of 2023, a decline of -2.2% from 2022. There are as many “Angel” investors in the market as there are people wealthy enough to buy into the industry. The fact that private security investors have no claim on the company’s assets should be viewed as a red flag and as a potential cause of negative events that may occur after private equity acquires businesses as a result of predatory acquisitions and subsequent practices. Each category of investor in PE has specific financial goals, management preferences, and investment strategies for profiting from their investments. Private equity provides working capital to the target company to finance the expansion of the company with the development of new products and services, restructuring of operations, management, and formal control and ownership of the company.

Private equity remains a major driver of economic growth by supporting small businesses and paying high wages to millions of workers that private equity-backed businesses employ. In 2022, private equity directly generated $1.7 trillion of GDP in the U.S., approximately 6.5% of GDP for that year.

The four main areas within private equity are venture capital, growth equity, buyouts, and distressed or special situations investing. Each area focuses on different stages of a company’s lifecycle and investment strategy, from early-stage startups to mature businesses needing turnaround strategies.

Private equity, when it is not involved in predatory practices, can help companies grow, saves local jobs, and boosts the retirement savings of millions of Americans. The caveat is that predatory practices create significant risks for workers, businesses, and the economy.

Public companies bought by private equity management firms are approximately 10 times more likely to go bankrupt than a control group subject to the same market forces. That’s largely because of how PE firms purchase companies. PE investors, typically wealthy individuals or institutional investors, often fund their acquisitions by taking out large loans. Frequently, about 70% of the money that PE investors use to buy a company will come from loans—allowing them to only pay 30% from their own funds. The acquired company then becomes responsible for paying off this debt. This is called a “leveraged buyout.”

In some cases, PE acquisition can help revive struggling businesses by bringing in new leadership or needed capital. However, the high debt levels associated with leveraged buyouts can raise substantial risks. For example, if revenues from the acquired company are not enough to pay off its debts, it can go bankrupt, which in turn leads to job loss and loss of the services that the company provided to the economy. Even if the acquired company does not fall into bankruptcy, PE firms typically seek to raise short-term revenue, in many cases through drastic cost-cutting measures like layoffs—which come at the direct expense of the company’s workers. The PE firm will then be able to place the acquired company back on the market and sell it to new buyers at a higher price. This is what is called a “buy, strip and flip” business model. PE acquisitions are not public companies and are exempt from publicly disclosing information about their operations, risks, finances, and liabilities—making it difficult to evaluate their performance and possible risks to the broader economy.

Private equity-owned businesses are concentrated in lower-wage industries, impacting job stability and pay for workers. When private equity is involved in predatorial activities it may not be creating more jobs and may, in fact, be working against, not improving or expanding the American economy for workers and companies involved in the transaction or for the economy.

Who benefits from private equity? By providing capital, operational knowledge, and strategic support, private equity can help lower middle market economy businesses thrive. Private equity (PE) has long been a driving force in the financial world, but its influence on the lower middle market economy in the United States is particularly noteworthy. However, predatory practices create significant risks for workers, businesses, and the economy. Private equity-owned businesses are concentrated in lower-wage industries, impacting job stability and pay for workers. Private equity’s growth in the health care sector negatively impacts Americans’ well-being. Private equity growth is also contributing to higher prices for food and other essentials. Research shows that New Mexico is at the highest risk of exploitation by private equity. Congressional Democrats are taking on private equity’s harmful practices, fighting for Americans’ health care, and ensuring wealthy CEOs pay their fair share. This endeavor is not being joined in by Congressional Republicans. While Trump’s policies supported private equity in a hands-off relationship with the industry, the Biden-Harris administration has worked to hold these companies accountable for the American people. My prediction for the four upcoming years of Trump’s second term in office is that the country will experience an increase in predatorial private equity business activities and that there may well be negative impacts and consequences on commerce, American companies and their workers and on the economy.

It has frequently been claimed by industry spokespersons that private equity-owned businesses create more jobs than they destroy, though the academic research paints a much more ambiguous picture. Even when private equity is good capitalism, it isn’t necessarily good for society.

Safeguards and regulations and some changes in the laws that regulate private equity can be made which could mitigate the negative impacts of predatorial practices by private equity and reduce the risks it poses to the economy.

Here are some of the things that can be done to protect and provide for a more stable economy:

Make private equity executives legally liable for the damage they cause.

Stop looting that enriches PE executives at the expense of workers, communities, and businesses.

Close tax loopholes and change rules that encourage predatory financial activities.

Protect workers if employers go bankrupt.

Require PE firms to be fair and transparent to investors in disclosing costs and returns.