Private Equity and “Job Creation”

By James Kwak

The phrase “job creation” always makes me a little queasy. The personal computer has probably contributed to the elimination of tens of millions of clerical jobs, yet I think most of us feel that computers are a good thing: they make people more productive, meaning more goods and services for everyone . . . and hopefully the people who lost those jobs will find work doing something else. In boom periods, like the 1990s, it seems to work, at least for most people, but I doubt that there’s any proof that productivity-increasing innovation always increases employment. But this line of thinking quickly leads to questions like whether the invention of the automatic toll booth is a good thing (because it eliminates what must be a pretty unpleasant job) or a bad thing (because it results in the layoff of people who may not have good alternatives), and those questions are above my pay grade.

Anyway, job creation these days usually refers to growing companies, making stuff people want, which tend to hire new workers—leaving aside the question of whether the products they make are causing other people to lose their jobs. This is the kind of job creation that Mitt Romney (and the private equity industry, at least publicly) wants to be associated with.

But private equity, as I wrote about last week, is just a way of taking over existing companies. While it’s possible for a private equity fund to invest in growing companies, they are more likely to invest in mature companies, for various reasons: it’s easier to borrow money against a company that has hard assets; mature companies are more likely to have the kinds of inefficiencies that build up over decades of poor management; you need steady cash flow to service debt, and high-growth companies are often spending most of their cash flow on new investments; and you’re more likely to find undervalued companies in sleepy industries.

Taking one step back, private equity firms are just investors. The contemporary glorification of the investor class is based on the idea that their money is what fuels the creation and growth of dynamic companies. And in principle, that’s true—if the investors are contributing new capital to a company. If you buy newly issued shares of stock in a company, you are giving it cash that it can use to grow (build factories, research new products, hire workers, etc.). The same is true if you buy bonds issued by that company (although the proceeds from the bond sale may be going to by back shares from other investors). But if you buy shares on the secondary market, you are not contributing new capital. (You are providing benefits to the economy, but they have to do with pricing and liquidity, which have an indirect impact on providing new capital to businesses.)

Private equity firms, in general, are buying shares on the secondary market (this is what “taking a company private” is all about), not contributing new capital. They are not increasing the amount of cash available for investment by companies. In fact, since they make money by paying themselves special dividends, they are reducing the amount of cash available for investment. In some circumstances this may be the best thing for shareholders, but it certainly has nothing to do with job creation—especially since we know that the dividends paid back to those private equity funds are only going to be used to buy more mature companies. The goal of a private equity firm is to make its companies more profitable: sometimes that means new products and new jobs, but it can just as easily mean the opposite (eliminating unprofitable product lines and fewer jobs).

So who is investing in new, high-growth companies? In the technology sector, at least, it’s largely venture capital firms. Venture capital and private equity firms have similar structures, they charge the same outrageous fees and share the same ludicrous carried interest exemption, and their partners tend to be very rich, but the similarities end there. When VC funds invest in a company, they usually buy newly-issued stock (convertible preferred shares), which means new cash is available for investment and hiring. In early-round deals, at least, they don’t take money out in fees and dividends. And while private equity firms need to maximize current profits to pay off all the debt they load onto their companies, venture capital firms are often willing to sustain losses for years in hopes of building something new.

Venture capitalists have numerous flaws, of course. In later rounds their interests can diverge from the company’s interest, and they have a tendency to think they know more about running a company than they actually do. (That seems to happen to people who become very rich managing other people’s money.) But the basic function of the industry is to collect capital from investors and funnel it to new companies building new things and hiring people. The same is not true of private equity.

43 thoughts on “Private Equity and “Job Creation”

  1. I would like to voice support for destruction. Organizations, once created, generally lose sight of their real mission and adopt the new mission of self-preservation (or, in better times, aggrandizement). Ideally, businesses would have a purpose, ‘core competencies,’ and surround themselves with the necessary support functions to make that core purpose effective. A public law firm (don’t get lost in the details) might provide ‘tax law services to oil exploration and mining companies.’ They might have, on the side, secretaries, notaries, document delivery, some real estate law, and so on. What happens if there is a flattening in the demand for those services to those companies? Will the firm pay hefty dividends, milk the business dry effectively, decrease in size, and shut down in an orderly liquidation? Or will it try to ‘reinvent’ itself, find new ‘opportunities,’ hoard capital, enter into all sorts of areas it knows little about, and eventually shutter with a big crash – while the key insiders have probably dumped their shares, leaving the losses to some pension fund?

    There is a birth, growth, profitability, decline, death cycle to businesses. No corporation should be growing forever. Most should be paying hefty dividends during the years of profitability. The equity should eventually be dissipated; but slowly, in an orderly fashion, efficiently. Radical, hasty, changes are rarely efficient.

    There is a need in this twisted economy for businesses that support the decline and death phases – as well as pruning away inefficient, reflex growth – by breaking down aspects of organizations that have lost their original purpose.

  2. @BenK — I agree with you completely. However, private equity is not necessarily the best steward for such a “buy and milk gently over a long decline curve” sort of model. Because they invest out of funds with limited lives (typically 10 years), their objective is rather to improve their portfolio companies’ value and sell them to somebody else (public investors, in an IPO, or private investors in a full sale). Only funds/investors with effectively unlimited lives could do what you suggest effectively. But those are very few and far between. The only possible candidate which comes to mind is Berkshire Hathaway, but Buffett has expressed no public interest in managing declining companies.

  3. Quick vote for technological destruction as well (which is sometimes known as the luddite fallacy… look it up!). But my vote doesn’t come from that, but from a quote I remember…

    I think it was Lee Iaccoca walking through a new factory with the head of the UAW and he pointed at all the new robots building his cars and said, “How are you going to get them to join your union?”

    To which the UAW boss replied, “Mr. Iaccoca, how are you going to convince those robots to buy your cars?”

  4. @Private equity is not “just” …”just a way of taking over existing companies.” James Kwak

    Technically and narrowly defined perhaps as good a way as characterizing the reality of how they operate, but private equity is a conversion process at the very ambiguous level of complex “equity” itself. One in which “securities” become the value instruments of algorithmic exchanges that only “later” (not logically “previous to…) become translated and converted to real currency (which of course is fiat and fractional itself). It has transferred the value of market transactions from industrial based production to pure p[rofit driven securities under a multiplier effect that simply defies reality. The system of finance has created a political economy of the republic, for the republican and by the republican …(where literal usage of “representative” agency and brokerage own the system through abstract paper that determines the ultimate proportions of access to technical, tactical, strategic and inevitably domination over all market resources.

    It is a mistake to think that there is perfect continuity in some accrued history of transactions and agglomeration. Private Equity today is computational colonization itself. It is no longer a difference of degree but has emerged as a complex of its own path dependent nature and network. This “holding company or flagship economy by finance” is emerging as unprecedented. In “private” equity there is no “public” trust…so no sense of literal corruption regardless of the cost ratio to human labor or even survival or the true supporting value of subsistence base industry. It is all expendable, ready for selling out, liquidation and ultimate re-capture at firesale devalued scrapheap values. We are possibly seeing the technological capacity of a flag-state empire of power finance…where the political system is a rotating board of directors (or dictators…to the more astute and cynical minded).

  5. The Oceans themselves have become the fortress “walls” of “finance-equity” an the Islands offshore have progressively increased as locations for global power finance:

    Offshore bank ;
    Offshore banking has often been associated with the underground economy and organized crime, via tax evasion and money laundering; however, legally, offshore banking does not prevent assets from being subject to personal income tax on interest.
    Following September 11, 2001, there have been many calls for more regulation on international finance, in particular concerning offshore banks, tax havens, and clearing houses such as Clearstream, based in Luxembourg, being possible crossroads for major illegal money flows. Defenders of offshore banking have criticised these attempts at regulation.
    “The IMF has said that between $600 billion and $1.5 trillion of illicit money is laundered annually, equal to 2% to 5% of global economic output. Today, offshore is where most of the world’s drug money is allegedly laundered, estimated at up to $500 billion a year, more than the total income of the world’s poorest 20%. Add the proceeds of tax evasion and the figure skyrockets to $1 trillion. Another few hundred billion come from fraud and corruption.”
    – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
    – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
    Offshore Financial Centers (OFCs):
    IMF Staff Assessments
    Last Update: June 16, 2011
    – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –

  6. These private equity regimes have operated over seas and offshore with relative impunity and crony capitalism sucks in crony political control fraud. While “outsourcing” may well have legitimate degrees, it needs to be recognized that when these agglomerated “realists” play hard ball overseas (often backed up by private mercenaries or American Interest political muscle itself, they come home to the USA with an interest to dismantle the (slogan labeled: legacies) “entitlements” of social security and other public interests and have been blatently looking to turn the US economy into the advantaged capital situation they enjoy in third world countries…that is they seek capital advantage by leveraging and placing the vast majority of Americans at an insidiously progressive…disadvantage…and dependency.

    It all looks so naturally occurring…and crisis management appears to warrant and legitimize “equity management” and other inflated asset bubble derivatives that rule the rudiments of value on these pirate sea markets. Routinely the creative destruction clause is brought in to explain demolition derby liquidation as reorganization and after cascading the downsizing scales …have the nerve to speak of
    JOB CREATION ! ?????

    This is the new Garden of Eden all right! And the snake pit marketing has a great deal of defenders and apologists…but the main serpants….well; …they are all doing god’s work. Or, so they say!

  7. James makes very a number of very good points about the PE job creation question. In particular, he goes beyond the analysis done by Josh Lerner, the Harvard Business School professor who has been looking at PE job creation for a number of years. I have read a number of Lerner’s writings on the topic, and have talked to him about it too, and I have never seen or heard any analysis–or even raising–of the point that net job creation must take into account job losses at competitors to a PE-backed firm that are losing market share to it.

    However, like almost all efforts to describe the industry in the press, James speaks over-broadly in some important respects. First, the term “private” in “private” equity has nothing to do per se with taking public companies private. Relatively few PE transactions are of this type. The reason for the word “private” is that PE involves buying non-publicly traded equity securities (which may be privately traded because the PE firm is taking the company private–but again, only a minority of the time). Second, most industry practitioners (of which I am one) and academics view venture capital as a flavor of private equity, not a truly distinct strategy. Insiders usually refer to what James calls “private equity” as “buyout”. Both VC and buyout strategies involve purchase of private securities by a fund organized for that purpose. VC and buyout funds themselves look similar in legal and economic structure. Moreover, VC and buyout exist on a continuum, with a middle-ground strategy that is commonly referred to as “growth capital”. This type of firm (e.g., TA, Summit, New Mountain) frequently invests in firms that are established and profitable, like buyout strategies, but where there is a potentially significant growth opportunity that is funded by adding capital to the companies’ balance sheets and doing so largely with equity rather than debt (more akin to VC).

    One other point, which is not a criticism of James, but something that outsiders generally don’t appreciate. PE firms brag about making their portfolio companies more efficient, hence more profitable. A meaningful part of this increased “efficiency” is actually so-called TAX efficiency, meaning that PE owners are very skilled at bringing in very sophisticated tax lawyers to pore over their portfolio companies’ books and figure out how to cut their corporate tax bills in various ways, some totally appropriate, others quite aggressive and legally questionable. The portfolio company managements have no choice but to go along with even the most aggressive tax postures, and the PE firms themselves are completely insulated from legal liability, since its their portfolio companies and officers who are filing the tax returns. When Romney talks about his career at Bain as “free enterprise” it amazes me that he gets no push-back about the fact that much of his profits came from reduced tax bills and most of his investment capital came from government pension plans. How’s that free enterprise?

  8. @Woych – Banks commanding medical research to get away from discoveries in Primary Care:

    I guess *shortages* are the market’s way of stabilizing the risk-free models of mechanization…?

    No investment in modernizing and maintaining municipal infrastructure does drill down to local health care….

  9. Bruce wants Per to name names in order to whittle down the problem somewhat, and so would I, until one looks at the numbers for and against such a move at the top end. There are few of us around that have any influence, and the masses are running in circles.

    To name names, one has to look no further than Ben and Timmy today, basicly, we are witnessing the mortgaging away of America. It seems that anytime someone wants to use the discount Fed window, they simply put up the real estate deed and get their low interest money. Another good reason to keep real estate propped up so if the loan should go bad for any reason, simply forfeit the land and move forward. This is the exact situation Greece faces currently and they don’t want to relinquish the property for another to possibly profit on. Our scene is no different except we were in denile about it all, or the citizens have yet to relize their country is being givin away to the highest bidder with money.

    And these are special names too.

  10. Venture Capitalists and Equity Funds are not the problem. Both approaches can create wealth, that is why they do it. Venture Capitalists probably destroy as many jobs as Equity Funds do, perhaps more. The iPod destroyed many Hifi system jobs. The fact that Apple didn’t employ the sacked employees isn’t the point.

    I don’t know why any sector of the economy should have special deals, and favour wholesale tax reform as a result. The special interest deal for Equity funds is just an example. All should go. I favour two taxes for business, one on wealth and one on income. Simple as! (My views on people taxes are much more complicated – another time!)

    Having an effective and available safety net is essential in a dynamic economy. We should expect businesses to make money. They are not good for much else. But we cannot expect people to live their lives without any modicum of security. That should logically require workers to be even more short term focused than business is, and we know the problems that come from that.

  11. The amount of wealth destroyed in USA after a decade (and counting) of funding the adventures of war lords in messupotamia is now equal to the entire economy of Canada – thought that was an interesting perspective on capitalist *free market* cream rising to the top…life maintenance basics for citizens – food, clothing, shelter, medicine and security from predatory force…all *too expensive*

    iPods for everyone!!!

  12. In Economics of Nanotech and AI, Robin Hanson argues for some very interesting trends regarding job displacement due to technology. I basically agree with him and it’s something that no current policymaker seems to take seriously.

    More to the point though, I second BenK’s response. This article is littered with some bias. For example, “Venture capital and private equity firms have similar structures, they charge the same outrageous fees and share the same ludicrous carried interest exemption” is loaded language from someone who would not admit that modern law school is a rip off.

    When a private equity firm does leach onto something and initiate death spiral mode, why is this supposed to be intrinsically a bad thing? I work in computational science for video and image processing, so take Kodak for an example. It’s been a fine American institution for a long time, has given some employees great lives and earnings, helped people retire comfortably, and given the general population some of the most ubiquitous and interesting technologies that we have in that market. But they are mismanaging their firm; they fail to be open to innovation; they systemically undervalue mathematics research for vision technology, etc. etc. If someone buys and crashes/burns Kodak, that seems like a pretty useful market purge to me. Yes, some (smart and opportunistic) folks will get a little richer doing that. Yes, some hard working folks will lose their jobs.

    But it’s not like the capital generated by dismantling Kodak will be flushed down a toilet somewhere. Ultimately, some folks will get hired due to influx of investment. Other camera technology firms will grow by picking up a new share of the market and hire new workers (perhaps those recently fired folks with lots of experience from Kodak).

    In general there just seems to be too much angry focus on the fact that some greedy, stupid, evil corporate person somewhere will make a large sum of money on something that sounds bad to regular folk who read about it in a newspaper. Whether or not there are legitimate quantitative reasons to disfavor private equity firms, articles like this one seem like a very bad line of reasoning. Too much is anecdotal and rests on the natural opinion that buyouts are bad because you can envision specific people being hurt by them. A case of availability bias if there ever was one.

  13. PE Guy. Thank you for the most reasonable, thoughtful and intelligent response that I have read on this blog in over a year. By the way, we are not related. I had given up reading this blog months ago, but may dip back in.

  14. I don’t know there Hiram, he almost sounds like a tax dodger that wants the current system of taxes to stay in place so his expert tax lawyers can continue to fleece most lawmakers who have no clue how to do their own taxes themselves because the tax lawmakers have made it exceedingly difficult to understand how to shift the tax burden to another part of society, so they put trust in another to sleep at nite in case they audited. I really can’t understand how a non-linear could accumulate so much money as Romney when I had to wake myself up just to stay alive from the sewer sappers and all the accountant watchdogs. But expiring the Bush tax cuts will go along way to reducing the deficit, which by the way was expodentially increased by not collecting taxes from the rich for so long a period of time. Now that the economy has not recovered, they still proclaim that raising taxes will hurt the economy. The economy is already hurt, they are actually refering to their economy doing badly, and hold the rest of the economy hostage to their policy’s. No politician but Paul will tip the balance back the other way. And are you perhaps an administrator of another blog that blocks points of views and that’s maybe why you left months ago.

  15. @PE Guy

    I agree that Kwak (again) badly misses the mark with his overly simplified view of Private Equity. I (like you) am an industry practitioner and feel from his posts that his views and understandings are very weak. I strongly suggest he spend some actual time understanding the industry and maybe some time with practitioners prior to criticizing and questioning the value add (note: not just in this post, but also referring to his previous post).

    One area I think he make an incorrect assertion is when he comments, “Private equity firms, in general, are buying shares on the secondary market (this is what “taking a company private” is all about), not contributing new capital. They are NOT increasing the amount of cash available for investment by companies. In fact, since they make money by paying themselves special dividends, they are reducing the amount of cash available for investment.” (emphasis added)

    I think this assertion is dead wrong. I will simplify here for ease of understanding, but in many cases Private Equity firms will look to restructure a company’s debt, operations, organization solely to free up additional cash flow. In essence that is what Private Equity is all about – unlocking unrealized value. Now, it is fair to argue who captures said unlocked value – but unlocking value is the whole end game. To argue that Private Equity firms buy shares in the secondary market, therefore they add no “cash flow” for future investing is an uninformed and ludicrous statement.

    Many Private Equity firms employ two distinct classes of employees – deal/finance/banker types and operations/strategy/management types. Both of these groups work together to identify areas of unrealized value. That may be in reworking a company’s balance sheet, restructuring existing debt financing, or in making (long overdue and necessary) changes to the organizational structure. All in all, the goal is to optimize the investment and unlock value for the investors.

    If Kwak has an issue with that – then he in essence has an issue with capitalism.

  16. @bob – “….But it’s not like the capital generated by dismantling Kodak will be flushed down a toilet somewhere…..”

    Wow, Paul McCartney’s new wife is working fast for her innersanctumsantori in NYC….

  17. CMK011 “…In essence that is what Private Equity is all about – unlocking unrealized value.”
    This is a sales pitch sectional version of a segment of a corporate “Group Think” episode of Gordon Gekko”s greed is good bible. It is simply not true as a standard of concerns that are much greater than some oranizational assessment role for quality control. ASK any CORPORATION in the country what they will do (poison pills and all) to prevent Private Equity “value releasing” expertise from even coming into their neighborhood.

    History of private equity and venture capital

    The truth is that Private Equity is a conversion of assets by any other means than constructive engagement; and typically is a wrecking ball crew to squeeze the life out of anything worth keeping on life support while the equity is liquidated and the hard assets exploited to exhaustion. In the process the past four decades have demonstrated that the “power” of wealth has been patterned in the mergers and acquisitions that have consistently made TBTF a reality by consolidating all that volatility of “wealth” creation into fewer and fewer hands…not towards variation and competitive efficiency…but to central control processing of consolidated markets where the “choices” are determined by the profit driven motives and the options are determined by path dependent control freaks who compete in a paranoid world of kill or be killed…zero sum game antics…where literally all is fare in business and war…and to hell with the Love portion of “that” formula…because they can “buy” all the Love they desire with their “creative” hoarded “wealth” in private storage.
    If Nixon were alive today he would not repeat his statement to the effect that we are all Keynesians now…
    He would undoubtedly simply look at market driven political marketing tactics and private equity and relent that …we are all “whores” now…!

  18. Isn’t this where the classic observation is made…? That about *whores* being better than….?

    Dog walks by, stops, pisses on a tree – in his doggy mind, that tree is his….

  19. It’s a bit weird to claim that the sort of private equity that buys public companies creates jobs. Even in the case where the company adds new products, it probably isn’t doing something that a brand new company couldn’t have done with at least as many people. It’s far more plausible to say that it saves jobs: if a private equity firm buys a company that was otherwise going to end up liquidated, and turns it around (likely by cutting out a bigger chunk that the original board would have been willing to), everybody left got saved. Of course, there is also “venture capital”, which definitely creates jobs (perhaps only temporarily, until the funded company burns itself out), and is not inaccurate to describe as private equity, but if the reason people care about “private equity” these days is Romney, that doesn’t seem to be something he’s been doing.

  20. @Bruce E. Woych

    Two quick things:

    1 – If your view of PE is based upon what you have read on wikipedia (i.e. the links you provide)… I fear that you still are woefully uninformed. I mean, could I know enough about architecture or physics to pass judgement on it (based upon my reading a couple links on wikipedia)? I mean, really? That is kind of sad and pathetic.

    2 – If PE were so bad that ANY corporation would go to great lengths to avoid it – then why have PE firms grown so much over the past 10+ years? Why have assets under management ballooned? Why have leaders of the premier PE firms become “captains of indsutry” and looked at as some of the best and brightest in the business world? I mean, reality and facts simply tear your argument apart. Of course, please don’t let facts get in the way of your biased and opinionated view. But, please don’t try to pass off said view and beliefs as actual facts.

  21. Here is the PE story IN GENERAL:

    Good PE firms incentivize their portfolio companies’ management to work harder/better/faster, and management incentivizes workers to work harder/better/faster. These portfolio companies succeed and, on average, hire more people once they have thoroughly tested the limits of their existing staff. The success of these PE-owned businesses often comes at their competitors’ expense who must fire people. This is not just an issue for domestic competitors, it’s an issue for global competitors. Thus, as the U.S. economy has a higher % of PE-owned businesses than elsewhere in the world, this is improving the U.S.’s competitive position relative to the rest of the world. Ultimately, we can’t protect the U.S. from global competition; either U.S. businesses become the leanest, most-disciplined, most profit-driven businesses in the world or we will face the wrath of Thomas Friedman’s “flat world” where the U.S. standard of living eventually merges with that of China, India, etc.

    So we can talk about what PE does to U.S. jobs, but it is a higher priority to think about what it does to the U.S.’s competitive position –> if our competitive position erodes, there won’t be any jobs to talk about.

    Regarding taxes:

    LBO firms use large amounts of debt which causes them to generate lower levels of taxable income due to interest expense. However, portfolio companies are usually sold about every 5-years and the capital gains tax paid at sale is large. Additionally, the lenders who loan money for the PE firms’ portfolio companies will have to pay income tax on the interest income they receive. In aggregate, LBO investing causes: portfolio company income tax payments to go DOWN, portfolio company related capital gains tax to go UP, and lending institutions’ income tax to go UP.

    (2) High-ranking PE firm employees (for both VC firms and LBO firms) get carried interest income. While legally different from stock options, from a cash flow perspective, carried interest is very similar. However, carried interest is only subject to capital gains tax while stock options are subject to income tax. Ultimately, this discrepancy is something that should be reformed. Of course, a lot of former politicians go on to work private equity firms (e.g. Clinton, Gore) or are closely related to private equity firms (e.g. Romney, Huntsman) so I suspect it is a politically unpopular subject.

  22. A second comment:
    The idea that PE firms “break apart” “good companies” and sell them off “like pieces of scrap” is a very poor characterization of the PE industry. Typically, PE firms DON’T break up businesses — they typically do the exact opposite — they MERGE businesses together. Usually, those mergers improve the efficiency and competitive position of the overall U.S. economy — deals that seek to do otherwise tend get canned by the FTC and other government organizations.

    When PE firms do “break up” conglomerates (which I find to be pretty rare), it is usually because the former management team and board of directors incompetently acquired companies that never really fit together. There are a lot of really bad boards of directors and family-relationship-driven management teams out there. Private equity ownership has been cleaning up this problem.

  23. @Typically, PE firms DON’T break up businesses — :

    I think you should have followed with,” they break up people”. The Japanese and German models toward the thought of worker productivity have created some useful and imaginary things no doubt. What they have not produced are healthy and stealthy citizens, they are a physcially weak and collapsing bunch o worker bees since the early 1900’s and probably before then. This competition for money is a two edge sword that leads to things like unsystainable health care costs and pains in the neck for a life time. We here in the US shall experience more of that from your competitive nature. Country’s that refuse to follow that model can/do fall financially victim to its cause, but somehow remain sovereign until a war breaks out to shuffle the deck. So PE is just that, private, until something takes it away to make it less than even that.

  24. Islamic Wealth Management: A Catalyst for Global Change and Innovation [Paperback]
    Sohail Jaffer (Author), Mr Sohail Jaffer (Editor)

  25. @cmk011

    Why doesn’t the industry of “freeing up cash flow” become more efficient due to free=market capitalism. Surely the skill sets of PE could be replicated in a consulting firm at far less cost to the PEed-upon enterprise.

    One consideration I believe is missing from the above discussion is the tyrannical structure of most corporations and the types and backgrounds of individuals who come to lead them. The personal qualities and connections that led them to leadership and the relationships developed once there ensure that their self-interest is served in any scenario.

  26. Let’s take a look at the premise: Private Equity creates jobs. The underlying suggestion here is trickle down at its idealistic best. Supply side reorganization and the relentlessly forward looking statement that rising tides lift all ships …(there’s a lot to say for “right of way” to small boats that is not mentioned here…but that’s another analogy).

    But with little or no question, the very nature of Private Equity is not about serving the bottom line economy of the public sector. It is not even about servicing the corporate market with a salvage mentality of economic efficiency. It is about wealth management.

    This “specialized” process has established itself back in Milken’s time with the promise of massive returns on the investment interests of high end clients. IT is self fueling with the aggressive nature of unrelenting greed that concedes nothing in its quest for survival. So at the heart of the process, we are talking about a market management process of excess and returns upon excess. There may well be many incidental stories of reorganization and sideline business merger successes that were technically and strategically desirable; but these consolidations are actually an amalgamation and agglomeration of a separate corporate socioeconomic phenomenon based upon competitive economic advantage, power privilege, and political correlates of opportunity and tactical risk reduction. So that area is something else altogether and is filled with mercenary types and the revolving door of power politics and corporate intrigue. (Lot’s of jobs there…these days; and it helps if the US government spent a million dollars training you for the job through elite military membership processing…all the way up the ranks). [Geeze…filing that one…it’s still another side of the story.]

    So what we end up with is essentially an epidemiological analogy: A system of 1% demographics representing the “reservoir” (special wealth & stealth economy of market driven perverted incentives)…along with a “mode of commission” (the actual attachment mechanism or mode of transmission in medical terms); the vector, host, and parasitic network of incidence (acute cases by onset) over prevalence (the mean and measures of a more chronic characteristic profile the rates of occurrence). What we would end up with are very specialized grids that demonstrate a proportionate relationship of churning wealth…and the question becomes…is that in proportion or disproportion to the original cost of structural investments from both private and public sectors…and are the returns on this translation of
    equity (as converted to assets and back to some form of transformed private equity ownership)…really such a desirable reshaping of the public sphere…and its prospects for a generative (democratic?) future?

    The lexicon of private equity is typically re-framed and opportunistic sounding. It is always couched in “forward looking” language and tends to enhance it’s own sophisticated style as being cutting edge tactical, technician rich and strategically informed. It is “literally” in a class of its own (and I do not mean that as a compliment). IT is an aggressive look towards growth by any means, essentially a capture, conquer, and exploit model of turnover…hit and run. In sustaining its own parameters it is relentlessly seeking new reservoirs of breeding ground…money pools…and in that it has come to service and join the ranks of the 1% capital intensive class pool of a separate reality.

    So in terms of “serving” the economy through the greater good of “capitalistic idealism” we have a corporate service industry (…so annoying to call this “industry” )…that seeks out a 1%client base to either strip of its value or service its money (by doing the same strip mining for the “investor” high end client…aka make money at all costs). So the true mission and vision of Private Equity Firms is to manage, sustain, and grow profit bearing returns out of an economic system that has had a mixed history of proving it can sustain perpetual growth as a whole entity. In the end the reality is a churning over of redistribution into more and more concentrated hands against the totality of the global economy…which of course does look like “wealth creation” in the short run…if you are among the winners in the winning circle. All the rest are simply cast as whiners! Bitter “losers” in the righteous pursuit of efficient market progressions…which …we might note…is also always framed as creating jobs and growth oriented in the segmented measures of boom and bust “normative” cycles.

    In truth, money does what money always does. It creates enhanced good…and enhanced bad. It desparately “tweaks” and “churns” a system that is already in free fall for what it is worth to a few insiders (aka…manipulations are so routine…flash crashes…and every trick you see on Wall Street…Boom riding, bust outs, priming the well; signal to noise asymmetrical information flow; inside back stabbing & trading; hostile compromise…media pumping, pump and dump… (also see for model analogy: : Short and distort) and every trick that money can buy…to assure and sustain the return on investments of its “client base” or 1% of the economic demographic.

    Is it possible to miss the forest for the trees and create some virute out of vice here. There is one thing that Private Equity does not do…despite its claim to charity organization and socially responsible investments…it does not share the wealth. Ask them! I

    So in all the firey “volitility” of these past three to five decades that has come to promote this “wealth creation” and “creative destruction” as the epitomy of capitalism…and therefore…(somehow) of the “free world” and therefore by some unaccountable extension…supporting the fortification of democracy….; under all that private concentration of gains…(over losses?)….where are the jobs?

    Zarathustra is laughing his arse off…and has chosen to plead the fifth.

  27. Saturday, February 04, 2012
    Think Debtors Must Pay and Austerity is the Way?

    Friday, February 03, 2012
    US Employment Growth Shows Fiscal Policy Matters

    By Marshall Auerback

    “Hmm….maybe fiscal policy does matter after all?

    By the same token, if the political environment changes in 2012 or perhaps 2013 after the November election, and more conservative voices gain traction in actual policy settings, then the US will follow the route taken by many of the Eurozone nations and Britain – that is, back towards recession. When private spending is strong enough the public sector can contract without damaging economic growth. So hopefully, US politicians will continue to be “irresponsible” and allow the deficit to shrink on its own via growth.”

    Thursday, February 02, 2012
    Doing What Needs to Be Done: Facing the Future with Full Employment and a Renewed Public Sector
    By Dan Kervick

    As you read this, millions of Americans who desperately want to work either cannot find employment at all, or cannot find the quantity and quality of work they need to meet their own needs and the needs of their families. This is real suffering. The unemployed are real flesh-and-blood people, not just fractions of percentage points on Labor Department spreadsheets.

  28. I’m confused. I think when you’re talking about “private equity,” what you’re really specifically referring to are leveraged buyouts, which is a particular type of private equity. Another *type* of private equity is venture capital. Leveraged buyouts and venture capital are two types of the larger category of private equity (which is simply a form of investment in corporations that uses of private capital — i.e. it’s not public equity). You’re never going to properly educate people about this sector of the finance industry if you don’t use the conceptual categories of corporate finance accurately.

  29. Some good comments here from some people who know what they are talking about. PE Bloke makes a good point about the fact that the net tax receipts to government impact of PE is complex. He points out that lenders theoretically earn taxable income from interest received on loans to PE backed portfolio company. This is true but is increasingly mitigated by the evolution of the syndicated loan market where an increasing portion (a clear majority on a dollar-weighted basis) of lender participants are not actually banks and are not tax-paying entities. Moreover, in my original discussion of taxes, I was referring to various tax maneuvers at the portfolio companies that, in my experience, commonly cause current corporate tax bills to decline significantly for reasons in addition to debt service payments.

    At the highest level, my critique of the PE industry (which closely mirrors the academic critique of the industry) is as follows:

    Participants in PE, both limited partner (LP) investors and private equity firm employees (GPs), believe that asset class returns are generated by “manager skill”. However, the overwhelming majority of returns are actually a function of leverage. This essential reality is obscured, to the benefit of industry participants, both LPs and GPs, as a result of two things. First, notwithstanding FAS-157 requirements, there is relatively little mark-to-market valuation of PE assets. This is true in multiple ways: assets are only valued at best quarterly, instead of moment to moment as they would be with publicly-traded securities; also even a reasonably good-faith valuation exercise (which many are not, since they are performed by self-interested GPs) will tend to mute quarter-to-quarter changes in asset value. As a result of this much reduced APPARENT valuation volatility compared to publicly-traded assets, the true risk of private equity is systemically underestimated, and the increase in volatility resulting from leverage is particularly understated. Second, the lack of good, standard performance information about industry performance (most particularly characterized by massive survivor bias) causes expected returns to be meaningfully overestimated. This is evidenced by the commonly stated observation that almost all PE firms are able to present their track records as “top quartile”. Finally, the economics enjoyed by GPs are wildly disproportionate to their value-added and are not at all aligned with the interest of LPs in larger funds.

  30. Thanks for these remarks!

    Stepping back, I just find it deeply ironic that a sector of the financial industry so manifestly a product of multiple aspects of legal regulation and corporate finance law is so tied to an understanding of itself as the pinnacle of “free-market” capitalism. I guess it’s a form of ideological mystification.

    There’s certainly room for discussion and debate about what some of the benefits of LBOs have been and could be. I genuinely believe that, because there were significant historical forces that led to the shift from mid-century stakeholder/managerial capitalism to late-century shareholder/financialized capitalism. People can have a genuine, good faith debate about the pros and cons of the various aspects of that transition.

    But I think there’s absolutely no possible way to argue for the LBO type of PE and their market niche in the sorts of “free-market,” libertarian-ish terms that so much of the finance industry and so much of the “pro” business community uses. (Or alternately to argue for it in the sorts of the vapid “job creation” and vague “supply-side” ways that so many politicians use.) Rather it needs to be a story about the evolution of government financial regulation and interpretation of corporate and securities law, and it needs to be a story about the pressures created by the need to compete in expanding, globally constructed markets.

  31. @PPP – “….Rather it needs to be a story about the evolution of government financial regulation and interpretation of corporate and securities law, and it needs to be a story about the pressures created by the need to compete in expanding, globally constructed markets….”

    Agreed. Time line begins when wall came down (Glass-Steagall dismantled, and the new *law* is to write some bs regulation AFTER the dastardly deed)

    So this *private* crap was all done with other people’s $$$$ – either depositor’s funds and/or 35% tax on *working poor*….

    Let’s be honest – there is no CHOICE for USA legislatures. There has to be a new tax policy for the *working poor* after the *bailout*.

    Did I miss the explanation for how entrepreneurship is helped by papers being handed over to the dog certifying that the tree he pissed on is his tree…?

    Next time all you risk seekers want a *high* – looky here at how even self-proclaimed idiots experiment first…

  32. A closer look at Mitt Romney’s job creation record
    The Republican presidential contender says he learned about expanding employment during his time heading a private equity firm. But under his leadership, Bain Capital often maximized profits in part by firing workers.,0,343872.story

    By Tom Hamburger, Melanie Mason and Matea Gold, Washington Bureau

    December 3, 2011, 7:23 p.m.

  33. Superficial analysis. There are some good points in this to be sure, but the big questions are:

    How do the gains from better efficiency, elimination of loss-making subsidiaries, and so on, benefit society? Do all the gains go to PE?

    In a buyout, the sellers realize an immediate gain in their share price — often 30-50% premium. THAT money IS available for fresh investment, elsewhere in the economy.







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