Announcing Investigative Series on the Private Equity Industry

In the coming weeks, Naked Capitalism will publish an investigative series on the private equity industry that will include articles written by current industry participants with considerable experience. It focuses on the activity formerly called “leveraged buyouts”: the purchase of established businesses, heavily funded by borrowing. The private equity industry has over $2 trillion globally in assets under management. With leverage, this translates into over $4 trillion of buying power.

These players claim to deliver value for investors by taking over companies and then improving how they are run. We intend to show, on the contrary, that:

The growth and performance of the private equity business depends on extensive support by the government, both in the form of tax breaks and substantial funding from “public,” meaning government employee, pension funds

Gross returns of private equity go overwhelmingly to the industry itself (through extraction of fees), and not to its investors.

Partly for this last reason, investors in private equity have overall obtained underwhelming returns. In fact, taking into account the illiquidity and implicit leverage inherent in private equity investments, investors would be better served by avoiding this investemnt approach

The private equity industry has also played a demonstrably negative role in the economy overall and has increased the severity of job losses during this current downturn

Critics of private equity have often claim that the industry produces high returns for investors at the cost of widespread job losses. These critics are far too charitable – as indicated above, the industry does not produce high returns for investors. However, it is true that the process by which the industry redistributes money to itself involves significant externalities. Consequences are not limited to effects on employment; by rendering companies more vulnerable to cyclical downturns, the industry also exacerbates the effects of the business cycle.

The industry has numerous, well-paid allies and defenders. In later entries in our series, we will describe their arguments and refute them.

NC’s initiative has been aided by the considerable information provided by former and current industry participants. Despite their own success in business, these individuals are convinced that better understanding about the industry is essential in order to reduce its size and destructive role. NC will respect the confidentiality of other knowledgeable sources who consider this project worthwhile and are interested in helping. Please contact me at

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  1. Warren Celli

    Yes, the private equity industry, where birds of a feather flock together… here’s is a good resource for dovetailing into the big picture…


    “So how does the transnational corporate class (TCC) maintain wealth concentration and power in the world? The wealthiest 1 percent of the world’s population represents approximately forty million adults. These forty million people are the richest segment of the first tier populations in the core countries and intermittently in other regions. Most of this 1 percent have professional jobs with security and tenure working for or associated with established institutions. Approximately ten million of these individuals have assets in excess of one million dollars, and approximately 100,000 have financials assets worth over thirty million dollars. Immediately below the 1 percent in the first tier are working people with regular employment in major corporations, government, self-owned businesses, and various institutions of the world. This first tier constitutes about 30–40 percent of the employed in the core developed countries, and some 30 percent in the second tier economies and down to 20 percent in the periphery economies (sometimes referred to as the 3rd world). The second tier of global workers represents growing armies of casual labor: the global factory workers, street workers, and day laborers intermittently employed with increasingly less support from government and social welfare organizations. These workers, mostly concentrated in the megacities, constitute some 30–40 percent of the workers in the core industrialized economies and some 20 percent in the second tier and peripheral economies. This leaves a third tier of destitute people worldwide ranging from 30 percent of adults in the core and secondary economies to fully 50 percent of the people in peripherial countries who have extremely limited income opportunities and struggle to survive on a few dollars a day. These are the 2.5 billion people who live on less than two dollars a day, die by the tens of thousands every day from malnutrition and easily curible illnesses, and who have probably never even heard a dial tone.[xxvii]

    As seen in our extractor sector and investment sector samples, corporate elites are interconnected through direct board connections with some seventy major multinational corporations, policy groups, media organizations, and other academic or nonprofit institutions. The investment sector sample shows much more powerful financial links than the extractor sample; nonetheless, both represent vast networks of resources concentrated within each company’s board of directors. The short sample of directors and resources from eight other of the superconnected companies replicates this pattern of multiple board corporate connections, policy groups, media and government, controlling vast global resources. These interlock relationships recur across the top interconnected companies among the transnational corporate class, resulting in a highly concentrated and powerful network of individuals who share a common interest in preserving their elite domination.

    Sociological research shows that interlocking directorates have the potential to faciliate political cohesion. A sense of a collective “we” emerges within such power networks, whereby members think and act in unison, not just for themselves and their individual firms, but for a larger sense of purpose—the good of the order, so to speak.[xxviii]

    Transnational corporate boards meet on a regular basis to encourage the maximunization of profit and the long-term viability of their firm’s business plans. If they arrange for payments to government officials, conduct activities that undermine labor organizations, seek to manipulate the price of commodies (e.g. gold), or engage in insider trading in some capacity, they are in fact forming conspiratorial alliances inside those boards of directors. Our sample of thirty directors inside two connected companies have influence with some of the most powerful policy groups in the world, including British–American Business Council, US–Japan Business Council, Business Roundtable, Business Council, and the Kissinger Institute. They influence some ten trillion dollars in monetery resouces and control the working lives of many hundreds of thousands of people. All in all, they are a power elite unto themselves, operating in a world of power elite networks as the de facto ruling class of the capitalist world.”

    More here…

    Deception is the strongest political force on the planet.

  2. F. Beard

    It focuses on the activity formerly called “leveraged buyouts”: Yves Smith

    Excellent choice.

    the purchase of established businesses, heavily funded by borrowing. Yves Smith

    Legitimate borrowing or so-called “credit-creation”? I suspect the later (hence “leveraged”?) in which case those businesses are being destroyed with counterfeit money.

    … and substantial funding from “public,” meaning government employee, pension funds Yves Smith

    I suppose this is legitimate borrowing (to provide the down payment for the leveraged buyout?) driven by the desperate need of pension funds to chase yield? Well, in the case of the Federal Government, which is monetarily sovereign, there is no need to chase yield at all so Federal Pensions should NEVER be lent out.

    As usual, I would bet, the banking cartel is the root cause of this problem.


      This should be good.

      Pull no punches. Name names. Hang the crooks. Expose the thugs.

      Or…make it a reasonably presented analysis of the economics. You know, sort of like McKinsey.

  3. Peripheral Visionary

    I think this is welcome, and certainly look forward to it. At the same time, I would expect full disclosure regarding potential conflicts of interest by the “current industry participants” who are providing the information.

    That would certainly include if they are acting as bundlers or fundraisers for any candidate for public office who may happen to be running against a candidate for public office who was formerly in the private equity industry (hypothetically speaking, of course). It would also include whether or not they are receiving any form of compensation or consideration from political action groups or lobbyists of any kind.

    Looking forward to the articles, and to the accompanying disclosures and disclaimers.

    1. reprobate

      Are you kidding? Lobbyists against PE? You’ll find more unicorns. Even the unions don’t go after them except for the poor old locals on the front lines.

      And the Democrats are just as big in prostituing themselves to PE as the Republicans. At least one of Obama’s Manhattan fundraisers had a PE fund manager as host. Rahm raised tons from PE. That’s why they haven’t made anywhere near as effective an attack on Romney as they could. They don’t want to alienate a VERY important donor group.

    1. Shambler

      Indeed, excellent Adam Curtis documentary; thought of this myself while reading the article.

  4. JustAnObserver

    Perhaps we could go back further than

    “… formerly called “leveraged buyouts” ”

    and use the more accurate term from the ’70s: Asset Stripping.

    1. Ms G

      That re-naming probably tells a big story all by itself concerning the transition from the 70s to the 80s and beyond.

    2. JTFaraday

      Ah. I find this whole topic fascinating, and a little history lesson would also be interesting.

  5. fledermaus

    “It focuses on the activity formerly called “leveraged buyouts”: the purchase of established businesses, heavily funded by borrowing.”

    I remember when I first learned about LBOs in my corporate law class in law school, I was stunned. Rather than give us the textbook explanation about making business more efficient my prof told us how it actually worked – the companies bought did not have significant debt loads and good cash flow. It is impossible to LBO a company distressed by high debts because there are no assets/equity to secure the buyout loans. If people ever understood how destructive LBOs were there would be public hangings.

    1. F. Beard

      – the companies bought did not have significant debt loads and good cash flow. fledermaus

      I presume you mean “had good cash flow”?

      So the stock price was less than it would have been in a healthy economy? If so then one protective strategy for a company would be to load up on debt (a “poison pill”) to buy back the stock?

      But what if instead the company had paid its workers with common stock and agreed to accept it back for company goods and services? That would dilute existing stockholders (perhaps only temporarily because of increased demand for the stock?) but perhaps the per share price would drop less than the aggregate price of the shares? Making buying a majority of them too expensive?

      1. leafleaper

        No they HAVE good cash flow and little debt at the time of the buyout.

        To accomplish the buyout, the stock price may be depressed by naked short selling by the wall street gang, but if the company can not borrow enough money to pay back the acquisition price, and a big tax writeoff, then milked for a hefty revenue stream, then it is not an attractive buyout target.
        Why do you think that IBM and APPLE spent the 90s buying back their stock.

        1. F. Beard

          That’s what I meant. Your sentence could be interpreted falsely as:

          the companies bought did not have significant debt loads and [did not have] good cash flow.

  6. Akhil

    A bit about the Indian private equity industry:

    Apart from extraction of fees, the Indian private equity industry lowers returns to investors and enriches their top executives by overpaying for acquiring stakes in companies and taking money under the table from promoters of the target company. The unaccounted money then finds itself in the parallel black economy of india through investment in property and gold. I wonder if this taking-money-under-the-table happens in the developed economies too wherein top executives are paid in the various tax havens.

    Looking forward to NC’s expose`s on the private equity industry

  7. Dikaios Logos

    Wow, Yves! I am super happy to read this! Putting these details out will be an enormous service.

    Funny, but this morning I posted a comment on the links post about Romney’s 13% rate. I finished with this paragraph, drawn on my knowledge of private equity types:

    “Big-time private equity guys are the most skilled operators in grabbing cash flows from others, constantly, and I do mean constantly, looking to gain any advantage. While the other stuff in the return may be legally defensible, exposing to the general public how these guys really run their financial affairs and become wealthy would almost certainly be a serious disaster. His returns are likely a mosaic of embarrassing revelations, not just one.”

    I hope that you are able to touch on how much more than jobs is involved. Everything in society that could make these guys rich is used. Really, I’m always amazed that even the ‘nice’ ones just can’t shut off these impulses to put every last bit of cash in their control. I look forward to NC readers can getting a sense for the mosaic of issues that facilitate this activity.


      I, myself, are looking forward to the reporting on the ‘nice ones’. Makes for a more balanced view.

      Until I see their blood, I know justice has not been served.

      1. F. Beard

        Oh bloodyboy, the guns, the swords are calling
        From glen to glen, and down the mountain side
        The summer’s gone, and all the flowers are dying
        ‘Tis you, ’tis you must go and I must bide.

        Kill a few bankers and the Devil will shrug. Kill banking and he’ll howl in pain?

  8. monday1929

    Has anyone attempted to figure out the NET job/pay gains vs Job/pay losses, loss of tax revenue etc. from Bain’s activities while Romney ran it or owned major stake in it?
    Yves, could that analysis be part of your series?

  9. dm305

    I am looking forward to this series.

    Josh Kosman’s Book Buyout of America was a good starting point for me. He also has a twitter account, and wrote a Rolling Stone Column on Bain capital. The negative influence of private equity on healthcare is especially disconcerting.

  10. Jim

    You can’t discuss PE without considering it’s impact on public servants.

    Reuters today ran a note regarding the number of public pension funds that are increasing their allocation to PE, reaching for their hurdle rate of 7.5%. And while PE encompasses both VC and LBO funds, LBO funds have significantly outperformed VC ones. In fact, last week, Calpers announced it was slashing its allocation to VC within its PE allocation.

    And in July, Calpers announced its fiscal year performance, CalPERS Reports Preliminary 2011-12 Fiscal Year Performance of 1 Percent.

    Within that 1 Percent, PE returns 5.4% while public equity returns were (7.2%).

    I don’t dispute that PE needs reform. But it should be reformed in such a way that cities and states don’t have to raise property or sales taxes to make up the difference.

    1. Yves Smith Post author

      We are going to go precisely after the claim you are making and demonstrate in gory detail that figures like the ones you are citing are inaccurate, that the conventions used in the industry considerably overstate actual, REALIZED returns based on the receipt of cashflows.

      1. Ms G

        Maybe also the related stripping of tax monies and public assets via PE firms increasingly “selected” by their government “partners” as the “private” parties in the Public Private Partnerships through which public assets (Schools, Infrastructure, Park Land, Parking Systems and, apparently soon, the Post Office) are being stripped for what remains? Some good work was done in the local Indianapolis press on the negative ROI (from the taxpayer perspective) resulting from the PPPs deployed through crony networks of Stephen Goldsmith while he was mayor of Indianapolis. As Deputy Mayor to Mr. Bloomberg, this pattern was repeated. When he left NYC office he stated he was moving on to pursue “infrastructure” projects, by which he could only mean privatization schemes involving PE firms.

        1. Warren Celli

          This is an excellent comment and highlights that there is always a two stage closely inter coupled process involved; 1. Selecting and gaining control of the victims — more of a media targeting process deception, and, 2. the actual mechanics of the rapes — more of a voo doo ‘financial’ deception.

          The “gory details” should include both stages as they are interrelated and equally important, especially so as they show patterns, practices and roles of specific government and private actors as they pass through the revolving doors of ‘public private’ facilitation.

          More and more each day it is the macro view that tells the story as the gangsters are free to roam globally and the victims are corralled and contained in their co-opted fake ‘nation state’ political systems.

          Deception is the strongest political force on the planet.

        2. Tom Parsons

          Yes, yes, yes, please! LBOs have horrified me ever since Pacific Lumber, which I could hardly believe was legal at the time.

          And now the privatization of public resources seems to be the new and improved extension of such looting. Not only are the assets stripped and the infrastructure degraded, but the public “customers” of the government-backed monopoly provide a monetizable revenue stream, with their payments into corporate pockets enforceable by all the powers of government.

      1. readerOfTeaLeaves

        Several years ago, if anyone had told me that I’d be looking forward to a series on PE, I’d have rolled my eyes in disbelief. But PE is surely one of the ‘structural problems’ in the economic system that needs a great deal more public understanding. And pronto.

  11. Anchard

    Exactly this:

    “as indicated above, the industry does not produce high returns for investors. However, it is true that the process by which the industry redistributes money to itself involves significant externalities.”

    Most treatments focus on only one of these(e.g. Barry Ritholtz focused last week on the return side, but didn’t touch the externalities), but that only gets at half the picture.

    I’m really looking forward to the series.

  12. Andrew

    Please take a look at the Glazer brother shafting of Manchester United.

    1. Borrow millions.
    2. Buy a company.
    3. Transfer all the debt to the company.
    4. Restructure debt several times, sell debt to mug punters.
    5. Slip a few million into your own pockets as you go along.
    6. Float company awarding yourself a generous 50% share
    7. Sell shares before shit hits fan and company goes bust.

    Job done. Financial assets transferred. Wealth destroyed.

    1. Jim

      Andrew, no one buying Manchester United did so to make money. It’s a vanity play, much like those who bought stock in the Green Bay Packers.

      ManU can go down to 1 dollar a share, and I doubt ManU holders would care. At least they shouldn’t.

      I expect more privately-owned teams in the US to issue class B shares to their fans.

    2. JTFaraday

      As it happens, I recently saw the film Moneyball about the Oakland A’s payroll challenges. Very interesting.

  13. Tim

    Is anything really any different about private equity now than it was in the 80’s when the movie “Other Peoples Money” starring Danny DeVito came out?

    Doesn’t seem like it. There was definite scandal about it in the 80s, now nobody seems to care.

    I care though. As a taxpayer I had to Bail out Chrysler because of the idiots running that show. At least they got caught with there pants down and ate some of their own brew.

    Mervyn’s clothing chain was an excellent retail chain everybody loved to shop at that also was bankrupted by Private Equity.

    BlockBuster video was terminally crippled by private equity as well, Netflix just kicked them while they were down.

  14. rob

    I think that there should be a push for a change that Josh Kosman was advocating in his book on the industry. This would be to repeal the “debt as expense,” exemption which seems to be why these companies exist as they do today.Nevermind the way they did it 50 years ago.Today,joe blow(former treasury sec. and his band of merry thieves)get a companies ruling honchos to allow them to (acting on behalf of the company they still run)to borrow 95% of the money that will be used by joe blow,to buy the company,thus giving soon to be former honchos a big bonus to go fishing with,and allowing joe blow and his merrymen to aquire the company with very little of their own money….. but what they are getting is a company riddled with debt…..which is fine, because the company can now start to deduct the debt payments from their income taxes,and can keep the cash from their operations.this cash can then be available for joe blow to give himself perks and bonus’s,up the wazoo.until such point the best option is to carve up the cash cow(who is now dying of starvation, as to feed it would be another expense,better left in the pockets of joe blow)and sell the underfed parts to the butcher and fire all the helpers..
    the gist seems to be that besides these “fees” that get contractually added to the PE co’s balance sheets for “running”these newly aquired companies(even if they do a horrible job and bankrupt the co. they bought),It is them(PE co.) being able to get the taxpayer to subsidize this seriously flawed business model.In the national debt we are all paying as american citizens,making up ,or at least on the hook for(with our heirs and assigns)to cover this gap in income tax that is NOT paid by the PE industry…
    I too am looking forward to this series…
    the whole private equity industry seems like they should go back to doing it with their own money,if they think it is a good idea…

  15. F. Beard

    It occurs to me that the banks’ recurrent wrecking of the economy makes it much easier for vulture capitalists to feast?

    1. Yves Smith Post author

      In case you missed it, we are anti Obama and anti Romney. We’ve written tons more that is critical of Obama than of Romney, start with Obama’s “see no fraud if a senior banker is under the spotlight”, as well as his lack of any interest in dealing with mortgage mess, save as a way to further enrich banks. Oh, and we aren’t too keen about Obamacare either.

      And both candidates court PE donors eagerly.

      1. Chris Rogers


        One’s comment was misconstrued, i.e., I was being rather ironic. Further, and as my own comments occasionally on these boards make clear, I’m no fan of the legacy parties and advocate that all readers rather than boycott the farce of the supposed election, actually vote Green – at least Jill Stein identifies with the average Joe and puts her money where her mouth is by supporting those being forced into homelessness and other causes the Democrats used to care about.

        I now follow similar principles in the UK and will only vote Green or for nationalist parties that support a divorce from a corrupted neo-liberal intoxicated Parliament that represents its own interests and not those of the electorate.

        We have many of the same issues in the UK as the USA, one of these being an unregulated financial services sector that is like TB, it consumes the host until death occurs.

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  17. psychohistorian

    I worked for Crown Zellerbach back in the day when Sir James Goldsmith bought the company, sold off the manufacturing to pay for the sale and walked away with all the timber holdings for free.

    When Sir James Goldsmith died the Economist called him a cad. Now we have cads running for president.

    I am looking forward to your series, Yves.

  18. DP

    If the Obama administration wasn’t afraid of the impact it would have on its fundraising, it should refuse to use the term private equity when discussing Romney’s time with and continuing investment in Bain and instead use the more accurate term leveraged buyouts, given that the vast majority of funding for these buyouts is with debt.

    The myth of LBO returns to investors exceeding the stock market comes strictly from the use of high beta in rising stock markets. From various studies I’ve seen, when LBO investor returns are compared to an appropriate benchmark, the S&P 500 with the same leverage, they come up well short.

    As Yves notes, this industry is about extracting money from various other parties: workers in the companies who lose their jobs or see their wages and benefits cut, pension fund investors who get subpar risk adjusted returns, taxpayers who subsidize the industry through the interest deduction for debt plus the preferential treatment of “carried interest” and capital gains. The industry extracts money from these parties to line the pockets of industry executives and employees and destroys economic value. Like much of the rest of the financial services industry, it is a parasite that feeds on the rest of society.

    I am sure this series will be great and look forward to following it.

  19. Ep3

    Yves, one company i have read about is Simmons, who make mattresses in Georgia. The article was in time or Newsweek several years ago. They were a strong 100 year old private company with well paid workers and string financials. Private equity bought them, raided the pension fund, borrowed millions in the company’s name, all while saying they were improving the efficiency of the company, cutting waste, etc., all while the product quality plummeted. They extracted outrageous management fees and paid off previous top management so that they wouldn’t fight back. And then, when Simmons began missing interest payments because revenues fell (build a shitty product ppl don’t want to buy it), financial problems compounded.
    Also, look at one of obamas favorites, Hart schnaffer and Marx, a men’s suit company.

  20. rhcaldwell

    Yves – Brilliant! Astute, timely (overdue, in fact), obvious (when shown where to look), and wildly necessary. I cannot wait for more, and hope your planned reframing and retelling of the private equity fairy tale gains traction well beyond NC.. PE has been a key thread in the disastrous financialization of both our real economy and our body politic, and it is past time for an informed and knowledgeable exposé of its methods and utter dependence upon externalities. Game on!

  21. Skeptical

    From what I’ve seen, the “successful” LBO follows this cookie-cutter formula:

    1. The acquisition is 90% debt-financed, and
    2. The new owners boost EBITDA by cutting overhead (i.e. firing people), but
    3. The cost savings are eaten up by increased interest expense, and
    4. Capital expenditures are delayed, and
    5. After 3 years, the the newly “profitable” company de-levers with an IPO, which
    6. Reaps a windfall for equity sponsors, who (at best) added nominal value to the company’s longterm prospects.

    We look forward to your important series.

  22. schmoe

    I assume you will look at tranactional costs.

    Consider Restoration Hardware, which was in Dealbook yesterday for a sexual harassment story. Dealbook said it was public in 2008 prior to a buyout by two PE firms, and will soon IPO again with an expected market cap of ~ $1b. So, it was public, owned four years by PE, and will again be public. What transactional fees were incurred in this?
    – The going private deal likely had a fairness opinion, bridge financing, etc. Look at the Del Monte legal documents (bigger market cap so not very comparable) for some detail on going private transactional fees.
    – While owned by PE, it likely was charged a “mgmt fee” of at least $1M/year. Not sure if it’s filed a draft S-1 yet; the fee would be in there.
    – If the $1b IPO is executed and all shares sold have the 7% IPO “tax” from the underwriters, $70M will be charged.
    – The PE Fund LPs paid a 2% annual mgmt fee, but 50% of the transactional and portfolio company managing fees were credited against the LP fees.
    – The going private and S-1 drafting will have have many billable hours by $1,000/hour lawyers.
    – Arguably, Restoration Hardware avoided the SOX costs of being public from 2008 – 2012 so that might offset some of the costs.

    Also, didn’t HCA also make a round trip from publicly traded, to owned by KKR and Bain, and now back to being public?

  23. Ray Phenicie

    I would like to see discussion on the aspect of the industry that feeds off of the 401k IRS allowance for taking pretax money from a person’s paycheck and moving it into equity funds run by investment companies like Fidelity. Too often this cozy arrangement is overlooked but it has an element of inflexibility in that most companies lock down the choices on the advise of the investment firm.

  24. mrtmbrnmn

    Hooray to you Yves!
    Here’s hoping your series rips the mask off these p$ycho pirate$!! Or better yet just drag them out of their gilded cages in their underwear and pitch them in the tumbril-destination: guillotine!

  25. Jennifer

    I believe the Kauffman (don’t know that spelling is right) foundation recently release a study on this topic–investor gains in private equity–and found them poor.

  26. Nelson Alexander

    Excellent idea for a series. Look forward to it with relish. Please improve credibility by fixing typo in paragraph five. And don’t forget Bain.

  27. rivegauche

    This is fabulous news. Thank you, Yves. Looking forward to learning about PEs for my own knowledge. Also anticipating using the knowledge gained. Take THAT, PE defenders!

Comments are closed.