Brendan Ballou is a federal prosecutor and served as Special Counsel for Private Equity in the Justice Department’s Antitrust Division. Previously, he worked in private practice, and before that, in the National Security Division of the Justice Department, where he advised the White House on counterterrorism and other policies. He graduated from Columbia University and Stanford Law School.
Below, Brendan shares five key insights from his new book, Plunder: Private Equity’s Plan to Pillage America. Listen to the audio version—read by Brendan himself—in the Next Big Idea App.
1. Private equity surrounds you.
If you rent an apartment, you might do so through a company that’s owned by Blackstone. If you buy insurance, you might do so through Apollo. If you go to the doctor or ride an ambulance, you may ultimately be paying somebody who’s employed by a KKR portfolio company. In fact, if you buy my book, private equity will be literally right in front of you. The font that we used for the book was licensed by a company that was owned by a private equity firm. Depending on the year (the order changes sometimes), Blackstone, Carlyle, and KKR would be the third, fourth, and fifth-largest employers in the United States—just behind Walmart and Amazon. And yet, so few people know what private equity is or what it does.
What private equity firms do is pretty simple. They take a little bit of their own money, some investor money, and a whole lot of borrowed money to buy companies. They then make operational or financial changes with the aim of selling the company for profit a few years later. It’s a simple idea, but private equity firms have a few fundamental flaws that lead to bad consequences.
For instance, private equity firms typically only own a business for a few years, so that encourages a certain level of short-term thinking. They also tend to load their businesses with debt and extract a lot of fees. Thirdly, private equity firms are really good at insulating themselves from legal liability. If you sue a private equity portfolio company, it’s often hard to recover money from the private equity firm itself.
When you combine those three issues (short-term thinking, reliance on debt and fees, insulation from liability) it tends to cause bad consequences for employees, customers, and for the businesses themselves. A recent study showed that private equity firms had a bankruptcy rate for their portfolio companies of about 20 percent, whereas comparable companies went bankrupt at a rate of 2 percent—so about ten times as often. Private equity surrounds us, and yet there are basic challenges with the business model that may be transforming our lives for the worse.
2. Private equity often succeeds by being great at law, not business.
When you look at the backgrounds of private equity leaders, often they don’t have experience in marketing, sales, engineering, logistics, or other typical foundations for building companies. Rather, their backgrounds are financial. So, the changes they make to businesses are usually financial and often leverage the legal system for their own benefit.
“Private equity firms aren’t focused on improving companies for the long term.”
In the 2000s, a private equity firm called Sun Capital bought the diner chain Friendly’s. Sun Capital executed a lot of tactics that were familiar to observers of private equity: extracting various fees and selling assets. Ultimately, they pushed the company into bankruptcy.
Bankruptcy is a little bit like flipping an hourglass where the people who were the owners lose out and the people who were the lenders take control. But Sun Capital had done this interesting thing where it was both the owner of Friendly’s and the largest lender to Friendly’s. When flipping the hourglass, Sun Capital sold Friendly’s from itself to itself. By executing this maneuver, Sun Capital pushed off pension obligations for retired Friendly’s workers onto the Pension Benefit Guarantee Corporation, which is this quasi-government agency that is paid for by other more responsible pension holders. Sun Capital held onto this asset free of financial obligations to Friendly’s retirees.
Oftentimes, private equity firms aren’t focused on improving companies for the long term, but rather on using the law to get advantages for themselves in the near term.
3. Private equity firms are really good at politics.
Private equity firms have given hundreds of millions of dollars to federal elected officials and candidates over the past few decades. But more than the money, private equity firms have people. They’ve employed former secretaries of state, treasury, defense, senators, chairs of the FCC and SEC, speakers of the house, a vice president, any number of generals, and a former CIA director.
One common success of this strategy is called the carried interest loophole. The basic idea is that there is a tax advantage that gives private equity executives the ability to pay a lower effective tax rate than in ordinary professions. This has been an issue that every president since President Obama has tried to close, and none have succeeded.
“Private equity firms have people.”
In the most recent iteration, President Biden tried to close the carried interest loophole first through his budget proposal, and then in negotiations over the Inflation Reduction Act. Not only did private equity manage to save the carried interest loophole, it got new loopholes in the process of these negotiations.
Private equity isn’t necessarily the best at running businesses, but it is enormously successful in protecting its preferences in the tax code and elsewhere.
4. Private equity firms are doing more than private equity.
After the Great Recession, many of the big investment banks converted into bank holding companies, which are much more highly regulated. In a sense, private equity firms took their place in terms of financial engineering, so many don’t even call themselves “private equity firms.” They refer to themselves as alternative asset managers. They are doing so much more than the leveraged buyouts that we associate with private equity historically.
For instance, private equity firms are now getting into the insurance business, buying up life insurance companies and using the money that policy holders pay to invest in their own projects. Reports suggest that some private equity owners are pushing these assets to offshore affiliates in Bermuda, where there are lower capital requirements. Private equity firms have more money to play and invest with, but less of a cushion if something goes wrong.
That’s concerning because private equity firms own these insurance companies but may not have to pay out their customers if things go bad. Rather, state guarantee corporations, which are funded by more responsible insurers, will have to pay out the policies of an insolvent insurer. We have a situation where private equity firms may benefit if things go well, and walk away if things go poorly.
“Private equity firms own these insurance companies but may not have to pay out their customers if things go bad.”
Insurance is far from the only area where private equity firms are expanding. In fact, the largest private equity firms are not just doing leveraged buyouts, but also getting into the work of hedge funds, infrastructure, and so much else. One of the most interesting areas that they’re getting involved in is 401(k)s.
Historically, 401(k) fund managers haven’t invested in private equity for fear of getting sued, but that’s starting to change. A letter issued by the government a few years ago essentially insulated fund managers from liability if they invest in private equity. The 401(k) world is trillions of dollars. Private equity firms spent probably a little over a trillion dollars buying companies last year, so by getting access to 401(k) funds, they will be able to supercharge their operations.
5. Private equity can be reformed.
Private equity firms tend to invest for the short term, load companies with debt and extract a lot of fees, and are often insulated from the consequences of their own actions. If you change those three things, if you get private equity firms to think for the long-term, if you get them less reliant on debt and fees, if you get them to take responsibility, then private equity firms can be a useful part of our economy. As long as businesses need to build new factories and hire new employees, there’s an important role for a finance system. The challenge is getting it to play responsibly.
There’s a role for Congress in pushing private equity to think for the long term and rely less on debt and fees: change the liability laws. But Congress isn’t the only lever of power here. Federal regulators can play a role. The Securities and Exchange Commission, the Federal Reserve, and the Treasury Department can all make an impact on enforcing this change. State and local regulators or legislators can ban certain extractive tactics that private equity firms engage in.
One of the things that I’ve been most inspired by is watching activists working on specific issues in specific industries where private equity firms are active. In the prison phone industry, for instance, activists have been extraordinarily successful at capping the rates of calls that private equity firms were raising to extremely high levels, making it essentially unaffordable for some prisoners to call their families. In the healthcare industry, activists have been effective at mandating minimum staffing requirements in nursing homes, another industry where private equity has been especially active.
Even though private equity is expanding in so many different areas and growing beyond the business of leveraged buyouts, there are ways that we can fix it. If you’re interested in how we can make a better, fairer economy, look up organizations like Americans for Financial Reform, the Open Markets Institute, American Economic Liberties Project, or the Private Equity Stakeholders Project. All these groups are doing important work, and you might be excited to learn what they’re doing.
To listen to the audio version read by author Brendan Ballou, download the Next Big Idea App today: