If this is true, why don't they go out of business? I just don't buy the argument that PE takes over businesses and makes them strictly worse. You don't make money doing that.
They will go out of business, in the long-term. What PE does is hot potato: they "trim the fat" off an existing business to goose up margins in the short-term, unload it to someone else, and that someone else is stuck with a business that's unsustainable long-term because that "fat" was actually resilience.
Sometimes, these buyouts are leveraged, with the company itself taking on the debt the PE firm used to buy it, so the PE's own risk is minimal.
That's the problem though. PE firms are stuck with billions and billions of dollars in businesses they can't cash out of because they have no other buyers than other PE firms.
That's why they are pushing the Trump admin to allow 401k funds to take over the toxic PE assets.
There are also a lot of PE strategies. Buying a class of small business and squeezing out value is one, but it's completely different from buying failing businesses and restructuring them, hoping for a turnaround.
Increased costs here, I assume, means to the customer, not to the business. PE buying up medical adjacent practices (vets, eye doctors, dentists) has been growing model over the last decade. They make money just fine because there's no alternatives, and manage to make both their employees and clients more miserable in the process.
You certainly can. It depends what kind of investors you can find. There is often a lag between the time sellers make changes to the business and the collective buyers' reaction to those changes, so if you can line up investors (whether it be equity or fixed income), then you can turn long term good will into short term cash for yourself.
For example, the business in the comment above might be selling veterinarian services, but the new owner's business is actually selling cash flow. The veterinarian services are just a means to an end, so it could be possible to take the built up good will and convert that to cash flow by cutting costs/raising prices in the short term, and then selling the new and improved cash flow.
You might ask, who would buy from this person again when they know the underlying business is being trashed? The answer is usually dumb money, such as defined benefit pension funds where the investor and the beneficiary are far disconnected. As long as it looks like due diligence happened, everyone can kind of get away richer in the short term with no one to stop them.
The hard part is lining up the investors, that requires being in the right networks.
Yes, there are some PE takeovers that are legitmately trying to improve things and generate more profit. You don't hear about those because it's not controversial. You only hear about the "slash costs and cash out" types of takeovers.
> I just don't buy the argument that PE takes over businesses and makes them strictly worse. You don't make money doing that.
The effects in health care were studied.[1]
Less competition supports higher prices. People can be convinced to purchase unnecessary services. People are slow to leave trusted doctors. Non compete agreements limit new competition. The time to train new veterinarians limits new competition. Short term profits fund future acquisitions.
In my town it works like this: Vets get taken over by PE, raise prices over time. People move to the old style vets. These are overwhelmed and can’t take more patients, so people have no choice but going to the PE vets.
Important extra step is that the market can't respond and increase capacity - it is increasingly difficult to set up a new vet clinic (nimby, local regulations, insurance, fitout costs) and so any existing vets who wants to roll their own usually can't get capital together to start a new clinic.
How many vet clinics do you know about? How often do you take your pet to the vet? Are there any “first visitors” events you need to do?
If someone is going to the vet once a year for blood work and a rabies vaccine; and there’s only like 3 in the whole city, you’re probably not going to rotate between them. What if the next one is even worse?
I have left a single vet over “bad behavior” and most of the other times it’s been over moving and things getting too far away.
The reality is most of their “getting worse” and “increased prices”, etc, is missed because most people come in once a year, so changes over time aren’t especially visible.
I have experienced it first hand so many times. You have to understand that PE comes in with an exit plan. They most often do not plan to hold the asset beyond 5, maybe 10 years max. Their goal is to come in, extract as much money as possible in the short term to recoup the expense, and then sell off the remaining assets for whatever they can get for it as a cherry on top.
How do they extract as much profit as possible? Because wouldn't the previous owner have tried to, you know, make as much money as possible? Yes, but PE firms have more capital and scale and will specialize in a certain type or types of business to maximize impact.
Here's how it works:
1. First the PE Firm will focus on a business type - maybe it is auto repair shops, maybe it is pediatric clinics, maybe youth sports facilities and leagues. It doesn't really matter. What matters is that they will buy a lot of them.
2. Now that they own quite a number in a certain geographic area, maybe even most of that type of business they have leverage over customers, employees, and sometimes suppliers. The PE playbook dictates they first cut costs wherever they can. Reduce staff, add surcharges and fees, negotiate better prices with suppliers.
3. The businesses are now operating at a slightly higher margin, which is great, because the initial capital outlay was huge and they had to pay a premium because no one really wants to sell to PE. So over the next 5 years or so they need to make all of that investment back and they usually will. They might lose some employees and some customers, but people hate change and most will stick around even though service is a bit worse. And anyway, who cares, their profit margins are now nice and padded.
4. It has been 5 years and now their businesses are really starting to show signs of cracks. It is getting harder to find competent onsite management who will put up with the terrible work environment. Customers are leaving. Some of those employees are starting their own shops. But who cares, the money has already been made back. Now is the time to sell before the whole thing implodes and if it already has imploded, well, that is less than ideal, but there are still assets to sell. Sell for whatever you can and walk away. The PE firm netted slightly higher than if they were to invest in the stock market. Could they have made even more by just running competent businesses over the long term? Maybe...but that would have required a lot of time and active management and no one wants to do that, so on to the next venture.
This! All day long.
For a minute Pre-COVID and the inevitable reassessment of my life choices, I was a Private Equity fund manager for a International PE org with significant assets in a wide spectrum of energy technology and agriculture ventures.
We operated with a slightly different approach; leveraging long term lease back of land and physical resources to the original operators with caveats, such as transitioning to Organic Certification and Cost Effective Staffing - read that as Wallpapering the Products' Perceived value while shorting the personnel costs through under-staffing and underpaying - with some real improvements which included international market access and lower ecological footprints by ceasing deforestation for expansion and removing toxic petrochemical fertilizers, herbicides and insecticides from the operations which are actually beneficial to both employees and the community.
However, the standard modus operandii in the industry was and still is some flavor of this get in, grow, leverage, and then exit approach.
Individual operations' access to low to no interest financing for OPEX and CAPEX was a fundamental uplift to the value of those operations. There existed the possibility of leveraging the organizations' histories to secure low-to-no interest loans equal to the estimated market value of those operations; spend that money to expand and partially offset the cost of acquisition (protecting the investment funds from market volatility) and leverage those expansions to reduce competition through assimilation or under-pricing the competition.
Often the 'exit strategy' can include sell-off of physical assets to cover the loans; or folding the organization and defaulting on outstanding loans.
The fund never actually has to be at risk, the upsides are up-front during the stage wherein the public sees the 'investment' into expansion of or improvement of goods and services before the inevitable degradation due to under-staffing and cost cutting through volume renegotiation or through changing suppliers and processes for cheaper and less effective inputs. When customer satisfaction and employee burnout reach a crescendo... move on.
The end for me was when the organization decided to use COVID as an excuse to cut an entire environmental tech development team from payroll; with zero benefits and the expectation that local government to provide the entire cost of team members and their families' survival, while selling the technology invented and being developed by those team members for approximately one dollar to show as great a loss as possible.
PE is at least as big a blight on the global economy and community well being as joint-stock monopolies serving a few majority shareholders.
