The idea behind private equity firms—to buy failing companies and turn them around for a profit—is not inherently bad. So why is private equity such a major driver of economic inequality? Jim Baker, the Executive Director for the Private Equity Stakeholder Project, explains these Wall Street pirates’ risky business practices and shows how workers are paying the price.
Jim Baker is the Executive Director for the Private Equity Stakeholder Project
Twitter: @PEstakeholder
Pirate Equity: How Wall Street Firms are Pillaging American Retail https://pestakeholder.org/wp-content/uploads/2019/08/Pirate-Equity-How-Wall-Street-Firms-are-Pillaging-American-Retail-July-2019.pdf
Website: https://pitchforkeconomics.com/
Twitter: @PitchforkEcon
Instagram: @pitchforkeconomics
Nick’s twitter: @NickHanauer
Jim Baker:
Private equity firms invest capital in companies perhaps to take them private, will then seek to dramatically grow cash flow at that company for their own and their investors’ benefit, and then will sell the company then and keep the profits.
Goldy:
They’re making money destroying companies.
Nick Hanauer:
They’re making money losing money.
Goldy:
Because capitalism, Nick.
Speaker 4:
From the home offices of Civic Ventures in downtown Seattle, this is Pitchfork Economics with Nick Hanauer, the best place to get the truth about who gets what and why.
Goldy:
I’m not sure that you know this about me, Nick, but my father was a psychiatrist.
Nick Hanauer:
I did know that about you. Explains a lot about your personality.
Goldy:
Yes, it does. Very, very into Freud. I bring this up actually because he did his psychiatric residency at Hahnemann University Hospital in Philadelphia. And years later, he also taught medical students there. It was a hospital, been there forever in the middle of Philadelphia, not in a very wealthy neighborhood, served a lot of inner city residents, high rate of poverty among its patients. And in 2018, it was bought by a private equity firm, and two years later, it was shut down and they’re selling off its very valuable real estate. And I bring this up because that is the topic of today’s episode, Nick.
Nick Hanauer:
Private equity.
Goldy:
Private equity. In this case, what some people call pirate equity, the pillaging of American companies by these big private equity funds.
Nick Hanauer:
Yeah. And I have my own personal story Goldy, which is that several years ago, my brother and I sold our family business that we had owned as a family for 100 years or something like that, not 100 years, but since the ’40s, and it was a profitable, well-managed company with a limited amount of debt and absolutely clean inventory. And we merged it into a competitor who was owned by a private equity company. It was bankrupt within a year. And these are two great examples of the egregious practices of a business that shouldn’t be harmful to the economy overall. Right? All private equity is, or should be, is groups of people buying companies and ideally improving them and selling them for a profit later. And what it has devolved into is this incredibly exploitive, corrupt practice of using levered money to buy companies and then extract all of the value out of it and kick the rest of it to the curb and make it somebody else’s problem, usually in publics.
Goldy:
Yeah. Let’s be clear, this isn’t just some investors putting money into a company and making a really bad, bad decision and losing their investment. That we could tolerate. Because if that’s what was happening, it wouldn’t happen so often because these people wouldn’t have more money to invest. Actually, they’re investing money into these companies and using that to pull a shit ton of profits out of these companies, driving them out of business and leaving, in the case of that hospital, the community and the employees, the former employees, to suffer. People now don’t have a hospital and their neighborhood anymore. In the case of your company, the employees, I’m sure your suppliers, your customers, all left holding the bag and these private equity funds-
Nick Hanauer:
Making money.
Goldy:
Making money. They’re making money destroying companies.
Nick Hanauer:
They’re making money losing money.
Goldy:
Because capitalism, Nick. And we’ve used a couple examples here at the start that personally touch our lives in some way, but this is a big business, isn’t it?
Nick Hanauer:
Yes. It is becoming an incredibly big business.
Goldy:
Bigger in some industries than others. 10 out of the 14 largest retail chain bankruptcy since 2012 where private equity acquired chains. For example, Kmart, and most egregiously, Toys “R” Us. A lot of retail workers, one in four of which live near the poverty threshold, are laid off as a result of these bankruptcies and store closures. And many others have lost their pensions, which by the way, I find to be one of the most egregious practices, you’re going to acquire a company and wipe out their pensions and leave the retirees and the government picking up the tab.
Nick Hanauer:
Yeah. 100%. We have a fabulous expert to talk us through all this nonsense today. Jim Baker is the Executive Director for the Private Equity Stakeholder Project. It’ll be really interesting to talk to him.
Jim Baker:
Jim Baker, I am the Executive Director of the Private Equity Stakeholder Project. We are a nonprofit organization, a watchdog group focused on the growing impacts of private equity and some more Wall Street firms on people and the planet. And so, we track impacts of private equity firms on workers and jobs, on the environment and climate change, on healthcare, housing, civil rights issues, et cetera.
Nick Hanauer:
So, why don’t we start by just explaining to our listeners what private equity is?
Jim Baker:
I guess one way to think about it is, private equity firms invest capital mostly from institutional investors. So, ranging from pension funds to foundations, university endowments, wealthy individuals. Unlike investing in stocks, they will invest capital in companies, perhaps to take them private, will then seek typically over a period of three to five, four to six years to dramatically grow cash flow at that company for themselves, their own and their investors’ benefit, and then will sell the company, will seek and [sell 00:07:20] the company or take it public again, again, four to six years later, and keep the profits. And so, that’s what private equity does. And so, typically private equity firms will look to double or triple their and their investors’ money within a three to five, four to six year period of time.
Nick Hanauer:
And you publish a report on how Wall Street firms were pillaging American retail. Tell us some more about that.
Jim Baker:
Yeah. So, the report is a couple years old, but many of the trends highlighted in the report are absolutely ongoing to this day. So in 2019, we work together with a couple of organizations, including United for Respect and the Center for Popular Democracy, to look at private equity investments in the retail industry. Because there have been lots of news coverage, as many folks have seen, about the retail apocalypse, or all these retailers going through bankruptcy. But we knew there was more to the story. And based on seeing what had happened at retailers like Toys “R” Us, et cetera, we knew that there was more to it. And so, we looked at essentially private equity investments in retailers over the decade prior, so 2009 to 2019, and looked at what happened to jobs at those retailers, and found that 600,000 people working at retail companies owned by private equity firms and hedge funds lost their jobs over that decade through layoffs, bankruptcies, liquidations.
We looked at both job growth at those companies versus job losses and found that private equity firms and other Wall Street firms had destroyed eight times as many retail jobs as they’d created over that decade. These job losses have ripple effects. So, when folks forecast increases in jobs, they talk about the multiplier effects, for example, somebody going into supporting a restaurant across the street or supporting a supplier while job loss is also a multiplier effects. And so, when we actually looked, 600,000 direct job losses in retail, but just based on thinking about multipliers, we actually think it led to more than 1.3 million job losses overall. And what I think is important to note about and note about the findings of it is, there’s a lot of news coverage about closures of retailers and there’s certainly truth to that. But just based on a Bureau of Labor Statistics data during the same period of time, the retail industry, as a whole, added over a million additional jobs.
So, these job losses actually ran counter to what the industry was doing as a whole. And I think part of what was also where we left at the report is that, while there were 600,000 job losses at private equity owned retailers over that period of time, in 2019, and still largely to this day, there were still around a million employees, US employees of private equity owned retailers. So, many other workers’ jobs still hang in the balance. And in fact, within the retail industry, we’re still seeing large private equity buyouts or attempted buyouts of retailers. For example, a couple of private equity firms right now are on the process of trying to acquire Kohl’s, the department store chain which has more than 100,000 workers. And both of the firms that are trying to acquire Kohl’s, Leonard Green & Partners and Sycamore Partners, they both have records of loading companies with debt to take out dividends for themselves, of taking companies, including retailers, into bankruptcy, of thousands or tens of thousands of workers losing their jobs.
Goldy:
Can you explain something which I think is confusing to a lot of people, how a private equity firm can take control of a company, essentially drive it out of business, drive it into bankruptcy, and still make money? How is it that they buy a failing business, and help it fail faster, and still profit from it?
Jim Baker:
Yeah. So, one of the places we looked at was Toys “R” Us, which is obviously generated a lot of coverage when it went through bankruptcy. And we did some work supporting efforts of Toys “R” Us workers to win a hardship fund during the bankruptcy process. And when workers first asked for the hardship fund, the company was like, “Oh, well, we’re bankrupt. There’s no money.” But when we looked closer, we actually noticed that KKR and Bain Capital, which had owned Toys “R” Us, had taken hundreds of millions of dollars in fees and dividends, and interest payments, out of the company during the period that they owned it. So, while Toys “R” Us itself went bankrupt and was liquidated, our analysis showed that the private equity firms, through the fees that they had collected from the company, actually made money on it.
So, workers had their severance terminated, creditors lost money, others lost money. But the private equity firms, because they had collected fees along the way, made money. The other practice that’s really common are, private equity firms taking what are technically called dividend recapitalizations, we just tend to, in simpler terms, called debt funded dividends, where they, frankly add, in some cases, large amounts of debt to the balance sheets of the companies that they own, and then use that cash to pay themselves dividends. So, they essentially pull money out of the company while they still own it. So, they make money even as the company becomes more indebted. And so, we’ve seen that with a number of the retailers that we highlighted in the report that had gone bankrupt. But frankly, we continue to see it to this day. Last year, 2021, was a record year for debt funded dividends, or private equity firms adding debt to portfolio companies, companies they own, to pull out dividends for themselves.
Nick Hanauer:
That’s a shocking practice. I think it’s really worth level setting just a tiny bit and say, A, that the practices of private equity firms generally are dishonest and pernicious, and we should regulate them in a much more profound way. And also, that the retail business, and certainly a lot of the retailers that are owned by private equity firms, were on their way out anyway. To be clear, Kmart isn’t gone because of private equity. The business was incredibly poorly run, and had been for a really long time, and they didn’t change with the times. And this is true of a huge proportion of the retail businesses in America that have not evolved in ways that are friendly to the present moment.
Jim Baker:
No, no, no. Look, I absolutely agreed.
Nick Hanauer:
And there’s no private equity involved in amazon.com because there’s no room for those folks in strong companies. They tend to prey on weaker companies and weaker industries because that’s where you find the running room. I just want to be clear that we’re not blaming private equity for the rearrangements of how people buy things in the world. They certainly have hastened the demise of some retail companies, and stipulate, there may be examples where there was a company that was bankrupted by these private equity practices that may have thrived well into the future. But we do need to distinguish between the pernicious practices and the strength or weakness of different kinds of industries. Right?
Jim Baker:
Yeah. I absolutely agree. Again, we think about something like Toys “R” Us as an example, where it is pretty clear in looking at it that the dramatic levels of debt that the private equity firms used to acquire Toys “R” Us did hamper the ability of the firm to effectively innovate. So, private equity and both the fees that were taken out and just the massive levels of debt clearly had an impact. Obviously, it’s in an industry facing substantial headwinds, you’re right, as we’re going through this transformation in how people buy things. But look, Toys “R” Us is also a perfect example, I’m not defending the company, but it’s a place where kids went to play with things as well.
Something that distinctly you could imagine to be perfect for an industry that could find a way to survive the onslaught, frankly, the retailers faced from online competition. That was one. And somewhere, we have seen some other types of retailers, or some other retailers that have evolved a combination of in-store and online presence to respond to the moment. Obviously, lots of them didn’t. Yeah. So, I don’t really want to defend the industry, the retail industry broadly, because I do think that also, many of the practices that we saw in retail, we’ve also seen in other industries. Part of the reason private equity firms were so active in buying retailers is they owned a bunch of land.
And so, one way that private equity firms could make quick money off retailers was to buy the retailer and then get the retailer to sell its land, and then use whatever cash resulted from that sale to pay themselves a dividend. We’ve seen the same practice in hospitals, for example. And so, private equity firms buying up safety net hospitals. Similar practices where we’ve seen them selling the land and the buildings, using that cash to pay themselves very large dividends, even as the patient care, even as the facilities, et cetera, suffered.
Nick Hanauer:
No, absolutely. And look, a private equity firm bought my family business several years ago, which was an absolutely clean, cash flow positive, well-run enterprise, merged it with a company that they owned, that they promised was twice as profitable as we were, and bankrupted it within 12 months of the merger. So clearly, they were lying about everything. And just unforgivably, stupid, and greedy behavior. I think it’s so important for listeners to understand is that the key to the private equity business model is debt, right? They take a little bit of capital that they have raised from their investors and they pair that little bit of capital with a massive amount of borrowed money from banks and other entities, and they use that money to buy the company. But now the company holds that debt, and that debt, of course, has to be repaid, usually with interest payments.
And so, a company that was debt free and cash flow positive, all of a sudden after our private equity firm owns it, can be cash flow negative because of the high amounts of debt that they have to service. That is the core of the strategy. And that’s why it often destabilizes healthy companies and drives them into bankruptcy.
Goldy:
Right. So, Jim, if you could elaborate on this a little bit, when you’re playing with other people’s money this way, what type of risky behavior has that created in the private equity firms?
Jim Baker:
Yeah, I would just second what Nick said about debt. When we look at debt levels at private equity owned companies are as high as they’ve been since the global financial crisis in 2007. Part of what we’ve seen, actually since this report was written and over the last couple of years during the pandemic is, private equity firms took advantage after fed and other central bank and preventions in debt markets, debt became very cheap and accessible. And so, private equity firms, like many companies, took advantage of that to load on additional debt to pay themselves dividends. And so, we’ve seen debt levels at private equity owned companies increase substantially. I think we’ve seen private equity companies taking out dividends at the very same time that there are dramatically problematic practices at some of the companies that they own.
We put out a report just a few weeks ago, looking at Packers Sanitation Services, which is a janitorial and cleaning company that specializes in cleaning meatpacking plants. And despite being a relatively small… well, not small, but not a massive company, there have been large numbers of OSHA violations at the company, multiple employee deaths in just the last few years, really dramatic health and safety issues at the company. But that hasn’t stopped Blackstone, the private equity firm that owns it, from taking hundreds of millions of dollars in dividends out of the company. Similarly, another example that we looked at or wrote about recently is, there’s been a ton of private equity investments in healthcare. And again, some of it bringing about important innovations, but in many cases, also just exacerbating problematic practices.
So, another example, we’ve seen a private equity firms own a company called Sevita. It used to be called the Mentor Network, which provides services to people with disabilities, services to for-profit foster care center, residential homes that they run, some of which have drawn dramatic complaints, have been shut down by state authorities. But similarly, that didn’t stop the private equity firms that owned it from taking hundreds of millions of dollars and dividends out of the company. So, I think what part of what we’ve seen is like this, even in the face of really dramatic problems or issues that frankly deserve investment to resolve at the companies, we’ve instead seen private equity firms just focused almost entirely on just maximizing the amount of money they can take out.
And again, these dividends do nothing to benefit the companies themselves, they really just add to the debt. Yeah, I think that’s what we’ve seen, is there’s this just dramatic disconnect, whereby the companies become really just a vehicle for adding debt and taking out dividends and seeking to maximize profits over a short period of time, even as there are problematic practices at those companies.
Goldy:
So, these practices have clearly gotten worse and have had more impact over the past few decades than they did before. Were they always legal? Did something change in the law or in the regulatory environment that allowed this to take off? Or is this just a change of mores?
Jim Baker:
Well, Nick, you may know no more about this than me, but let just say a couple of things. So, the private equity and private capital industry, including private real estate, infrastructure, et cetera, really has grown dramatically in just the last several years. So, it managed less than a trillion dollars in assets in 2004. Last year, it managed around 10 trillion dollars in assets and it’s projected to grow to somewhere between 18 and 30 trillion by 2026, depending on who you ask. I just think we’ve seen this massive growth over the last… Although, in many cases, private equity firms are private. So, there may not be a lot of publicity around that growth, but really this massive growth over the last decade or so couple decades.
And I just think that, with that, we’ve seen these practices on a larger and larger scale. So, one other number I would cite just as an example, the private equity industry put out in the end of 2018 and the end of 2020, their estimate of how many employees, private equity companies employ in the US. And it jumped by 33%, from 8.8 million employees at the end of 2018 to 11.7 at the end of 2020. Now, just to be clear, that’s not a result of job growth. There have been academic studies that highlight that private equity acquisitions typically result in job losses at companies. And so, we just have seen more and more… in that case, it’s a jump from 6.9% of the US private sector workforce to around almost 10% of the US private sector workforce.
And that’s during COVID. That’s during the period that the economy saw substantial job losses. So I think, generally, we’re seeing private equity firms impacting more and more people, whether that’s people at their jobs at work, just because they’re buying more and larger companies, companies like G4S, a security company that now has 800,000 employees globally, or Dunkin’ Brands, which owns Dunkin’ Donuts, Baskin-Robbins, et cetera. So, we’re seeing private equity firms buying larger and larger companies that impact more workers. And then also, obviously, seeing them buying, like I said, in industries like healthcare, which impact lots of other folks, patients, healthcare, consumers, et cetera, or housing, and so on.
Nick Hanauer:
So, let’s get to what we should do about all this. I think it doesn’t make sense, strictly speaking, to just outlaw private equity, but more particularly, some of the practices. So, if you were in charge, what would you do?
Jim Baker:
Yeah, look, I think you’re absolutely right. And I think our view is that, I think as you said, private equity at its base is just people getting together to invest in a company. And so, the question is all about the practices and the terms of how you do that. And so, things that you could do are to outlaw some of the egregious practices, things like the debt funded dividends that I mentioned, which only benefit the private equity firm, or at least limit them so that they’re not taking any more in dividends than the actual profits that the company is generating. Frankly, the thing that’s been proposed, that I think is important, is ensuring that private equity firms are on the hook to some degree for the liabilities that their portfolio companies incur.
And we’ve seen this in very limited instances, in a few cases where private equity owned healthcare companies have committed Medicaid and Medicare fraud, where the private equity firm was ultimately held responsible. We do think there needs to be a greater degree of responsibility that private equity firms take. If they’re incurring massive debts or massive liabilities or engaging in practices, things that harm people’s health through the environment, that themselves incur massive liabilities, then our belief is the private equity firm should ultimately be responsible for those liability.
So, something that ensures that they take responsibility for liabilities that they incur, limits on their ability to just pull fees out of companies or dividends out of companies, or just loot companies. And perhaps, limits on how much leverage they can use itself, which would hopefully focus the industry a lot more on what it should be about, which is how do you make this a better run company, or how do you make this a-
Nick Hanauer:
And when it is a better run company and making better products, you can no doubt sell it for more than you bought it for.
Jim Baker:
Exactly. Exactly. In theory, what it was supposed to be out in the first place, but we’ve just found-
Nick Hanauer:
It’s just been corrupted.
Jim Baker:
Yeah. There’re just ways that firms have taught and sought to gain the practices so that you give… it’s really just about extracting money. Yeah.
Nick Hanauer:
So, is there a specific policy agenda that someone has advanced to reform private equity practices that you are an advocate for?
Jim Baker:
Yeah. We’re a supporter of the Stop Wall Street Looting Act, which Senator Elizabeth Warren has put forward. I think we’ve also supported specific interventions in particular industries. So, healthcare, I gave as an example where you think of it as an industry where there’s a massive, massive amount of public money going into healthcare. There’s also especially vulnerable populations. So, I would say we’re both supportive of broad efforts at reforms, as well as more focused efforts at industries where there’re both vulnerable populations and large amounts of public money going in.
Nick Hanauer:
Yeah. So, we always ask the benevolent dictator question, what would you do if you had the power? Is that it?
Jim Baker:
Yeah, I think so. I think what I just said before, which is the limits on debt, private equity firms being responsible for the liabilities, or the actions of the companies that they ultimately control. Yeah.
Nick Hanauer:
Yeah, yeah. Interesting. What else we got, Goldy?
Goldy:
I think we got the final question.
Nick Hanauer:
Why do you do this work?
Jim Baker:
Yeah, great question. So, my background in this work is actually working for, most of the last couple of decades, in the labor movement, working to support efforts by janitors, hotel housekeepers, security officers, folks like that, efforts of those folks to win living wages, to win decent jobs, et cetera. And part of how I frankly got started working on private equity was working with hospitality workers and noticing private equity firms buying up more and more companies in the industries in which these folks worked. But in the process of doing that, we also noticed that many of the same companies were impacting ordinary people in lots of different ways.
So, many of the same companies weren’t just buying up employers, but they were also buying up hospitals where people sought care, or buying up housing where people rented, or buying up people’s mortgages and foreclosing on them. And so, I think it really was, part of what is the why we do this work is just a sense that there is this… the very much growing impacts that these firms have are a bit below the surface. And so, they may not be readily apparent. I see our work, and my work, is continuing in the work that I’ve done for the last couple of decades, which is working to support efforts by ordinary people to press for better living conditions, for a more just life for themselves and their families.
Nick Hanauer:
Thank you so much for being with us. Fascinating, depressing, there’s so much work to do.
Jim Baker:
I know, lots of work to do. But look, it does work below the surface, but I do think we’ve been encouraged by growing attention that the issue has commanded. So, we’re obviously hopeful.
Nick Hanauer:
Well, thank you for being with us.
Jim Baker:
Thanks so much.
Goldy:
Talking to Jim, I think I’ve seen this movie before and it was way back in 1987, the movie Wall Street.
Nick Hanauer:
Yes. It’s so true. I guess the only change is, it just gotten more egregious.
Goldy:
And bigger, more common. And it’s funny, Nick, because you often bring up one of the line from Wall Street.
Nick Hanauer:
Greed is good.
Goldy:
Greed is good. And it turns out, greed is not good.
Nick Hanauer:
No. Greed is not good. Greed is not good. And we’re learning more and more about why it’s not good every day. And certainly, the private equity business, that industry is doing its level best to prove to the rest of America every single day, that greed is not good, that greed simply enriches the few and impoverishes the many and destabilizes both economies and democracies.
Goldy:
And let’s be clear, you brought up the fact that a lot of these retail firms were struggling anyway, because there’s a shift in buying patterns, this happens anyway, big retailers… When I was a kid, there were still Woolworths. And this is before they started dying before we shifted to online purchasing, there was Sears, whatever. And new retailers taste change. But let’s be clear, there’s a big difference between a gradual natural death of one of these retail giants, and what happened at Toys “R” Us, where all of a sudden they just closed down hundreds of stores, putting people out business and people out of work, and also, by the way, leaving vendors with bills unpaid. It hurt a lot of vendors in the process. And when you’re a company like Toys “R” Us, I know from when I was a little software publisher, when we had a retailer or our distributor went under after being acquired, and that was 40% of our income that year, which we didn’t get paid.
Nick Hanauer:
Yeah. For sure.
Goldy:
So, it pretty much put us out of business. It has this ripple effect throughout the economy. So, you have this dying company, and this private equity fund makes money off of accelerating the dying, shifting that cost to everybody else, the workers, the vendors, the community, and tax payers as well. So, it’s not simply, “Oh, we’re just going to put Sears out on an iceberg and let it fade away.”
Nick Hanauer:
That’s right. No, and the risks are getting greater because private equity companies own more and more of the economy.
Goldy:
And that’s a really important point, Nick. And I think what you’re seeing here is one of these… it’s a feedback loop. That as inequality has grown in the United States and more and more capital has been concentrated at the top, in the hands of fewer companies and people, they’re looking for ways to make money out of their money. They need a return. And one of the ways they’re getting this return is by buying up more assets and drawing profits out of it any way possible. So, one of the reasons why you have so much growth in the private equity industry is that there’s so much more capital to pump into private equity.
Nick Hanauer:
That’s true.
Goldy:
Whereas, if this was just money was going to wages, that’s where I was going, you’d have a very different dynamic.
Nick Hanauer:
Goldy, I feel bad that I’m not more acquainted with the policy agenda that can reform some of this stuff. We should do some research on that. I know that you could regulate these practices in ways that would make them just less pernicious. And that’s what we should do. Because it shouldn’t be illegal to buy companies to improve them to sell them. But what’s going on right now, that seems to me to be intolerable.
Speaker 4:
Pitchfork Economics is produced by Civic Ventures. If you like the show, make sure to subscribe, rate, and review us wherever you get your podcasts. Find us on Twitter and Facebook at Civic Action and Nick Hanauer. Follow our writing on medium at Civic Skunk Works and peak behind the podcast scenes on Instagram at Pitchfork Economics. As always, from our team at Civic Ventures, thanks for listening. See you next week.