Remember Toys ‘R’ Us stores? Those brightly colored, toy-filled wonderlands of our youth? Well, that iconic brand has since become one of the most well-known, commonly cited casualties of the global private equity industry.
The private equity industry often generates profit from the buying and selling of companies using “leveraged buyouts”, a practice that provokes frequent criticism and scrutiny. Private equity firms are known for producing incredible amounts of wealth for the people running them, so the industry has been nicknamed the “billionaire factory.”
“There were approximately $1.2 trillion worth of companies bought by private equity [in 2021] alone,” Carter Dougherty, Americans for Financial Reform communications director, tells Teen Vogue. That same year, according to Securities and Exchange Commission (SEC) chair Gary Gensler, there were more than 18,000 private equity funds with nearly $5 trillion in gross assets. By 2022, that number had risen to more than $6 trillion, according to SEC data.
“But this picture is incomplete without asking what happens to the workers,” Dougherty continues. “What happens to the [purchased] companies? Is this a productive use of capital or is this sort of modern-day piracy? Because a lot of what private equity does looks like looting.”
Today, private equity firms are present in nearly every industry, from the country’s biggest childcare providers, local newspapers, to an array of services within public prisons. Industry critics are raising alarms about the negative impacts of private equity on the health care and housing sectors (private equity firms have contributed to popular short-term home rental service Airbnb’s $1 billion in investments). And the infamous controversy over Taylor Swift’s master recordings? Swift herself openly referenced the “unregulated world of private equity” in her 2019 acceptance speech for Billboard’s Woman of the Decade.
So, what is private equity and how does the industry actually work?
What are private equity firms exactly?
Private equity firms are companies that manage a collective fund made up of other people’s money, buying and selling other companies with the goal of eventually turning a profit. Anyone can own public equity in publicly traded companies through buying and selling shares and stocks, but private equity firms generally purchase majority stakes while keeping the details of their funds, financial information, and money management private. Dougherty calls it the “behind-closed-doors” version of public stock trading.
Private equity firms rely on funds that are largely made up of sizable types of investments such as pension funds, university endowments, revenue from home, auto, and life insurance company premiums, and the family offices of the super wealthy. Pension funds, for example, invest people’s retirement savings in private equity funds to generate the money future retirees will ultimately depend on.
How do private equity firms make so much money?
As with anything in finance, says Dougherty, the goal for private equity is to make profits by purchasing when costs and financial risks are low, and then selling at a profit. Though the industry likes to portray itself as a savior for “distressed” companies, he says, that’s one of the most common misconceptions about private equity. Because turning a profit is the chief priority, a firm won’t buy a company unless it has “lucrative assets and lucrative revenue ranges” the firm can benefit from, Dougherty notes. The presumption that firms are “investing” in supposedly failing companies — implying some sort of expansion or enrichment — is another area he says needs clarifying.
“Very often when private equity investors say that they are ‘investing,’ what they're really doing is speculating,” explains Dougherty. “A private equity firm buys companies A, B, and C. In total they're worth, let's say, $5 billion. But they haven't invested $5 billion; that's simply a change of owners. If I buy a bicycle from you, I haven't invested in the sense that I've improved the product, right? It simply changed ownership.”
In that change of ownership, because of the way leveraged buyouts work, private equity firms usually get the added benefit of taking on relatively little financial risk. And in that process, private equity firms cover a small portion of the cost of a company, and take out debt to cover the rest.
The peculiar part of this arrangement is that the debt is legally considered the responsibility of the company being purchased, not the firm. In a leveraged buyout, private equity firms take out debt using the newly acquired company’s own assets as collateral. So a company that perhaps wasn’t entirely doomed is suddenly saddled with millions or billions in debt and is under the management of owners who might have little or no experience in how to actually run the company.
Dougherty brings up Toys ‘R’ Us as a prime example: By the time the 70-year-old company filed for bankruptcy and closed its more than 700 remaining stores in the US, it was carrying about $5 billion in debt from its private equity buyout more than a decade earlier. In one move that proved to be particularly damaging, says Dougherty, the new owners opted to make a short-term profit by selling the retail giant’s real estate, then requiring the company to pay rent on its own retail locations. One way retailers can survive tough economic periods, he adds, is by not having to pay rent because they own their own real estate.
Let’s take a closer look at private equity in health care and housing
In recent years, private equity has made considerable financial inroads in health care and housing. Critics say this is particularly troubling given firms’ emphasis on profits. When it comes to managing essential provisions like health care and housing, prioritizing “cutting costs” can have disastrous results with real human impacts.
“Their priority is increasing cash flow at whatever cost,” says Eileen O’Grady, health care research and campaigns director at Private Equity Stakeholder Project (PESP). “For health care, we've seen that mean cutting staff, reducing less profitable services at hospitals — that might be labor and delivery services or pediatric services — or finding other ways to strip assets out of health care providers to achieve those high returns.”
O’Grady says PESP has seen private equity show up throughout the health care space, including in hospitals, nursing homes, mental health and addiction treatment services, disability services, and pharmaceuticals. PESP has also seen firms decide to save money by not investing in building improvements, she says, leaving elevators broken and leaking roofs unfixed. She cites examples of physicians being pressured or incentivized to bring in more profits, and mentions instances of dentists being accused of performing medically unnecessary procedures to meet revenue goals set by private equity firms that own the practices.
Adds Dougherty, even certain instances of “surprise billing” that leave patients with unexpectedly massive bills for emergency room treatment can be traced back to private equity firms.
“I have met with many nurses’ unions who are very, very worried about their ability to care for patients when private equity firms come in and say, ‘We need to cut staff because we need to cut costs because our profits are not high enough,’” says O’Grady, who points out that fighting the private equity industry is also a labor issue. “They may not have enough supplies, resources, or time to care for those patients. That means those patients are endangered. It means the staff are overworked. So it is a profound labor concern because not only are their jobs getting worse, they're no longer able to do the thing they want to do, which is care for people and provide quality health care.”
Mad Bankson, PESP’s housing research coordinator, says private equity is also expanding its reach in that sector, purchasing single- and multifamily homes and buildings, student housing, affordable housing, and manufactured housing parks, also known as mobile-home parks. “Often that means they are deferring maintenance in combination with trying to get more revenue,” says Bankson. “One way they really do that is through junk fees. They'll pass charges on to tenants that are made up or not something a tenant normally pays for. It can be anything from lawn maintenance to charging $75 to have someone come and take a look at something that's wrong with your house, even if it's something that by your lease or state law is supposed to be fixed by [the property owners].”
Private equity firms might also opt to quickly unload properties to turn a profit. That can leave tenants in suddenly precarious or unstable housing situations or at greater risk of eviction from private equity landlords who may be willing to break the the law of tenant rights and bank on tenants not fighting back.
“There was a congressional investigation that found that major private equity-connected corporate landlords were illegally evicting people throughout the pandemic,” Bankson says. “And the reason they do that is either to collect fees from people or force them out to get a tenant who can [afford] raised rent.”
Dougherty says the size and reach of the private equity industry’s financial influence is having an impact on the housing market. “Private equity firms have assembled big real estate empires, and that's one of the things driving housing prices in this country,” he explains. “Private equities buy a large number of homes in a certain area, and they have the financial muscle to muscle out homeowners who want to buy for the first time or they raise rents on people who end up renting from them.”
Are there any policy solutions proposed at the federal level?
The Stop Wall Street Looting Act (SWSLA) is one broad attempt to regulate the private equity industry at the federal level. It was introduced in Congress by Representative Mark Pocan (D-WI) and Senator Elizabeth Warren (D-MA) in 2019, and was reintroduced in 2021. According to Dougherty, SWSLA attempts to tackle two key regulatory issues: making private equity firms liable for the debt they borrow on behalf of the companies they acquire, and enforcing better financial transparency for the managing fees private equity firms charge. So far, though, there has been little progress in advancing the legislation.
Recently, the SEC voted to make a series of transparency-related changes regarding private equity fee disclosures and financial reports. This is certainly a step forward, but critics and experts say the new rules also include several concessions that will allow private equity firms to remain powerful players in the economy.
“There's no doubt that there are times when private equity can shine,” Dougherty says. “But honestly, most of the time when you're seeing these massive buyouts, we are talking about undertakings that are going to involve a lot of squeezing of companies and the workers for the benefit of some already very, very rich people.”
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