What good does private equity bring to the world ?

Don't want to sound like a layman.

I see PE companies cut OPEX by laying of many and this also alters the quality of services they provide such as:

A. Healthcare services (cutting people per head in senior residences)

B. Buying pharma companies (downsizing operations such that there are less people at plant)

C. Buying up enough real estate in a particular city such that it causes rentals go up

Comments (47)

  • Analyst 1 in IB-M&A
Nov 27, 2021 - 6:05pm

PE companies don't bring any good to the world, simple as that, no matter how much some PE associates try to delude themselves with "we're creating value".

Their purpose also isn't to bring good to the world. PE companies aren't NGOs or charities. PE companies exist to deliver returns to their investors.

  • Analyst 2 in IB - Gen
Nov 27, 2021 - 6:09pm

Facts. I don't get the obsession people have towards holding PE companies up to a higher moral standard, that's simply not what they were meant for. No one requires a HF or a beer company or Raytheon to bring net good into the world.

Nov 28, 2021 - 3:00am

Practically speaking, yes, the net effect of PE is pretty negative for most people not actually involved in PE. PE is really a method for investors to generate returns in the private markets. Sure they may run orgs better than their previous ownership etc but the end goal of all of it is to make sure returns are at their peak. Anyone who says there is a nobler cause for why PE does what it does is either naive or disillusioned. Personally when I was in PE, all conversations about potential investments always stemmed from whether or not we could reap returns from said investment.

Some folk always argue that PE is keeping industries honest by showing they can run companies without bloat and efficiently but that's just a side-effect of seeking returns in reality. I'm not saying there's anything wrong with that obviously it's the epitome of capitalism but gotta stay honest here.

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Nov 28, 2021 - 9:46pm

Why is having peak returns as your end goal a bad thing as a PE firm? Surely if a PE firm is is able to hit "peak returns" on an investment then the portfolio company has definitely benefitted as well in the process (i.e. you can't make >3x on an investment unless you have substantially increased the business' size through EBITDA growth or cash flow generating ability etc.). Would those things not be beneficial to the net impact of a portfolio company on all its stakeholders including employees, customers, suppliers etc.? Sure there may be some fat trimmed along the way, but ultimately isn't this what is going to happen if we expect to run an efficient enterprise, which PE needs to do due to its need to aggressively pay off debt/ de-leverage their investment throughout the holding period?

Dec 2, 2021 - 2:41am

The question wasn't about the benefit to the PE firm though. Obviously hitting or blowing past your hurdle rate is good for the fund but that's not was what being brought into question right? If you look beyond, often times the result of achieving such returns is due to a series of financial engineering tactics on portcos which overall may be bad for the communities they reside in or whatever right? Like I believe in the benefit to the PE firm having worked in PE but I'm just trying to point out the other side and how it may be perceived by those not in the industry.

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Nov 28, 2021 - 7:52am

I can't speak for large cap PE but LMM definitely creates real value. So many of these companies floating around are luckier than smart operators who stumbled into a good product, but struggle with the business end. Surprisingly, these can companies can go quite far. I think PE also adds a nice check for some of these entrepreneurs and improves the core business. 

A close friend of mine who sold a packaging company to Bain first sold a control stake to an LMM firm, who he credited with helping him scale quickly to a point where he could exit to Bain for example. 

To be honest, I have benefitted massively from investor oversight too. Our investors don't bug us much, but they do point out when we are being stupid or irresponsible, which is easy to do as an entrepreneur. :)

  • Investment Analyst in PE - Other
Nov 28, 2021 - 8:21am

They fund the pension payments of teachers, police officers, firefighters. They allow underprivileged kids to get scholarships through university endowments, they fund cancer research and other important medical causes, they allow institutions of art and science to operate with foundations. To ignore the true underlying purpose is ignorant and something that people who despise this industry hate to acknowledge. If it weren't for all these noble causes that have stockpiles of investable cash PE wouldn't be nearly as relevant or prominent.

Nov 28, 2021 - 10:44am

Come on bro - the true underlying purpose is so the PE guys can make a fuck ton of money. I personally don't see anything wrong with that, but as mentioned above in other comments, don't act like PE exists to make the world a better place

  • Investment Analyst in PE - Other
Nov 28, 2021 - 10:49am

It exists to make money. That money in large part goes to noble causes. Why is the act of making money immoral in your mind? Yes, the higher ups are compensated well because they have a unique skillset and work in a manner 99% of the population is unwilling to do.

  • Investment Analyst in PE - Other
Nov 28, 2021 - 10:51am

Please tell me who is going to ensure these pensions and other institutional LPs meet there return objectives if it isn't PE/hedge funds/credit funds/infrastructure funds/real estate funds/LO AM/etc…

Nov 28, 2021 - 1:41pm

Sounds like you work for the wrong firm.   The good firms grow top line revenue by innovating, developing new products etc.  While tremendously lucrative, this effort benefits the many beneficiaries of our institutional partners.   

It's pretty hard to find a good deal out there these days....and it's pretty hard to find a good firm too.

Most Helpful
Nov 28, 2021 - 10:47pm

What good do craft breweries and alcohol companies bring to the world?  Car manufacturers?  Or Coca-Cola?  How do we reconcile the diabetes rates wherever it plants its flag with shareholder returns and the jobs it creates?    Or Walmart on a net basis when you account for the exploited Chinese labor.  Same with Nike and Apple and Amazon and EV manufacturers (have you seen what goes into making their batteries??)  and so on.  Every industry has negative externalities within an eco-system we take into account but how else are you going to function an economy or fuel any sort of growth-both a result of fulfilling needs?   

PE catches a bad rap for a couple of reasons:  People complain whenever the fat gets cut.  Zero-based budgeting and other lean initiatives take a blowtorch to most payrolls, and that upsets people who feel entitled to long-term employment at a firm for its own sake, regardless of bloat and waste.  Also, some of the famed go-to techniques rub folks the wrong way: overleveraging a company to boost returns when you know it won't necessarily generate the CFs to survive, or billing PortCos with all sorts of "fees" on top of their overhead, lol  

But net-net I've seen PE scale plenty of smaller companies, successfully manage previously stagnant businesses, and maintain portfolios of competitive companies.  But those instances don't make for good headlines, so all you read about are "vulture capitalists" or some shyt. 

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  • Analyst 1 in IB-M&A
Nov 29, 2021 - 8:46am

PE isn't really investing - they don't have a thesis like a tiger cub hedge fund does. They just cut costs and reduce inefficiencies and use leverage. In a 10 year bull market using excess leverage, there returns aren't remarkable. When interest rates rise there will be a reckoning for sure. 

Nov 29, 2021 - 11:13am

PE isn't really investing - they don't have a thesis like a tiger cub hedge fund does. They just cut costs and reduce inefficiencies and use leverage. In a 10 year bull market using excess leverage, there returns aren't remarkable. When interest rates rise there will be a reckoning for sure. 

LOL, wut? You need to pay more attention. Thesis-driven investing has been going on at PE funds for a long time now.

Nov 30, 2021 - 9:53am

Ok well the research suggests otherwise and that it is mainly Beta not Alpha. Read the Alpha and Beta of Private Equity Investments by Alex Buchner. Time to get educated, genius. I can send you more research reports on the topic for you to get more informed. 

Please break out the returns based on 

a. Cost Cutting

b. Financial Engineering

c. Growth

     1. Beta

     2. Alpha

Thx. 

Nov 29, 2021 - 9:50am

Very few people get into PE to "do good." It is for the competition and to make money. Then you have the folks who go into tech to "make change in the world."

You can then view PE as, at the end of the day, investing on behalf of teachers, firefighters, etc. for their retirement, whereas the guy who went into tech's role is to create an addicting "like" button in order to throw fake news and advertisements that are meant to trick the uneducated masses, all for the prospect of more profits.

At the end of the day, you can rationalize either as much as you want. 

Nov 29, 2021 - 10:25am

Just an aside, but your point C is completely innacurate. It would be nearly impossible to buy enough rental properties in any largish city to raise rents across the board. Housing is an incredibly complex market, but prices have been skyrocketing the last 10 years because we are drastically underdeveloped. The country (and most importantly, cities) has seen population grow without adding nearly enough commensurate dwelling units. A single PE firm couldn't influence rentals single handedly. 

Just to give you a sense of scale, the latest data I could find from a simple Google search is the total amount of money renters spent in 2017 was $485b, so just round that up to $500b for today. Even with a conservative 7 cap, half a trillion in rental income implies a total value of the real estate at $7.1t, even trying to capture 0.1% of that is $7b. Just to get a sense of how small a thousandth is, the Boise, ID metro area is 0.2% of the US population. I'd like to see anyone try putting $7b to use in Boise. 

Nov 29, 2021 - 7:17pm

What he's saying is true for relevant, growing markets. Think up and coming cities like Nashville or Atlanta. No one is throwing money at rentals in places like Mobile, AL. 

Array

Nov 29, 2021 - 8:44pm

Nashville MSA is 0.5% of the US population and Atlanta MSA is 1.7%, or $35.5b and $120.7b of value in the rental market, respectively. And that's ignoring their portion of the $36 trillion SFH market rentals have to compete with. PE is definitely heavily involved in real estate, and with the explicit goal of raising rents as much as possible, but there are too many actors to consider it entirely institutional private equity's fault. Real estate is one of the most fragmented markets out there, even the huge players are less than 5% of any given market. The only reason they, and the rest of the landlords, are able to so effectively raise rent is because there is a severe lack of supply, not because they are acting on cartel economics. 

Nov 29, 2021 - 10:25am

Lots of good stuff here but note that for a properly functioning capital market, you need a bridge from a growing smaller business to IPO. Imagine if there were no PE firms providing this liquidity.  Suppose I have a private business that has expanded to 10 stores.  Should I expand to 20, 30, or 50 stores? Well, if that makes my business illiquid from a sales persective, that might be an unwise idea.  I might be better of just selling my 10 stores now.  Even at 50 stores, I'm not big enough to go for an IPO and maybe I don't want to be a public company even if I could.  Maybe, I don't want to run a 50 store empire for the long run and would rather someone else take it from here while I enjoy the fruits of my labor.

This doesn't seem like a big deal but it would actually mess with the financial system quite a bit if you had no good bridge between a larger small business to public market IPO. If you want to think about it even deeper that would mean public companies could access capital markets but anyone smaller would be shut out....not exactly a great outcome either.

Nov 29, 2021 - 10:28am

Hack-and-slash PE is pretty much over - financial engineering is commoditized. Markets are putting a sizable premium on top-line growth, and it's being reflected in how funds manage their portfolios. They now have to invest heavily in growth (read: R&D and/or S&M headcount) and operate their businesses far more strategically / intelligently than was previously was required to hit their hurdle.
 

How much value does PE create? Debatable, but however much, they're creating more these days, in the form of bigger, better businesses that tend to employ more folks. 

Nov 29, 2021 - 10:40am

Most people who ask these kind of questions should be asking what good they bring to the world instead.  The honest answer probably isn't as satisfactory as the feeling of looking down on [insert industry here]

I come from down in the valley, where mister when you're young, they bring you up to do like your daddy done

  • 3
Nov 30, 2021 - 10:09am

PE performs many necessary functions in the economy (not discounting the negative effects, but this question is asking about positive ones):

  • More efficient capital allocation; money goes where it will be most productive
  • Cutting the fat; PE enables leaner, more nimble organizations to flourish
  • A controlled burning; things like asset stripping and being a 'vulture' not only enable value for PE investors, but also help to cleanly kill dying industry which may be hindering progress
  • Improving outcomes with dedicated expertise; a lot of LBOs end with a better corporation, producing more value for society as a whole. Something that otherwise may not have been possible without the expertise of PE associates
  • Diversification and Unemployment Prevention; since many firms act like conglomerates into themselves, they benefit from the ability to weather large storms that otherwise would have bankrupted an organization
  • Fair Valuations; similar to stock buybacks, PE investing in a market can raise valuations to a correct and fair level. Though it may have adverse side effects (see BX and gentrification)
  • Introducing liquidity into markets; PE can revive, sustain, and create industries with the financial capability PE introduces. And big money often follows PE.
  • Sustaining innovation; PE can finance companies at a greater length than VC can and can shield private companies from the obligations that come with being public (see SpaceX, etc.)
  • Etc.

There's definitely more, but this is off the top of my head.

  • Intern in IB - Gen
Nov 30, 2021 - 3:31pm

Private equity funds your grandma's pension. I don't see the ACLU or social workers doing shit for my grandma

  • Works at Other
Dec 2, 2021 - 7:50am

 see PE companies cut OPEX 

I thought about going to corporate but then wondered what would happen if a PE firm bought the firm I worked for. 

Dec 2, 2021 - 3:53pm

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