Private equity ghouls have a new way to steal from their investors
Private equity is quite a racket. PE managers pile up other peoplesâ moneyâââpension funds, plutes, other pools of moneyâââand then âinvestâ it (buying businesses, loading them with debt, cutting wages, lowering quality and setting traps for customers). For this, they get an annual feeâââ2%âââof the money they manage, and a bonus for any profits they make.
On top of this, private equity bosses get to use the carried interest tax loophole, a scam that lets them treat this ordinary income as a capital gain, so they can pay half the taxes that a working stiff would pay on a regular salary. If you donât know much about carried interest, you might think it has to do with âinterestâ on a loan or a deposit, but itâs way weirder. âCarried interestâ is a tax regime designed for 16th century sea captains and their âinterestâ in the cargo they âcarriedâ:
Private equity is a cancer. Its profits come from buying productive firms, loading them with debt, abusing their suppliers, workers and customers, and driving them into ground, stiffing all of themâââand the companyâs creditors. The mafia have a name for this. They call it a âbust outâ:
And theyâre coming for more. PE funds are ârolling upâ thousands of Boomer-owned business as their owners retire. Thereâs a good chance that every funeral home, pet groomer and urgent care clinic within an hourâs drive of you is owned by a single PE firm. Thereâs 2.9m more Boomer-owned businesses going up for sale in the coming years, with 32m employees, and PE is set to buy âem all:
PE funds get their money from âinstitutional investors.â It shouldnât surprise you to learn they treat their investors no better than their creditors, nor the customers, employees or suppliers of the businesses they buy.
Pension funds, in particular, are the perennial suckers at the poker table. My parentâs pension fund, the Ontario Teachersâ Fund, are every grifterâs favorite patsy, losing $90m to Sam Bankman-Friedâs cryptocurrency scam:
Pension funds are neck-deep in private equity, paying steep fees for shitty returns. Imagine knowing that the reason you canât afford your apartment anymore is your pension fund gambled with the private equity firm that bought your building and jacked up the rentâââand still lost money:
But thereâs no depth too low for PE looters to sink to. Theyâve found an exciting new way to steal from their investors, a scam called a âcontinuation fund.â Writing in his latest newsletter, the great Matt Levine breaks it down:
Hereâs the deal: say youâre a PE guy whoâs raised a $1b fund. That entitles you to a 2% annual âcarryâ on the fund: $20,000,000/year. But youâve managed to buy and asset strip so many productive businesses that itâs now worth $5b. Your carry doesnât go up fivefold. You could sell the company and collect your 20% commissionâââ$800mâââbut you stop collecting that annual carry.
But what if you do both? Hereâs how: you create a âcontinuation fundââââa fund that buys your old fundâs portfolio. Now youâve got $5b under management and your carry quintuples, to $100m/year. Levine dryly notes that the FT calls this âa controversial type of transactionâ:
These deals âlook like a pyramid schemeââââone fund flips its assets to another fund, with the same manager running both funds. Itâs a way to make the pie bigger, but to decrease the share (in both real and proportional terms) going to the pension funds and other institutional investors who backed the fund.
A PE boss is supposed to be a fiduciary, with a legal requirement to do whatâs best for their investors. But when the same PE manager is the buyer and the seller, and when the sale takes place without inviting any outside bidders, how can they possibly resolve their conflict of interest?
They canât: 42% of continuation fund deals involve a sale at a value lower than the one that the PE fund told their investors the assets were worth. Now, this may sound weirdâââif a PE boss wants to set a high initial value for their fund in order to maximize their carry, why would they sell its assets to the new fund at a discount?
Hereâs Levineâs theory: if youâre a PE guy going back to your investors for money to put in a new fund, youâre more likely to succeed if you can show that their getting a bargain. So you raise $1b, build it up to $5b, and then tell your investors they can buy the new fund for only $3b. Sure, they can get outâââand lose big. Or they can take the deal, get the new fund at a 40% discountâââand the PE boss gets $60m/year for the next ten years, instead of the $20m they were getting before the continuation fund deal.
PE is devouring the productive economy and making the worldâs richest people even richer. The one bright light? The FTC and DoJ Antitrust Division just published new merger guidelines that would make the PE acquire/debt-load/asset-strip model illegal:
Today (Jul 20) 16h: Signing, Tor Books booth #2802 (free advance copies of The Lost CauseâââNov 2023âââto the first 50 people!)
Tomorrow (Jul 21):
1030h: Wish They All Could be CA MCs, room 24ABC (panel)
12h: Signing, AA09
Sat, Jul 22 15h: The Worlds We Return To, room 23ABC (panel)
If youâd like an essay-formatted version of this post to read or share, hereâs a link to it on pluralistic.net, my surveillance-free, ad-free, tracker-free blog:
[Image ID: An old Punch editorial cartoon depicting a bank-robber sticking up a group of businesspeople and workers. He wears a bandanna emblazoned with dollar-signs and a top-hat.]
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