The way a firm makes profit can say much about how it behaves. For instance, Private Equity makes money off of fees taken from investors and from maintenance fees from the companies that they own. They can make substantial commissions if they can sell the companies they own for a profit. This means that short-term profits that make the company appear attractive to a buyer are more important than costly long-term business infrastructure improvements that might not pay off for 10 years. This lack of long-term motivation has hurt Clearchannel because they stopped investing in their employees in favor of short-term profits by cutting as much staff as possible. Private Equity also makes money by shifting debt onto others. This is called an LBO or “Leveraged Buyout”.
No Skin in the game.
The complaint about the LBO deal is that Private Equity firms are not responsible for debt payments. Those come out of the company checkbooks of the very companies that they are buying. Even though Private Equity bought Clearchannel, they dodged the responsibility of paying off the debt by placing that squarely on Clearchannel itself. This is unexpectedly simple and legal. Clearchannel has to pay their debt to the bank and fees to the firm that gave it that debt. This is a danger when you consider that debt is a bet or a wager against future income. If the company does well, it can pay off that debt. If the company does poorly, it could go bankrupt or need to fire all the employees it can so they do not go bankrupt as quickly (Clearchannel). By not having “skin in the game” Private Equity firms can behave more reckless with a company’s debt load and it’s employees.
We made a DVD extra for the next pressing of Corporate FM that explains this in more detail.
Should Private Equity get a tax break for these mergers? Clearchannel agreed to all of the debt that is drowning it today because of a tax loophole called “interest tax deductibility”. This deduction was meant to grow our economy but Private Equity manages to do the opposite by using the loophole to finance the buyout (and elimination) of competition. Private Equity-owned companies avoided paying $127 billion in taxes since 2000 due to the loophole reports Josh Kosman, author of The Buyout of America.
What is to be done? Kosman suggests that: “the most simple solution is [by] ending interest tax deductability on corporate takeovers… It will make the most aggressive buyouts like the one for Clearchannel unprofitable so they won’t happen”. That solution also helps lower our national debt. Win/win.