WHAT IS PRIVATE EQUITY?

What is Pri­vate Equity?  How do they make their money?  The answer to this mir­rors the answer to “Why does com­mer­cial radio suck?”picture: Private Equity Guy

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 as they have stopped invest­ing in their employ­ees (and you the lis­tener) in favor of short-term prof­its by cut­ting as much staff as pos­si­ble.  Pri­vate Equity also makes money by shift­ing debt onto oth­ers.  The debt is shifted onto the sta­tion.  This maneu­ver is called an LBO or “Lever­aged Buy­out”.  See video below. 

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.

Tax­payer subsidized

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.

{ 0 comments… add one }