Archives for February 2024

Most private equity firms are paid on the 2-and-20 model: a 2 percent annual fixed fee on all the money it invests and 20 percent of all profits above a certain threshold. The United States taxes money made from investments—so-called capital gains—at a lower level than money made through ordinary labor, whether at a factory or in an office. The distinction is ambiguous and unfair, but even more so, private equity firms have convinced the IRS that their 20 percent income should be taxed at the lower capital gains rate than at the higher ordinary income rate.

Brendan Ballou in Plunder

First, because private equity firms own the companies they buy for just a few years, they must extract money from them exceedingly fast; there’s simply not much reason for them to consider the long-term health of the companies they buy. Second, because private equity firms invest little of their own money but receive an outsized share of potential profits, they are encouraged to take huge risks. In practice, this means loading companies up with debt and extracting onerous fees. And third, partly because legally separate funds technically own the companies, private equity firms are rarely held responsible for the debts and actions of the companies they run. These facts of short-term, high-risk, and low-consequence ownership explain why private equity firms’ efforts to make companies profitable so often prove disastrous for everyone except the private equity firms themselves.

Brendan Ballou in Plunder

Private equity firms are different from investment banks, which originally centered on helping other businesses buy one another or issue stock. They are also different from hedge funds, which tend to buy and sell public securities, such as stocks and bonds. Rather than buying individual securities, private equity firms buy whole companies. And rather than doing so on behalf of other businesses, they do so for themselves.

Brendan Ballou in Plunder