Concerns are being raised about the use of “financial alchemy” by private equity firms, particularly around their reliance on complex financial engineering techniques like leveraged buyouts (LBOs) and the recent trend of “continuation vehicles” (CVs) and “CV-squareds”.
Here’s a breakdown of the concerns:
- Excessive Leverage and Potential Bankruptcy: Private equity firms often use substantial borrowed funds (debt) to acquire companies in LBOs. This can amplify returns if the company performs well, but it also places a significant debt burden on the acquired company, potentially making it vulnerable to economic downturns or unexpected events and increasing the risk of bankruptcy. The bankruptcy of Toys “R” Us following a leveraged buyout is often cited as a cautionary tale.
- Short-Termism and Asset Stripping: Critics argue that some private equity firms prioritize short-term profit maximization for investors over long-term value creation and the well-being of the acquired company. This can manifest in:
- Cost-cutting measures: Leading to layoffs, reduced employee benefits, and impact on employee morale.
- Asset stripping: Selling off valuable assets of the acquired company for short-term gain, potentially leaving it with depleted resources and diminishing its capacity to generate sustainable profits. This practice is viewed negatively as it often benefits the private equity firm while weakening the company and harming employees and communities.
- Continuation Vehicles and Conflicts of Interest: The emergence of continuation vehicles (CVs), where private equity firms move a piece of a portfolio company into a new fund, and “CV-squareds” (CVs of CVs), is causing particular scrutiny. Concerns include:
- Potential conflicts of interest: Private equity firms can potentially use these structures to renegotiate fees and their interest in the assets as they are moved between funds, according to FA Mag.
- Lack of transparency: The opaque nature of these deals and limited disclosure requirements raise concerns about fair valuation and potential for insider dealings.
- Market Consolidation and Reduced Competition: Private equity investments can lead to market consolidation, potentially reducing competition, limiting consumer choices, and driving up prices. The merger of Albertsons and Safeway, facilitated by private equity ownership, sparked concerns about reduced competition in the grocery industry, according to The Wall Street Journal.
