By Claire Sawyer, Associate Director of Content Development, CAIA Association
Like many things in public discourse these days, private equity tends to be characterized in a pretty extreme fashion. It’s either the haloed savior of modern capitalism or (perhaps more commonly) the mustache-twirling villain that’s destroying the planet and everything on it. From more benign examples like product quality decreasing after a retail company is taken private, to instances of horrifying and sometimes fatal neglect in private nursing homes, private equity has earned some of its negative reputation. But, as is often the case, it’s worth digging a bit deeper. Is there something inherent to the private equity ownership structure that makes it uniquely prone to bad outcomes? Is there anything good to balance the proverbial scales?
In the latest episode of Capital Decanted, our hosts are joined by Pete Stavros and Daryn Dodson to cut through the noise, challenge oversimplifications, and attempt to provide a clearer picture of how we got here, why the industry needs attention, and whether it can evolve in a way that serves both investors and broader society.
The Dangers of Oversimplification
Negative caricatures of private equity, while sometimes (perhaps often) deserved, ultimately obscure the nuanced realities at play. It’s easy to point fingers and rally behind ideological extremes, but this approach doesn’t serve the industry or the public in the long run. We need a more balanced discourse that recognizes both the valid criticisms and the potential for positive impact.
Let’s start with the bad.
Leverage & Bankruptcy: A hallmark strategy of private equity is leveraging debt to finance buyouts. This practice can juice returns, but it also comes with inherent risks. The problem arises when a portfolio company is saddled with too much debt, leaving little room for reinvestment in growth initiatives or talent retention. The criticism is that GPs may over-leverage companies, extracting as much cash as possible to pay down debt, which leads to financial instability and, ultimately, bankruptcy. However, recent data shows that PE-backed companies represent a relatively small percentage of bankruptcies (between 5 and 15%), which is in proportion to their share of the market. While leveraging debt certainly increases bankruptcy risks, the overall impact of private equity-backed bankruptcies may be overstated.
Asset Stripping & Value Extraction: Another common criticism of private equity is the practice of asset stripping, where firms sell off valuable assets while extracting value without making long-term improvements to the underlying business. This strategy can be financially beneficial in the short term but often leaves the company weaker in the long run. These kinds of value extraction strategies can undermine the long-term health of a company, and the resulting harm to employees, customers, and communities shouldn’t be overlooked.
Growth at All Costs: A final criticism revolves around private equity’s focus on maximizing returns, sometimes at the expense of ethical decision-making or long-term sustainability. This is especially true in industries that provide essential services to the general public. Many private hospitals, nursing homes, and prisons have seen increased financial pressures and ethical dilemmas (to put it mildly) as PE firms have sought to maximize returns. The widespread practice of cutting costs to improve short-term profitability has led to heartbreaking stories and, at times, blatant violations of basic human rights. These examples clearly point to the need for more oversight and scrutiny in industries where public trust and human wellbeing are at stake.
While the above examples are all legitimate criticisms that should be taken seriously, they aren’t necessarily indicative of systemic failures within the private equity model itself. Public companies have also been repeatedly guilty of ethical lapses or questionable practices aimed at maximizing short-term gains. As Pete says in the episode, "I think the form of shareholding is honestly irrelevant, if it's public or private...factually, good and bad things have happened in both." Ultimately, there are deeper factors driving the worst-of-the-worst examples we’ve seen from both private and public companies, but that’s a story for another blog.
The Potential for Good
A key difference between public and private equity lies in the level of transparency and accountability required from public companies, which are more frequently scrutinized by the media, shareholders, and regulatory bodies. In contrast, private equity firms, often shielded from this scrutiny, can engage in practices that are not subject to the same level of examination. While this has obvious drawbacks, it also means that private equity firms can act more quickly and decisively towards positive impact, should they be so inclined. As Pete outlines in the episode: “A large private equity firm has more responsibility for people than the mayors of most towns. Just think about the scale of some of these firms and how big of an impact that they can make."
As those of us in the alts space are well aware, obtaining traditional financing became more difficult for small and medium-sized businesses following the GFC, and private capital has stepped in to fill that gap. Unfortunately, such a funding gap still exists for diverse entrepreneurs and fund managers, which appears to be a product of bias. As Daryn says in the episode, “There are periods of time when people in the investment industry pull away from an area, and that has little to do with the quality of assets in the area and a lot to do with perception and bias.” And the data bears this out – Black fund managers have a harder time securing fundraising despite good performance, and this bias gets worse as performance improves. Similar challenges are faced by women and other underrepresented groups.
But, as Daryn also says, “the word ‘bias’ itself suggests that people may be missing opportunity.” In other words, private equity has another opening to step in and unlock both positive returns and positive social outcomes from an untapped segment of the market that’s being unfairly neglected. And, as our guests discuss in the episode, the industry is starting to wake up to the opportunity before them. Overcoming the biases at play is no small task, but the more concentrated ownership of private equity inherently means that there are fewer minds to change. That alone makes it a promising vehicle for progress.
And this gets at one of the key takeaways from the episode: private equity is neither inherently good nor inherently bad; it’s just an ownership structure. What ultimately dictates outcomes is the will of owners within that structure and what impacts they want to have on the world around them.
Breaking New Ground
Private equity is far from a monolithic entity, and while the criticisms we’ve outlined are valid, they don’t represent the entirety of the current industry, nor do they necessarily dictate its future. PE has the undeniable potential to be a force for good, creating jobs, driving innovation, and fostering long-term economic growth. But for that potential to be realized, the industry must evolve and embrace a greater sense of responsibility, to both investors and the wider public. This won’t be an easy feat, but there’s a strong argument to be made that it’s worth doing, not only because it’s right, but because it’s good business.
As John said in closing out the episode, "You don't need to fight the narrative. You change it by actually changing the nature of the industry."
About the Contributor
Claire Sawyer is Associate Director of Content Development at CAIA Association. Prior to her current role, she served as Program Manager and Relationship Manager for the UniFi by CAIA™ learning platform. She holds the Sustainability and Climate Risk (SCR) certificate from GARP and is a Level 2 CAIA Candidate. She earned a BA in Legal Studies from UC Berkeley.
Learn more about CAIA Association and how to become part of a professional network that is shaping the future of investing, by visiting https://caia.org/