Authors Note: This article was inspired by the fact that over the last month I have had three different interactions with people, from three different private equity buyouts, and every interaction was negative. As a result, I wound up writing this article which turned into a vent piece.
Full disclaimer: I’m prejudiced against private equity as I write this due to a personal experience that was similar to the stories that I heard over the last few weeks. If you’re not familiar with my story, one of the worst experiences of my life, it was the direct result of private equity.
I had been working with a chemical manufacturer early in my career, and when making the determination if we should start our family, I consulted with my boss about my job stability as my sales were low. He was part of a large population of workers at the company who had been there for 20 to 40 years. He assured me that my job was stable because I was the only person on his team who was always willing to help out. This isn’t that surprising as the company was structured as a straight commission sales organization. That tends to foster a population of reps who are focused on their own success as opposed to the team success. The model worked pretty well as the company had been in business well over a hundred years and as I said, if you were good at what you did you had a job for life. My sales may not have been great, but my contribution was strong. I believed my boss when he said my job was stable and I still do to this day. The company had nothing to lose and everything to gain with me on the payroll. About a month later we conceived our first child. A few weeks after that, our parent corporation sold the company to a private equity investor group. It was just a few short weeks after that when my boss came to see me. It was a heartfelt conversation, but he had no choice; he had to let me go. Our new owners decided to consolidate many of the organization’s operations including sales and move to an operational model that drove higher profitability. They could cut costs very quickly by eliminating all of the reps who were both junior and senior. If your sales were low, or your income was high because of your tenure, you were gone. I watched dozens of people who had committed their life to a company be dismissed seemingly without an iota of consideration on the part of the new owners.
Before I go any further I should probably explain what private equity is. There are organizations that have a ton of money that they have to invest. These are cash rich businesses with an investment arm, pension funds, and things like high net worth individuals. They can invest this money in ways that are a little bit riskier or more targeted than typical open markets. Private equity firms will solicit investments from these funds and use the money to purchase companies that the equity firm believes is under performing. In some cases they take the companies from public to private hence the name. The equity firm manages a portfolio of companies and generally uses many of the same tactics to manage each one regardless of the industry. The tactic that affected me was streamlining operations. If the new owners could drive out expenses while keeping profitability mostly the same, they would do that ruthlessly.
Another thing that the equity companies will do is invest in their new purchase. Sometimes it’s by bringing in technology or extending the scope of the existing company. Often it’s a strategy of simple market consolidation. If there are five big players in a market and the equity firm can buy two or three of them and merge them that significantly limits competition which drives prices and resulting profitability up. If you’re a customer this is usually a bad thing. If you are an investor it’s a great thing.
It also means the equity management firm is eliminating redundancy through the internal mergers. This is another area where people lose their jobs. If you’re merging three companies into one you only need one executive team, one HR team, etc. As the companies are private, there’s a little bit less oversight from shareholders as there would be if the company was publicly traded. If a big profitable public company said they were getting rid of a third of their workforce just so they can increase profitability even more, there would be some fallout by employees, politicians and even some shareholders.
Sometimes the case is made that the type of consolidation that private equity helps to foster is good for a nation in that it makes the nation more competitive. If a country has twenty smaller companies in an industry versus a massive market controlling competitor in another country, the twenty smaller ones are usually at a competitive disadvantage. If you have one massive competitor against another massive competitor, think Boeing versus Airbus, then the two organizations balance each other off. It also makes it difficult for anyone else to enter into the market so the few big boys get to split the whole thing themselves.
Private equity, and the process of market consolidation, is absolutely one of the factors that drive income inequality. It’s not the only one, but it’s definitely a contributor. At its core, it is a function that drives fewer people to have a bigger piece of the economic pie. The argument can be made that the total pie is getting bigger so everyone eventually benefits, but I have never seen jobs created or wages go up when private equity was involved. In fact as we have allowed more mergers and consolidation in our markets, it has coincided closely with income disparity. If you’re an investor, or a nation concerned with its economy and competitive positioning, it’s better to have leaner and highly profitable companies. If you are a member of John Q Public, not so much.
I’ve spoken with many people who have gone through what I have been through as private equity activity continues to grow. Their experiences are usually similar to my own. After the original employer gets acquired, usually a massive chunk of the workforce is let go. Investment into the original organization’s operations slows as the equity company wrings every last penny of profit they can out of their new acquisition. Eventually the original company is sold to another organization that has little interest in bringing it back to its former glory. They either want the tech that goes with their acquisition or they wish to use it to enhance their existing operations.The original company at this point is just a pawn In the game of big business. There’s little regard for corporate culture, the workforce, or focus on making investments into the company and its people to be the best it can be.
I know people who’ve been through this numerous times in their career. It’s brutal on the employees. By the nature of the equity organization being privately held, The average person is usually kept in the dark about the primary initiatives of the new owners.
For the ones who are let go, they typically have to deal with the great reset switch in their careers where they are starting from scratch at a new organization. On top of that there is the actual cost of the transition. Going through a period of unemployment kills the ability of somebody to build equity in their own life. There usually isn’t a good enough safety net to weather the transition. Private equity is not known for providing severance measured in years even if the employees tenure was measured in decades. I know from personal experience and from many other people, sometimes it takes years to get back to where you were in your career.
So far this article is sounding a lot like a rant against the private equity business. I’m not so anti-business that I think this type of investment should go away. In fact I’m very pro-business. I do see where there could be some benefits to mergers and acquisitions. I understand that a more flexible economy generally is a stronger economy. I understand macroeconomic trends as well and sometimes consolidation is absolutely necessary be it a private equity or public mergers.
The ultimate problem is that this is really a win-lose scenario. If you’re an investor you win. If you’re the private equity company, you win. If you are part of the workforce of the company that’s being acquired, generally speaking, you lose. The question then becomes how do we turn this into a win-win for everybody?
The knee jerk reaction is to mandate massive unemployment and severance payments inclusive of all benefits when there’s a layoff. In an earlier article I discussed a plan for layoffs that required two months severance for every year employed. Going back to the company I was dismissed from if everybody got two months severance for every year they worked, some of the old timers would have had five years worth of full pay and benefits. Fifteen if it was broken out over time like in my plan. I still like this idea but I think it needs to be augmented a bit. The world is complicated and because of this we need multifaceted solutions.
In addition to my ideas about severance compensation for long-term employees, I’ve been playing around with this idea of a mandatory ESOP programs in large and publicly traded organizations. I haven’t done enough heavy research yet, but I do think there is something there as most employee owned companies are well run and provide a great quality of work and life for the employees. An ESOP program is an employee stock ownership program. In effect the employees are part of the shareholders of the company. When the company makes a profit and distributes that profit to the owners, the employees get their share. Ideally, If the company is sold, the employee ownership program is merged with the program run by the parent organization. An analogous version of this idea already exists in some industrialized nations, There is legislation in these countries mandating that workers have representation on their employers board of directors. This tends to help drive wages and benefits up but it doesn’t allow for windfall profits to be shared with the entire workforce of the organization.
Using the ESOP program model, if the equity company comes in and buys a majority steak, and starts driving profits up, a huge chunk of those profits go right back to the employees. The working environment may not be pleasant anymore, but the paychecks will be.
The key here is balance. No matter if it’s private equity or a buyout or merger from a large corporation both the investors and the employee shareholders have to benefit. You can’t drive so much profit and control out of the company that nobody wants to invest in it. At the same time the current system of winners take all at the expense of the existing workforce isn’t exactly healthy for our economy either. If there’s anything history has taught us, it’s that the bigger we can make the middle class, the better off everybody is. Business, properly managed, is the engine that drives the middle class growth.
I started this article by saying how much I dislike private equity. I would love that to eventually change. Today if an employee hears about a buyout of their company, they know almost by default that they’re working environment is going to get worse or they won’t even have a working environment anymore. Whether it is an ESOP program, employee representative board members with enough voting power to affect corporate direction or some other structural change I would love it if the day comes when a private equity buyout means that everybody’s life is going to get better. That will only happen when private equity and related investment exist to serve everybody at the company, not just the investors.