Brendan Ballou is the author of Plunder: Private Equity’s Plan to Pillage America. Brendan is also a federal prosecutor, and served as special counsel for private equity in the antitrust division at the Department of Justice. (Although, he will be the first to tell you, the book does not reflect the views of the DOJ.)
Now, the idea behind private equity or PE is simple: a private equity firm gathers up a bunch of cash, raises some investor cash, and takes on a lot of debt to buy various companies, often taking them off the public stock market. Then, they usually install new management and embark on aggressive cost cutting and turnaround programs mostly because they have to pay down all that debt pretty fast. The company can then be sold or taken public again for a hefty profit. But don’t worry — if it doesn’t work out, the PE firms are extracting fees at every step of the process, so they get paid no matter what happens.
In another world, these PE deals are just boring financing strategies or maybe the backbone of the occasional juicy corporate takeover story. In Decoder world, PE is everywhere. We’ve spoken to James Daunt from Barnes & Noble, who was installed as CEO in a PE deal that has revitalized the bookstore chain, Jeremy Andrus, the CEO of Traeger Grills, who bought the company in partnership with a PE firm, and of course, Elon Musk bought Twitter and took it private.
Since the modern PE industry kicked off in the 1980s, it’s grown virtually unchecked, and as Brendan explains, that’s had seriously negative consequences for all kinds of markets and consumers because PE firms have reshaped how business works.
Private equity affects everything from the modern nursing home industry to the SolarWinds hack, one of the biggest hacks in US history.
This is a wonky episode, but it’s essential.
This transcript has been lightly edited for clarity.
Brendan Ballou, you are a federal prosecutor and you served as special counsel for private equity in the Antitrust Division at the Department of Justice. You’re also the author of a new book called Plunder: Private Equity’s Plan to Pillage America. I feel like those might be related ideas. Welcome to Decoder.
Thank you so much for having me.
The joke on our show is that this is a show about org charts. Fundamentally, it’s a show about how companies are structured and how they work and how their structure connects to what they make and what their values are. Private equity companies are really opaque in that way. There are a handful of really big ones we’ve all heard of. There are a few smaller ones. How does a typical PE company work? How is it structured?
They surround us in a lot of ways. If you consider them together with their portfolio companies, Carlyle, KKR, and Blackstone would be the third-, fourth-, and fifth-largest employers in America. That order might not be exactly right, but they’d be right behind Walmart and Amazon. And yet, most people, I would venture to say, have not heard of those three companies. And part of that is because when Carlyle buys a nursing home chain, they don’t brand it a Carlyle company, or when Blackstone rents you a single-family house, it’s not branded a Blackstone property. Generally, what happens is there is a smallish legal entity that is the private equity firm itself, which advises a series of funds. Carlyle will have Carlyle fund one, two, three, four, and so forth that have a lot of investors, often sovereign wealth funds, pension funds, and so forth.
Those funds ultimately buy companies, whether it’s nursing homes, single-family rentals, veterinary clinics, OB-GYN practices. The really interesting thing about that, and I think what drew me to this as a lawyer but also concerns me as a citizen, is that because of the layered ownership structure of private equity firms, oftentimes private equity firms have control of the companies they buy but very little responsibility when those companies do arguably illegal things.
During the entire Twitter acquisition drama, a bunch of us on The Verge staff reread Barbarians at the Gate, which is the very famous 1980s book about KKR buying RJR Nabisco, maybe the classic example of a private equity deal that just went completely sideways in a million different ways. I highly encourage everyone to read it, just a classic of the ’80s corporate raider genre. Those companies, they’ve softened their image. The idea that they’re ’80s corporate raiders has gone away, and now they’re seen as operators or stewards of capitalism in a way. How has that changed? Are we just not seeing what they really are? Or is there a meaningful difference from what was happening in the ’80s to now?
The short answer on leveraged buyouts is no. It’s the same basic idea, which is buy a company with a fair amount of debt, try to make some changes, and sell it for a profit. That basic business model is the same that it’s always been. Private equity firms have very successfully rebranded themselves and pulled themselves up by their bootstraps in terms of reputation. And part of that is that private equity firms have just expanded far beyond private equity. For a company like Carlyle or Blackstone, a lot, perhaps a majority of its business, is now involved in private credit, insurance, real estate. In a lot of ways, private equity firms have replaced the investment banks of the Great Recession in terms of their importance to the financial operations. There’s a quote that stuck with me when I was researching this. An analyst was saying, I’m paraphrasing slightly, “Blackstone reminds me of Goldman Sachs 10 years ago. Wherever something interesting is happening, that’s where they are.”
I think when you’re talking about the changing private equity reputation, I think it’s because private equity, to overstate it a little bit, has become everything.
I’m really curious about that part because we spend a lot of time talking about venture capital on the show. Once you are actually operating a business, the big private equity firm has become a part of the puzzle in a way that is not only invisible to most people in America, but invisible even to the people who might be thinking about starting a business. You’re going to get to a certain size, and a PE firm is going to show up with a significant interest in your business and change the way you operate or take your business over from you because that’s also an exit that might seem attractive — even if it’s not attractive for the long-term health of your company.
It’s really interesting. Securities lawyers who know more about this stuff than I do will quibble with some of this stuff. I’m a humble antitrust lawyer. But part of the reason that happened is fewer companies started going public and instead, because of a series of deregulation that happened really over the past 20-some years, it’s become a lot easier for companies to stay private — essentially solicit money on the private markets rather than go through the work of going public and having the disclosure obligations that come along with it. Private equity enters the picture in two ways. One is through a traditional leveraged buyout where they say, “Decoder has really taken off. We want to take it to the next level. We’re going to buy it from you.” That’s a traditional leveraged buyout, and maybe they improve it, maybe they don’t. But also through the private credit market where they say, “Okay, you guys want to grow a little bit. We know that you need a loan. We’ll offer you some money. We’ll treat it just as debt rather than as an equity stake.”
The really interesting part about that is, as I understand it, the private credit market is just significantly less regulated, almost by definition, than the public market. There are voices out there saying that private credit, in large part led by private equity firms, could lead to a bubble simply because of how little transparency there is in it.
And that’s when you hear about companies raising debt. This is the problem that’s underneath all of that.
So the positive case for PE — and again, this is the case that goes all the way back to Barbarians at the Gate, we’re talking about a 40-year argument we’ve been having about private equity — is sometimes these companies are too bloated. They’re sitting there in the public markets, they can’t grow, they can’t increase their stock price. They can exit, they can pay a lot of people out because private equity’s going to buy the company. The PE company’s going to come in, they’re going to slash costs. Because they own a bunch of companies, they’ll impose some operational efficiency, because they’ve got great managers. Because they own a bunch of companies, they can simplify your supply chain, and then they can re-exit the company again: leaner, stronger, better, faster. And when it works, it works and when it doesn’t, so it goes. But that’s the positive case. Do you see that playing out? Or are they just basically raiding a bunch of companies, extracting the profits, and moving on?
There’s always going to be a role for capital to play in our economy. As long as businesses need to build factories and hire new workers, somebody’s got to be willing to risk the money to help them do that. And to the extent that private equity firms are helping to do that, that’s great. The challenge is that, one: private equity firms tend to invest for the short term. I always joke that if I was trying to maximize the investment on my house, I’d redo the kitchen and add a new inset bookcase. If I was trying to maximize the money over the next week, I would burn it down and try to collect the insurance money. The timeframe that these firms are considering really changes whether they want to invest in research and development, whether they want to invest in employees, whether they want to invest in new output.
“When things go wrong, private equity firms are very rarely held responsible”
That’s one problem. The other is the debt issue. Private equity firms tend to buy businesses with debt that they are not responsible for but, instead, that the company they buy is responsible for. When KKR buys Toys“R”Us or when Carlyle buys the nursing home chain ManorCare, the debt is held by the company that they bought, and the companies need to spend an enormous amount of money servicing that debt. Toys“R”Us was spending as much money just servicing its debt as it was making in income at the time that it went bankrupt. That’s often a drag on the businesses. The third, you’re talking about the perspective of private equity firms that they get companies to be leaner and meaner. Somebody said that they’re like heat-seeking missiles for profit. Fair enough. The challenge that you’ve got is, when things go wrong, private equity firms are very rarely held responsible.
And what that means is it tends to lead to risky short-term strategies that, if they blow up in somebody’s face, it’s not the face of the private equity firm. I think it’s not that private equity leaders are more greedy or anything like that. It’s that the legal structures that we’ve got around it mean that they just have a different set of incentives.
And those legal structures have changed. This is another theme that comes up in your book over and over again: that this actually has happened before. Laws were changed in the past to stop what you call money trusts. We relaxed those laws, we’re right back here, and maybe we should tighten those laws up again or make other specific changes.
It’s really interesting. I think that there’s a strong historical analogy to private equity firms in the 2020s, which is the trust of the 1920s and 1910s. Legally, the structure of a private equity firm is very similar to things that you might have heard about from the Gilded Age around the sugar trust, the oil trust, and the money trust. Then, there was a long period of dominance in our American economy and politics by the trust and the related interests. But ultimately, the populist and progressive movements constrained the powers of the trust, set out the baseline for our antitrust and securities laws that worked for three generations until the 1970s, and really built the foundation for a working economy in America. We’ve got a lot of problems with the private equity business model today, but I think the past suggests that there might be a way to solve this.
This show’s about decisions. I ask every executive how they make decisions. There are a lot of themes in how executives answer that question on the show, but the theme they come back to all the time is that you need to know what you’re doing, you need to think long term, and then, you should figure out what decisions are short term and make those as fast as you can. But you’ve got to have your eye on the ball, and you’ve got to have a long-term vision for what you’re trying to accomplish.
If you just go back and listen to every executive who’s ever been on the show answer the “how do you make decisions?” question, it’s some variation of “I know what I’m doing, and then I try to make decisions to get there as fast as I can.” That absolutely cuts against what you say private equity companies do, which is that they’re hyper short term. One of the arguments that I hear from PE companies is, “We’re going to pull you out of the public market. We’re going to pull you out of the quarter-by-quarter pressure so you can reset the company with a long-term vision and then do a good job.” And when we’ve had companies that are successful in PE deals come on the show, that’s what they talk about. Barnes & Noble does that, Traeger did that: “We’re going to reset the company, we’re going to make it grow, then we’re going to go back and become public again.” Why do you think a bunch of executives who uniformly, as the conventional wisdom, know that you have to have a long-term vision, end up in a private equity situation where they’re making ultra-short-term choices?
Well, the money.
I knew that was the answer, but I figured I had to ask the question.
No, that’s far too flip of an answer. I should say, there’s a range of private equity firms. Some think short term, some think long term, and the longer term–
“Not all private equity firms” is what you’re saying.
Yes. Generally, the ones that are thinking longer term, being in the private markets can give executives the space they need to breathe, relieving them of the pressure of quarterly and annual earnings reports, and that can be really important. The challenge that we’ve got is many, if not most, private equity firms have not structured themselves that way and are looking to make an exit in three or five or seven years. But it takes more than that to build a factory. It takes more than that to get a new and innovative product line going, and as a result, they just can’t make those kinds of decisions.
Let’s talk about the ManorCare example for one second. You lead off the book with it. Carlyle buys a nursing home chain, they extract profit from it. Walk us through what happened there.
Carlyle’s a large private equity firm. It bought HCR ManorCare, which was once the second-largest nursing home chain in America and then executed a number of tactics that are pretty playbook in private equity land. They executed a sale-leaseback, which means they sold the underlying assets of the nursing home chain and had the chain lease it back for a quick hit of money, but now they’ve got a long-term obligation. They executed what’s called a dividend recapitalization, so ManorCare had to borrow money to pay Carlyle and the other investors a profit. Ultimately, staff needed to be laid off, complaints and health code violations spiked. Unsurprisingly, a resident of one of these facilities dies. Without sufficient staff, she has to go to the bathroom by herself. As alleged, she slips, hits her head, and ultimately dies. But when her family sues for wrongful death, Carlyle gets the case against it dismissed.
And what it says to the court is, “Oh, no, we don’t technically own ManorCare. Instead, we advise a series of funds whose limited partners through a series of shell companies ultimately own ManorCare.” And that was enough to convince the judge to dismiss the case. What I think it illustrates is how a private equity firm can often control the operations of a company without ultimately being responsible for what happens at that company.
This is one of the first claims you make in the book that stood out to me: private equity companies, when it comes down to it, are pretty bad operators of businesses. Which strikes me as a pretty huge claim, but also counterintuitive. This is a group of people that buy companies, they do whatever they’re going to do, try to make them better, sharper companies. You’d think they have at least some experience on a broad level of being able to look at a company’s books and say, “Here’s what works here. Here’s where the fat is, we’re cutting it. Here’s where your opportunity is, we’re growing it. We’re at least good at the business part of this. We might not know anything about running nursing homes or steel mills, but the abstract business logic you need to make a company leaner or more efficient, we’re great at that. Bring us in for that.” And your argument is that, actually, they’re pretty bad at that.
I don’t want to make sweeping claims that every private equity firm is bad at operations. That’s certainly not the case, and we’ve got some examples of firms that invested for the long term and brought sector-specific knowledge that I think ultimately did a lot of good for the companies they bought. But the basic issue is if you look at the biographies of the people that run private equity firms — and this is no slight against them — generally, they’re not folks with experience in engineering, product development, sales or marketing, logistics, or anything like that. They have experience in finance, and so the expertise that they bring to an acquisition is financial expertise. Just as to the extent that I would bring expertise to something, it would be legal expertise. You wouldn’t want me running the company. The challenge that we’ve got is, oftentimes, when private equity firms think that they do have operational experience, it sort of blows up in their face.
The New York Times did a really fascinating profile of a series of private equity firms’ acquisition of Payless shoe stores. And they made a number of operational mistakes like buying World Cup soccer sandals for countries that they didn’t actually have stores in. They shut down a factory that did quality control checks on a Chinese production facility and ultimately they had so many bad shoes that it more than made up the savings in inventory that they had to throw away. That is just one example, and there are thousands of acquisitions that are out there. But the basic thing that’s going on here is when private equity firms buy companies, because they have a financial background, generally the changes that they’re trying to make are financial ones. Whether it’s loading a company up with debt, spinning parts of the company off, or trying to combine companies in a roll-up. But that’s different from experience in running a company.
If these companies are bad at operating businesses, and they tend to break things apart and extract the value and run away leaving you in bankruptcy as they did with Toys“R”Us or whoever else, why do people make these deals?
I think that private equity can be tremendously successful, certainly for the private equity firm, oftentimes for the limited partners that invest with them, and generally, for the executives of the companies that sell to the private equity firms. Whether it’s a big company like Toys“R”Us that sells to KKR or a small one like a veterinary clinic or a dermatology clinic whose doctor wants to retire, selling to a private equity firm can make a lot of sense because you’ll get a large payout because you’ve got a lot of equity. The challenge that you’ve got is for the people that remain. In the medical space, I just mentioned dermatology, the challenge of private equity ownership has become so pervasive that I look at job listings now, and they will literally say, “We need dermatologists at such and such practice,” and they’ll say in all caps, “NOT PRIVATE EQUITY OWNED.” So it’s become a problem enough in the industry that people see this as a business model that should be avoided.
I feel like I need to disclose that my sister’s a dermatologist, and she has sold her practice to a PE roll-up.
This explains your great skin.
Why is this happening in these markets? Dermatology in particular, just candidly, watching my sister go through it, it seems like this entire market is being taken over by PE companies. They can’t all exit the same way. They can’t all just extract fees from the same client base in the same cities, and yet, they’re all rushing into literally the same markets. Dermatologists and veterinarians and the other practices you mentioned are location-based. There are only so many that you need in a city, and they all seem to be rushing into the same markets. Why is that?
I think it’s two things. One is a lot of the acquisitions that we’re just talking about are part of roll-up strategies. The idea here is, “We’re going to buy all of the dermatology or many of the dermatology practices in a given geography.” Potentially, that has efficiencies, you have the same back-office billing and so forth. But potentially, it’s an opportunity to exert market power. If you control a significant percentage of the dermatologists in a given geography, you can raise prices, you can cut quality care because there’s only so far people are going to be able to drive to get to the next location. Roll-up strategies are really common in the private equity playbook.
“Poorer customers don’t have alternatives, so you can raise prices, [and] you can cut quality care”
I think the other thing to get to why certain businesses are attractive is that, obviously, private equity is expanding in a lot of different directions. There was $1.2 trillion in acquisitions in 2021 — so a not insignificant part of the US economy. But one of the surprising things that I saw in my research was that private equity firms often target businesses that service working-class people rather than rich people, which I’ve always found very surprising. You’d think if you’re in the business of making money, you’d go after the rich people. But it seems that the model is that often businesses that service working-class people are attractive because poorer customers don’t have alternatives, so you can raise prices, you can cut quality care, whether it’s in prison services or mobile homes, across a range of practices. You can do all these things essentially without consequence because your customers don’t have an alternative.
You were in the Antitrust Division at the Department of Justice. We’ve talked a lot about antitrust law on this show. We’ve talked a lot about the neo-Brandeisians, the hipster antitrust movement, getting away from the consumer welfare standard. This seems squarely outside the “we need to reform antitrust” problem. You’re going to buy all of the veterinarians in a city and raise prices, you don’t need to reinvent antitrust law. Robert Bork would say, “You’ve bought up all of the veterinarians in the city and raised prices. You’ve literally harmed the consumer welfare. We should stop it.”
I think Robert Bork would find perhaps a reason even to justify that one, but–
Probably because he got hired by a private equity company.
I can’t get into too much of the details because of my work, but I will say one of the interesting challenges that you’ve got with private equity roll-ups is when you’re looking at antitrust potential cases, when it’s one big company planning to buy another big competitor. I wouldn’t say it’s an easy case, but it’s a straightforward one because it’s a national or international market and you look at, “How are the market shares of these companies going to change?” And then you hire some economists and try to figure out, “Is that enough to raise prices?” Here, because the acquisitions are much more distributed across geographies, and in antitrust you have to define a geographic and product market, it’s actually a much larger case in some ways to go after these smaller acquisitions because you’re not looking at a national market but many local ones. I think that these sorts of roll-ups are subject to the antitrust laws, but the antitrust cases, interestingly, are much more complicated.
I don’t want to push too hard on this because I know you want to keep some distance here, but I just have to say that sounds absolutely backward to me. We’re going to try to block the AT&T-Time Warner merger, and we’re going to do calculus in front of a judge to show that prices will go up or down 15 cents when it’s obvious what the real problem is, but we can’t say that. That was a very complicated, big deal that was a 50 / 50 shot because you had to make a bunch of complicated leaps about what AT&T’s business logic was, which ultimately, made no sense and they sold it anyway.
“I’m going to buy all the veterinarians in Chicago and then our plan to make that worth it is raise prices,” is absolutely straightforward. I can explain that to anyone and say, “Do you think you should allow this?” And the answer, regardless of political belief, would be, “That seems bad.”
I can’t get into the details here because of my work, but I will say I think that the leadership of the Department of Justice and the Federal Trade Commission are very attuned to those arguments and thinking about how antitrust laws can be used to help regular people, not these abstract, airy arguments. I’ll also say, and I think that this is a really important point, that under the law, the federal government is not the only enforcer of the antitrust laws. Every state attorney general has the authority to enforce the Clayton Act. Individual litigants have the power to do that, too, so I think as public awareness is growing on these issues and people are understanding how these roll-ups are occurring, there are a lot of different levers people can push on to make action here.
It seems like another piece of the puzzle here is just some of the tactics you’ve described. We’re going to go buy ManorCare, we’re going to sell all of their real estate, make money on the sale, and have the company lease it back. They did that with Shopko, which was a big retailer in Wisconsin where I grew up. That kind of strategy seems very obvious. It seems to create the same exact kind of chaos for every company that undergoes those moves. Why is something like a leaseback arrangement so common, and why doesn’t it seem to be as regulated as it should be, given its very obvious negative consequences?
Just to set a baseline on the sorts of tactics that we’re talking about, a sale-leaseback is where the private equity firm directs the company to sell its assets — the Shopko store, the factory, the hardware that it has — and then leases it back to itself. And that gives you a short burst of cash from the sale, but then you’re shouldered with the ongoing obligation to pay back the things that you once owned. We also mentioned dividend recapitalizations, where a firm will direct a company to borrow money to pay itself a profit.
These sorts of things have been on the books for a long time. I think private equity firms have been really smart about identifying the opportunities here and using them. Extracting from those two examples specifically, I think it’s just important to note how effective private equity firms have been in protecting their legal advantages over the years. Private equity firms have donated something like $900 million since 1990 to federal candidates. They have a bench of employees that include former cabinet members, secretaries of state, treasury, defense, chairman of the FCC, SEC. When it comes to protecting preferred legal advantages, like the carried interest loophole, surprise medical billing, and so forth, I think that they’ve just been really, really effective in a way that even other very powerful industries have not been.
The healthcare industry and the farm industry lobbies quite a bit in this country, but they’re villains. People can see what they’re doing, they understand the experiences they’re having. They understand that there’s a different kind of experience you might have if you just go to Canada or something. The PE companies are invisible. You can’t quite see how those rules affect regular people. Is that why they’ve built such a political advantage here? Or is it just that they revolving-door every ex-government official onto the board of a PE company?
“Private equity is everywhere and nowhere”
I think it’s a combination of those things. A lot of former government officials went to PE, so they’ve got a friendly face when it comes to lobbying. I think people go to private equity in a way that they might be more reluctant to go to an oil and gas company or even a healthcare company or something like that. But I also think it goes directly to what you just said, which is that private equity is everywhere and nowhere in a lot of ways. And one of the things that I think PE firms have been most successful at is making their issues seem boring, when you talk about the carried interest loophole, your eyes start to glaze over it. It sounds so dull, and yet, it has such profound implications for the equity of our tax code.
Or when you talk about surprise medical billing, those laws are the difference between a fifth of Americans carrying significant medical debt and not. It affects literally tens of millions of people’s lives. But I think private equity firms have managed to seem very opaque, very dull, and almost prestigious in a way that I think a lot of other industries have not been able to do.
I’m going to just ask you a very silly first-year law student question. I was not a great law student, but–
Oh yeah, you were a lawyer.
I wasn’t great at that, either, but this thing you’re talking about where the private equity companies actually operate the companies they’re invested in through their funds, they direct their operations, they roll them up, they have preferred supplier agreements, I think you have the example of Talbots in the book where they forced them to change clothing suppliers and Talbots folded. It’s just very obvious that you could go to a court and say, “Look, get through the corporate veil” — the law school term is “pierce the corporate veil” — “and get to the people making the decisions.” This whole show is about decisions. “Get to them, we can see them, they’re right there, and they bought this clothing retailer, and they own that T-shirt maker, and they’re forcing this clothing retailer to switch from this vendor to the one they own, and people hate it.” And it doesn’t seem like that is easy or even possible.
We’re geeking out like first-year law students here, but it’s really hard to hold the private equity firms responsible for their portfolio company’s actions, and to put a pin in the doctrine that you just said, this is called “piercing the corporate veil.” The legal doctrines around veil-piercing vary from state to state, but generally, it is extraordinarily hard to do that, in large part thanks to good litigating from defense side law firms. As a result, I don’t want to overstate the case, but it’s almost impossible for a private equity firm to be held legally responsible under common law veil-piercing arguments. And that might make sense for ordinary investors, like if Brendan or Nilay were invested in a given company through our Vanguard account, it wouldn’t really make sense to sue us because we don’t really control their operations. But if you control 51 percent of the stock, if you control 100 percent of the stock, then it seems plausible to me that you probably should be responsible for the actions of the company that you own.
Is that argument winning anywhere?
No. I’m not sure the argument’s even really being made at this point. I’ve been researching on Westlaw, and I think that the cases that have been made have generally gone in favor of the investors, not the plaintiffs. I think we have an added wrinkle here in that, a lot of times, plaintiffs don’t even know that the company’s owned by a private equity firm. I went to this conference of lawyers that represent nursing home patients, and they were saying, “It’s impossible for us to figure out who owns the nursing home.” And they’ll play very complicated games to put the assets in related shell companies so that even if you do win the case, you don’t know how many assets there are for you to recover. So partly, it’s a challenge with the law. It’s the challenge of very sophisticated investors and companies structuring their businesses in a way that makes it even harder to figure out who’s responsible.
There’s an interplay here with bankruptcy, which is a move that you say a lot of private equity companies use, and it’s part of their playbook. And it just strikes me that your creditors are usually pretty good at getting their money back. If you’re going to go into a company, load it up with debt, load it up with fees on servicing that debt, do a leaseback where now you’re loading it up with even more fees and credit obligations, and then you’re going to tank the company and walk having collected your bag, the creditors are going to say, “Who is responsible for this disaster? We want our money back.” Are they winning?
I can’t speak generally, but the examples that I’ve been interested in have been when there have been purposeful bankruptcies by private equity firms. And I can tell one story: Friendly’s, which was a dining chain in the Northeast. Sun Capital, the private equity firm, bought it and then did all the tactics that we were talking about earlier. They executed a sale-leaseback, they did a dividend recapitalization, had layoffs, ultimately pushed the company into bankruptcy. They were the equity owner of Friendly’s, but they were also the largest creditor of Friendly’s. And in the bankruptcy process, normally, the ownership sort of flips. So, as the largest owner and creditor, Sun Capital was able to sell Friendly’s from itself to itself. Reading the court documents around this, there was a fascinating shadow play of describing this as a third party. It was like, “No, it’s just a different fund of Sun Capital’s.” And it was not, I should be clear, fraud or deception or anything like that. It was just clever lawyering.
But the reason that they do that is it allowed them to push off the company’s pension funds from their books and onto the quasi-government agency, the Pension Benefit Guaranty Corporation. It meant that Sun Capital and Friendly’s would no longer be responsible for the pension debts, the PBGC would. And that’s one of the ways that they can use bankruptcy to their advantage. if you’re both the owner and the largest creditor, you can push aside the other unsecured creditors, and that gives you another advantage here. So that’s a long answer to your short question that I think private equity firms have proven extraordinarily adept at using the bankruptcy system as well to their advantage.
You’ve got another claim in the book that says, “Look, the problem here is that judges and members of Congress and regulators, they just don’t see how it works. All these moves are hyper-technical, hyper-financialized, and your average district court judge is just flabbergasted, “What’s going on?” And saying, “It’s capitalism at work.” Is that changing? Is it that they’ve just gamed it too hard, and they’ve hired too many people under their boards of directors? How do you fix that kind of problem? We see it in tech all the time, every tech lawsuit is a disaster of misunderstandings. But you’re saying here, it’s happening on the business side as well.
So fortunately, we have podcasts like Decoder to educate people on the basics of private equity and help people understand the problems that we’ve got in the business model. Maybe I’m showing my bias here as a bureaucrat, but I think that there are a lot of people in state, local, and federal government that want to do the right thing by ordinary people but don’t understand the consequences of some of these actions. Just to go back to bankruptcy, there are really technical arguments around things like credit bidding and 363 sales that, really, judges just need to be made to understand the consequences of these things. But there’s nobody on the other side helping them do that. I see the same thing happen in other agencies.
It would be really helpful if there were ordinary people talking about, “Here are the consequences of understaffing nursing facilities at private equity-owned nursing homes. Here’s the consequence of private equity firms not having a fiduciary duty to their limited partners when pension funds make investments. Here’s the challenge that we’ve got when prison phone services charge exorbitant rates at the direction of their private equity owners.” I think it’s a project of helping people understand how private equity works and then how it impacts their life. If we can do that, there are a lot of different levers that we can move to have some change.
I want to ask a few more broad questions. And then you end the book with a long list of very specific policy recommendations that I want to get into.
Too long. Yes.
We had Cory Doctorow on the show ages ago, and he’s like, “You don’t want to write the book that’s 12 chapters of problems and one chapter of ‘Call your representative,’ you want to write the solutions.” And you have a lot of solutions. There’s this idea that, you’ve got full hypercapitalist, laissez-faire, just go for it, the market will figure it out, and then you end up with a quasi-controlled market anyway because you have a handful of giant firms dominating entire sectors of the economy, and instead of having state control of it, you just have two guys.
And that seems like a problem that we can see expressed right now. In the private markets, you’ve got a handful of PE companies; in the public markets, you’ve got a handful of index funds, and they might as well just be controlling the economy. That seems like a problem that should cut across party lines. We should have functional markets. Everyone agrees that competition is good for consumers and that having new firms enter lowers prices and makes better stuff. Do you see the political will to actually go and change it, or do you see people saying, “This is basically hypercapitalism, it’s the thing that we want” on whatever side of the aisle you’re on?
“It is not capitalism; it is a perversion or an aberration of capitalism”
It’s been really fun talking about this book with people because I was doing an interview with a fairly conservative Republican at the beginning of the week, I was doing an interview with some Democratic Socialists of America-adjacent folks in the middle of the week, and I said to them both, “Wherever you are on the spectrum, from true free market capitalist to Harringtonian socialist, the basic problem of the private equity business model should concern you” because it is not capitalism; it is a perversion of capitalism or an aberration of capitalism. And so, I think that there should be a bipartisan cross-ideological consensus on this, which is: if you want a healthy economy that works for people and works for the long run, we need to change the incentives of private equity.
Now, can that be done? I have to say, I am really encouraged by what’s happening around private equity in specific industries. I just mentioned prison phone services where PE has been very active. There have been a number of activist organizations that have had extraordinary success in limiting the rates that need to be paid by prisoners to make phone calls. At one point, it was as high as $25 for a 15-minute call. This is activism that was happening at the local, state, and now, the federal level. Legislation was just passed in Congress last year to address this. Similar movements are happening around nursing homes. I think there can be real movement on this if you focus on a specific issue or a specific industry. And I think that because we’ve seen it happen
The elephant in the room when you come on a podcast like Decoder is the tech industry, which has upended most of American life. It’s mostly a bunch of companies that were started fairly recently, they have not been colonized by PE, maybe they’ve taken some money. But on a show like Decoder, you show up and say, “Look, Shopko was killed by private equity.” I think most of my listeners are saying, “No, they were killed by Amazon. Toys“R”Us, they just blew it, they just forgot to make a website that worked and figure out the logistics of delivery. And Amazon did a better job of that because they were the scrappy challenger brand that disrupted that industry.”
What is the interplay there? Because I really do think most listeners of this show have come along for the ride. Most listeners of this show are pretty interested in being competitors, and they’re going to say, “Well, look, that’s a problem for the dead companies. We’re going to start new companies that do a better job and win.” That just seems like a pretty big tension if you’re describing an economy that’s being taken over by PE.
That’s a great point, and I’m always adamant about pushing back slightly on the story of Toys“R”Us. Toys“R”Us was profitable the last year before it declared bankruptcy. The challenge was that it had so much debt that it was servicing that rather than being able to expand its operations, and it had advantages that Amazon didn’t have in terms of physical stores. But that’s a rant perhaps for a future podcast. In terms of, if you’re in the tech industry, why should you care about private equity, two things. One is private equity has expanded into the tech industry in a lot of different ways. The most prominent example, unfortunately, is probably the purchase of SolarWinds, which was the cause of what was called the greatest hack in United States government history.
Based solely on the reports filed with the SEC, it appears that SolarWinds moved its engineering work at least partly to Belarus after it was acquired by private equity firms. That’s not necessarily the vector by which the attack happened, but if you care about long-term security, perhaps moving your development operations to a Russian ally is not the best move. So part of it is that private equity is moving into the tech industry, but the other part is what we need to be caring about, which is the overall vibrancy and competitiveness of the American economy. And one of the challenges that we’ve got — America faces this every 30, 40 years — is we invent a broken business model. Twenty years ago, it was subprime lenders, 40 years ago, it was savings and loans, 60 years ago, it was conglomerates, 100 years ago, it was trusts. It’s something that we keep doing, and it ultimately has a tremendous drag on economic performance. So if you care about the country growing and prospering, then the challenges that we face with the PE business model should probably concern you.
Do you see a future where the Big Tech companies, which now control just massive swaths of the economy themselves and have enormous amounts of money in the bank, start to do things that the PE companies do? If you had Apple’s amount of cash, the number of things that you can do to move the needle is vanishingly small, which is why they keep chasing after cars and healthcare. But it might be easier to buy nursing homes and run the PE playbook and achieve at least fiscal growth that way. I’m not saying that comports with their values, particularly in Apple’s case, but if you’ve got a war chest like that, this is a set of options you might have on the table.
Apple seems to have handled its excessive cash by doing stock buybacks. There’s another way that you can use that money. Eventually, you’ve got enough money sitting around and you need to figure out what to do with it. Private equity certainly seems like it would be very appealing. And I think that that should be concerning if you think that this is ultimately going to be a drain on the economy. But, Nilay, I wouldn’t give them any ideas if I were you.
In our world, here on Decoder, we mostly get startup CEOs or midsize company CEOs that are saying, “There’s a kill zone around these companies, where, if we make a product that competes with them, they’ll just bundle it into the operating system and my company’s doomed.” And that seems like one set of competitive problems. But the other set is they’ll just buy everything. And stopping that does not seem to have worked very well for the DOJ or the FTC, at least until recently when there’s been more of an effort to file the cases and lose, just to try to change the law. Do you see an interplay there?
Maybe this isn’t quite responsive to your question, but the other interesting possibility is that venture capital firms become more like PE firms. Andreessen Horowitz is just becoming such a massive entity that, eventually, they might be looking at more the leverage buyout model than the traditional “bet and hope you win the lottery.” But I get your point, which is there’s so much money around tech right now that it’s possible that the private equity business model essentially becomes inevitable to at least one of the players there.
You have a lot of specific solutions at the end of the book. I want to talk about those. One of them is actually regulating roll-ups, regulating mergers, regulating combinations of firms. That does connect to the antitrust reform movement to say, “We should stop more of this. We should have more companies, not fewer. We should not allow companies to roll up every veterinarian in Chicago.” Is that possible? That seems, at once, the easiest thing to suggest to just the random person and also, the hardest thing to achieve.
I obviously can’t go too far into specifics here. But I will say the basic laws of antitrust apply to everybody, whether it’s a gigantic multibillion-dollar acquisition or if it’s a small purchase of an OB-GYN or veterinary or dermatology clinic. These laws apply no matter what the size if the effect is, to quote the relevant statute, to substantially lessen competition. I think that there is a real possibility here. Obviously, you have the physical constraints of the Department of Justice and FTC, which is that DOJ antitrust staffing levels are the same as they were in the 1970s. Fortunately, there’s been some legislation to change that, but there’s a limited number of cases that can be taken on. I think that the leadership of both the FTC and DOJ antitrust are very attuned to these sorts of issues.
I’ll also say, at the risk of being repetitive, that DOJ and FTC are not the only enforcers here. States, and especially private litigants, can take action here. Not to get too in the weeds, but one of the challenges that you’ve got with private litigants is they just don’t see where the money’s going to come from in taking on these cases.
Especially because these companies keep targeting poor and working-class people.
Exactly. But I think that there’s been really encouraging civic-minded litigation against private equity firms for some of their practices. The American Academy of Emergency Medicine sued a private equity firm and its physician staffing company for violating state corporate practice medicine laws, saying, “Hey, you guys are coming into emergency rooms and essentially telling us how to practice medicine. That violates state law.” They ultimately lost that case, but–
I was reading the book, and I was struck by how many extremely sensible, well-meaning cases you discuss, and then at the end the caveat is: and then they lost the case. And it seems like a recurrent theme throughout this book: people have a great legal theory and, to the innocent bystander, the case makes a lot of sense, the problem seems obvious, and then they lose on a technicality of standing or corporate structure or funding sources. It’s crazy technical legal defenses, not the substance or the merits of the case itself.
Well, two things on that. One is, I don’t want to armchair psychologize, but I do think it’s often very hard for judges to rule against companies when those lawyers for those companies who make five times what the judge makes, who dress extremely well, who have an army of associates sitting on the back benches, say, “Hundreds of people are going to lose their jobs, the company’s going to fall apart, and you’re going to be held responsible.” I think it’s very hard for a judge to go against that, just as a human in thinking about their psychology. And the other thing is this has happened before. Before the trusts were ultimately constrained, we had what was called the Lochner era. You had an era of court opinions that was incredibly hostile to social progress, and ultimately that changed through judges retiring and judges changing their mind and also popular pressure.
I think a lot of non-lawyers forget, and maybe a lot of lawyers forget that judges are human beings and are influenced as much by public understanding of these issues as anyone else is. So I would not give up on the judiciary quite yet.
A recurring theme we have on this show and across The Verge is that, particularly our audience, a tech audience, wants to think of the legal system as a computer, like a deterministic system with inputs and outputs. And that’s how many judges want to think about it. Famously, John Roberts said, “I just call balls and strikes.” That’s a deterministic argument. I think that might be changing. We’re in for an era of Gen Z judges, and I think it’s going to be pretty wild.
You have a lot of these specific prescriptions here for agencies. The Department of Health should require minimum staffing in nursing homes. Around prison phones, you say the FCC should regulate the cost of phone calls from prison. Those kinds of very specific regulations within specific businesses and specific industries, here are the rules — it seems politically easier to get them.
It seems politically easier to defend them in a court and say, “Look, here’s all the harm that was caused. Here’s the rule. The rule will stop the harm. Here’s the authority that’s vested in whatever part of the United States code that governs this agent... We’re off to the races.” And it’s weird. It’s easier for the government to make some rule that’s like, “All the doorbells should be blue” than it is for the government to say, “We should have a bunch of competition and actually have a market that decides what color the doorbell should be.” Why do you think that? Because that’s the one where, when you talk to the conservative Republican, they should see that protecting the market keeps the government regulation off of them. But it seems like many of these firms would prefer, “Here’s one specific regulation at a time, like the cost of a phone call from prison approach” than the market approach.
“It’s a basic idea of fairness: the people who make decisions should be responsible for those decisions”
I think it’s a really good point about activism and organizing. I was getting dinner with an activist, she’s in her 80s, and she was giving me good advice, and she said, “It’s hard to start a movement if you don’t have something to move.” And I think I’ve seen that happen with a lot of activists, they figure out something to move, and often it’s easiest to do that around a very specific issue because you can personalize it, you can humanize it. It’s harder to do that around abstract issues like “how do we change corporate veil-piercing doctrine?” I don’t want to give up too easily on the idea of some of these bigger structural changes. In one way of talking about it, it’s an obscure legal common law doctrine; on the other, it’s a basic idea of fairness: the people who make decisions should be responsible for those decisions.
And if an institution like Congress historically has struggled on some of these policy issues, there are a lot of different avenues here. States could be acting here. If you’re a state legislator, a great thing to say would be, “Okay, I’m going to introduce a bill that says, ‘If you’re a company headquartered in our jurisdiction and a private equity firm buys you, lays off a bunch of people, the company goes bankrupt, the private equity firm should be liable to the losses of the workers.’” That is a pro-worker, pro-resident reform. It makes intuitive sense. I think that there is a way to have these big structural reforms. It might just not happen through the parts of the government that people are used to.
We’re coming up on time here. What’s next in this movement? You’re describing it as a movement. You do have this list of specific things to move. You have this notion that maybe it’ll be more diffuse across states and maybe private litigants. What’s the next turn here?
Part of it is the work that you’re doing, which is helping to educate people on private equity and the challenges with the business model. The other thing we need to do is empower the activist community here so that they can keep doing this work of both educating people and pushing elected officials and people in government. There are a number of organizations out there: Private Equity Stakeholder Project, Americans for Financial Reform, American Economic Liberties Project, to name just three. Empowering those groups to really help build a grassroots movement is going to be really important here because, I want to be clear, this is not a thing that we’re going to solve in 18 or 24 months. This is the work of a generation to fix a flawed business model, just as it was the work of a generation to constrain the trusts. But if we did it once, we can potentially do it again.
Gen Z judges, man. I’m telling you, this is our future.
It’s going to be amazing. The book is Plunder: Private Equity’s Plan to Pillage America. It has one of the best opening sentences of all time, which is you mentioned that the font that the book is set in is licensed by a PE company. I literally just stopped and laughed at that. Thank you so much for coming on Decoder.
I really appreciate it. Thank you.
Decoder with Nilay Patel /
A podcast about big ideas and other problems