Why We Need to Be Concerned with Private Equity's Grip on American Business

Private equity companies certainly have their place in the business world, but controlling such a large share of it is problematic.

Readers of this space and those I've counseled in my business dealings over the years have heard me rail often about the potential problems related to private equity investments.

However, it appears as if few are listening.

I was at the Tugboat Institute a few weeks ago when its founder, Dave Whorton, presented a startling fact cited by Douglass Tatum of University of Wisconsinand theJim Moran School of Entrepreneurship at Florida State -- about 20 percent of American businesses are either directly owned by a private equity company or by a subsidiary of one. 

What's the best deal? 

Private equity companies certainly have their place in the business world, but controlling such a large share of it is problematic.

By nature, all of these companies under private equity's purview are highly leveraged. We all know that sometimes that is acceptable, but if the economy tanks, the company's market changes, or some other bump in the road arises, that high leverage can be a significant impediment to continued success.

In addition, by nature, the investors will demand a very high growth curve over the next three to five years. Decisions will be made based on short-term financial metrics, with the needs of customers (not to mention employees) considered secondary, if at all.

That's because private equity doesn't care about the long-term future of a company. It's akin to strip mining -- extract the assets, and future consequences are damned. 

Yes, it makes money for investors (and makes money for the company for a while), but it invariably leaves the company in a weaker position than if its growth and future was carefully planned.

Complicating the issue, many companies are flipped from one round of private equity to another, which increases the pressure to increase the growth curve at the expense of future company health.

Multiple rounds of equity raise can't possibly be good for a company, let alone the United States as a whole.

Bubbles Burst

Many in the business world seem to have short memories and assume that good times will last forever. How often have we heard people talking about the end of the economic cycles that have ruled the business world for decades upon decades?

No matter how optimistic you are, the good times will come to an end. As painful as they are, recessions have their place-- they wring out inefficiencies in the market and also knock out weaker businesses. After that occurs, the economy is healthy and ready for real growth.

Remember the so-called "Great Recession" from late 2007 into the summer of 2009? That was caused by a similar bubble, albeit with real estate. Lenders got greedy, relaxed their underwriting standards, and began making home loans to people who shouldn't have been home owners.

That house of cards collapsed.

I'm not saying a recession is around the corner, and when one does come along, there may be factors other than private equity's extreme influence, but nothing good ever comes from lousy practice.

In other words, beware of private equity.