The business of PE is to extract money from a target company. The business of PE has nothing whatsoever to do with "right sizing" or bringing "professional management" or "efficiency" to a business. A PE firm does not try to actively destroy a target, but the on-going health of the target business is not a goal or much of a consideration of the actual PE process. If a target PE company survives after going through a PE process, it is more an accident than an outcome.
A PE firm gets paid in three main ways:
- First, the PE firms acquires a target by borrowing the money to buy the target. Then the PE firm, owning the target, has the target borrow an even bigger amount to pay back the PE firm for it's original borrowing, plus pay large fees to the PE firm for managing the process.
- Next, the PE firm siphons off any cash from the target to pay itself bonuses.
- Finally, the PE firm does not bring in professional management; rather it incentivises the original management to cash cow the company for a period of time, paying the interest on the new debt but doing little else, until the PE firm can take the target public again, at which point the old executive team is paid off handsomely and the PE firm gets paid the lion's share of the offering proceeds.
Note that at any point in the process the PE firm can walk away and do well. The target only has to survive the initial acquisition to make significant money for the PE firm.
Vitus is has not been a party to any PE business, but has read extensively about PE. Now, Matt Taibbi has written an excellent piece about Mitt Romney and the PE business, which amplifies on the above, and much more. The article is long but very highly recommended. The money quote of the article is the last two paragraphs:
Mitt Romney, it turns out, is the perfect frontman for Wall Street's greed revolution. He's not a two-bit, shifty-eyed huckster like Lloyd Blankfein. He's not a sighing, eye-rolling, arrogant jerkwad like Jamie Dimon. But Mitt believes the same things those guys believe: He's been right with them on the front lines of the financialization revolution, a decades-long campaign in which the old, simple, let's-make-stuff-and-sell-it manufacturing economy was replaced with a new, highly complex, let's-take-stuff-and-trash-it financial economy. Instead of cars and airplanes, we built swaps, CDOs and other toxic financial products. Instead of building new companies from the ground up, we took out massive bank loans and used them to acquire existing firms, liquidating every asset in sight and leaving the target companies holding the note. The new borrow-and-conquer economy was morally sanctified by an almost religious faith in the grossly euphemistic concept of "creative destruction," and amounted to a total abdication of collective responsibility by America's rich, whose new thing was making assloads of money in ever-shorter campaigns of economic conquest, sending the proceeds offshore, and shrugging as the great towns and factories their parents and grandparents built were shuttered and boarded up, crushed by a true prairie fire of debt.
Mitt Romney – a man whose own father built cars and nurtured communities, and was one of the old-school industrial anachronisms pushed aside by the new generation's wealth grab – has emerged now to sell this make-nothing, take-everything, screw-everyone ethos to the world. He's Gordon Gekko, but a new and improved version, with better PR – and a bigger goal. A takeover artist all his life, Romney is now trying to take over America itself. And if his own history is any guide, we'll all end up paying for the acquisition.