I have experienced it first hand so many times. You have to understand that PE comes in with an exit plan. They most often do not plan to hold the asset beyond 5, maybe 10 years max. Their goal is to come in, extract as much money as possible in the short term to recoup the expense, and then sell off the remaining assets for whatever they can get for it as a cherry on top.
How do they extract as much profit as possible? Because wouldn't the previous owner have tried to, you know, make as much money as possible? Yes, but PE firms have more capital and scale and will specialize in a certain type or types of business to maximize impact.
Here's how it works:
1. First the PE Firm will focus on a business type - maybe it is auto repair shops, maybe it is pediatric clinics, maybe youth sports facilities and leagues. It doesn't really matter. What matters is that they will buy a lot of them.
2. Now that they own quite a number in a certain geographic area, maybe even most of that type of business they have leverage over customers, employees, and sometimes suppliers. The PE playbook dictates they first cut costs wherever they can. Reduce staff, add surcharges and fees, negotiate better prices with suppliers.
3. The businesses are now operating at a slightly higher margin, which is great, because the initial capital outlay was huge and they had to pay a premium because no one really wants to sell to PE. So over the next 5 years or so they need to make all of that investment back and they usually will. They might lose some employees and some customers, but people hate change and most will stick around even though service is a bit worse. And anyway, who cares, their profit margins are now nice and padded.
4. It has been 5 years and now their businesses are really starting to show signs of cracks. It is getting harder to find competent onsite management who will put up with the terrible work environment. Customers are leaving. Some of those employees are starting their own shops. But who cares, the money has already been made back. Now is the time to sell before the whole thing implodes and if it already has imploded, well, that is less than ideal, but there are still assets to sell. Sell for whatever you can and walk away. The PE firm netted slightly higher than if they were to invest in the stock market. Could they have made even more by just running competent businesses over the long term? Maybe...but that would have required a lot of time and active management and no one wants to do that, so on to the next venture.
This! All day long.
For a minute Pre-COVID and the inevitable reassessment of my life choices, I was a Private Equity fund manager for a International PE org with significant assets in a wide spectrum of energy technology and agriculture ventures.
We operated with a slightly different approach; leveraging long term lease back of land and physical resources to the original operators with caveats, such as transitioning to Organic Certification and Cost Effective Staffing - read that as Wallpapering the Products' Perceived value while shorting the personnel costs through under-staffing and underpaying - with some real improvements which included international market access and lower ecological footprints by ceasing deforestation for expansion and removing toxic petrochemical fertilizers, herbicides and insecticides from the operations which are actually beneficial to both employees and the community.
However, the standard modus operandii in the industry was and still is some flavor of this get in, grow, leverage, and then exit approach.
Individual operations' access to low to no interest financing for OPEX and CAPEX was a fundamental uplift to the value of those operations. There existed the possibility of leveraging the organizations' histories to secure low-to-no interest loans equal to the estimated market value of those operations; spend that money to expand and partially offset the cost of acquisition (protecting the investment funds from market volatility) and leverage those expansions to reduce competition through assimilation or under-pricing the competition.
Often the 'exit strategy' can include sell-off of physical assets to cover the loans; or folding the organization and defaulting on outstanding loans.
The fund never actually has to be at risk, the upsides are up-front during the stage wherein the public sees the 'investment' into expansion of or improvement of goods and services before the inevitable degradation due to under-staffing and cost cutting through volume renegotiation or through changing suppliers and processes for cheaper and less effective inputs. When customer satisfaction and employee burnout reach a crescendo... move on.
The end for me was when the organization decided to use COVID as an excuse to cut an entire environmental tech development team from payroll; with zero benefits and the expectation that local government to provide the entire cost of team members and their families' survival, while selling the technology invented and being developed by those team members for approximately one dollar to show as great a loss as possible.
PE is at least as big a blight on the global economy and community well being as joint-stock monopolies serving a few majority shareholders.
How do they extract as much profit as possible? Because wouldn't the previous owner have tried to, you know, make as much money as possible? Yes, but PE firms have more capital and scale and will specialize in a certain type or types of business to maximize impact.
Here's how it works:
1. First the PE Firm will focus on a business type - maybe it is auto repair shops, maybe it is pediatric clinics, maybe youth sports facilities and leagues. It doesn't really matter. What matters is that they will buy a lot of them.
2. Now that they own quite a number in a certain geographic area, maybe even most of that type of business they have leverage over customers, employees, and sometimes suppliers. The PE playbook dictates they first cut costs wherever they can. Reduce staff, add surcharges and fees, negotiate better prices with suppliers.
3. The businesses are now operating at a slightly higher margin, which is great, because the initial capital outlay was huge and they had to pay a premium because no one really wants to sell to PE. So over the next 5 years or so they need to make all of that investment back and they usually will. They might lose some employees and some customers, but people hate change and most will stick around even though service is a bit worse. And anyway, who cares, their profit margins are now nice and padded.
4. It has been 5 years and now their businesses are really starting to show signs of cracks. It is getting harder to find competent onsite management who will put up with the terrible work environment. Customers are leaving. Some of those employees are starting their own shops. But who cares, the money has already been made back. Now is the time to sell before the whole thing implodes and if it already has imploded, well, that is less than ideal, but there are still assets to sell. Sell for whatever you can and walk away. The PE firm netted slightly higher than if they were to invest in the stock market. Could they have made even more by just running competent businesses over the long term? Maybe...but that would have required a lot of time and active management and no one wants to do that, so on to the next venture.