Is private equity secretly running your life? The elusive financial force that owns almost 10 per cent of the UK economy

Did you know that a secretive thing called private equity owns almost 10 per cent of the UK economy? Did you know that it controls the jobs of several million people and may well own your local hospital, water supply, children’s school or even your home? No? Here is a book that aims to straighten you out on all that.

Private equity is one of those things that you either know about or don’t. If you are in the finance business you know, because it is the story of the past quarter century. If you are not in that world, if leveraged buyouts and limited partners and debt pushdowns are all just so much business-page noise, then you are in the majority. And it turns out that means you may not know who is really running your life.

Hettie O’Brien’s The Asset Class is an attempt to lift the lid on the pervasive but elusive financial force that is private equity. Before we go there, however, it may be helpful to turn the clock back to the 19th- century origins of the public joint stock company, which is a business run by managers on behalf of shareholders. The shareholder company has had its fans and its detractors, but it is generally recognised to have transformed the economy. It allowed capital to be pooled and it gave a large group of people a say and a stake in how businesses were run. The relevance of all this to private equity is that private equity is a way of doing the exact opposite.

The private equity modus operandi is to put the principles and practices of the shareholder company into reverse. Shareholder or ‘public’ companies (the sort that are traded on stock exchanges) operate under very onerous rules of disclosure, mainly thanks to regulation that followed the Wall Street Crash of 1929. They are beholden to the public, the regulators and above all to their shareholders. The private equity worldview is that this is all wrong. Shareholders don’t know what is good for businesses and nor do governments. Stock markets don’t know either. Private owners know best.

Private equity’s acquisition machine might set its sights on a company that is already private; but good private companies are in short supply. Public companies – which tend to have lots of operations that can be cut down or sold off – are a better bet. If you can buy or otherwise control enough of the shares of such a company, it can then be taken private and put beyond the reach of all the bothersome regulations that govern public companies.

As O’Brien tells it, this all started in the 1970s with a man named William E. Simon, a one-time bond trader and latterly a US government employee, ‘who despised the government’. Many of the things government did – such as trying to improve public health and eradicate poverty and generally engage in unprofitable activities – he hated.

His solution was to create the antithesis: to set up a shop buying companies that had been acting as though they were governments and then forcing them to change. That meant taking them private, cutting them down to size, while also shaking things up and then selling them at a profit. In short, the private equity model.

Simon hated government debt – but not all debt. In fact the private equity model he originated runs on debt. The money used to buy companies is largely borrowed, and once the deal is done the debt is shifted (or ‘pushed down’) on to the acquired company’s balance sheet. Or, as Simon put it when describing his first acquisition, a greetings card company: ‘Essentially we charged the company we bought for the sum we paid for the purchase and then some.’ The company cost $80 million and was sold for $290 million 18 months later.

Back in the 1970s, Simon’s company was a lone operator. Today there are around 21,000 private equity funds. Even Kim Kardashian has one. But it turns out there are intrinsic limits to the private equity model.

For one thing, private equity runs out of suitable companies to buy; and as it moves on to unsuitable businesses, it also runs out of willing buyers at the end of the process. Today’s higher interest rates mean that all the debt that has been piled on to portfolio companies is now more expensive, making the portfolio less attractive (private equity currently has an estimated $3.8 trillion in unsold investments on its books). The industry often ends up selling their assets on to other private equity companies, or even selling to themselves (using byzantine fee structures that somehow make this counter-intuitive move profitable).

After all is said and done, has private equity delivered on its original promise to unleash the creative entrepreneurship that is stifled by the rules and regulations of the public market? Given that private equity portfolio companies are about ten times more likely to go bust than non-PE companies, maybe not.

This book is a broadside against all that private equity is, but O’Brien’s weapon of choice is more blunderbuss than guided missile. The targets keep shifting – from private equity, to investment funds, to pensions, to venture capital – and sometimes they are treated as if they are all the same, which they are not. Perhaps it would have been better to stick to the asset class in question and mark its homework accordingly.

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One thing I don't understand about private equity is why the purchased company seems to be the one buried in debt. For example, if I buy a troubled restaurant chain, and I don't have enough cash on hand, I would have expected that I would have to borrow the money either in my own name or my company's name. However, every case I hear about the purchased company gets stuck with the bad loan instead of the buyer.

The local Big Boy franchisee had such trouble. A private equity company bought them, sold off their land and buildings which the franchisee had to then rent. Then the franchisee got behind on their rent and supplier payments and went under. It looks like the venture capital company got off scot free, rather than losing everything on a bad investment.

This is simply how a leveraged buyout (LBO) is structured. In an LBO, the target company—not the buyer—takes on the debt because the company’s own assets and cash flows are used as collateral and repayment sources. This is intentional, legal, and central to how private equity amplifies returns.

In a leveraged buyout, the private equity firm contributes only a small amount of equity (often 10–40%) and finances the rest with debt (60–90%) .

Crucially:

The debt is placed on the balance sheet of the company being acquired, not the buyer.

Just like a mortgage uses the house as collateral, an LBO uses the target company’s assets to secure the loan.

The Private Equity firm doesn’t want to use its own cash to service the loan.

Instead, the company’s operating cash flow pays interest and principal over time.

Using “other people’s money” (OPM) means the Private Equity firm invests a small equity check but controls a large asset. If the company grows, the equity returns are magnified.

So, Why doesn’t the buyer take the loan personally?

Because the buyer wants to avoid risk and maximize ROI.

If the PE firm borrowed in its own name:

It would be personally liable

Its entire fund would be exposed

It couldn’t do multiple deals at once

Returns would be lower

By putting the debt on the target:

The Private Equity firm’s downside is limited to its equity investment

The company bears the financial burden

The PE firm can walk away if the company fails (as in Toys “R” Us)

The model only works if the company:

Has stable cash flows

Can handle high leverage

Can cut costs aggressively

Can grow EBITDA

When these conditions fail, the debt becomes a chokehold.

Example:

Toys “R” Us took on $5B in debt and couldn’t modernize or compete with Amazon, leading to bankruptcy

So here’s the Bottom line:

The purchased company takes on the debt because that is the core mechanism of a leveraged buyout.

The PE firm uses the company’s:

Assets (as collateral)

Cash flows (to repay debt)

Balance sheet (to hold the liability)

…while risking very little of its own capital.

This is why LBOs can produce spectacular successes (Hilton, Dell) or catastrophic failures (Toys “R” Us).

I can understand why the buyer wants to stick the debt and risk on the purchased company. It just seems like most times I've seen it that company goes into a quick death spiral with the purchaser stripping the company for parts, especially any land or buildings it might own.

If I were a supplier, a leveraged buyout would instantly move all sales from net 30 terms to prepayment required. Your restaurant isn't getting a pound of beef from me until after you've paid for it, preferably cash or a certified check instead of a company check. And if I were a previously secured debt holder there is no way I would sign off for the purchaser to get a senior position to me.

Maybe I've been watching too many "why this company died" videos recently, but it seems like a LBO is the first step to a bankruptcy far too often, with the LBO purchaser getting the first cut at the carcass.

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