“Private equity” describes a specific for-profit corporate structure. Private equity firms form discreet “funds,” recruiting rich individuals and institutions to buy in. Funds typically focus on particular industrial sectors or types of investments. Investors’ money is locked up for a period of time, with significant penalties for early withdrawal.
Private equity firms make their money by charging their clients management fees and taking a slice of profits. The industry phrase “2 and 20” refers to firms imposing a 2% fee on investors’ funds and skimming 20% of profits for themselves.
PE funds usually acquire businesses by borrowing money, using the target companies’ assets as collateral for the debt. Target companies often find themselves with unsustainable debt after the deal, and wind up closed or dismembered after paying hefty management fees to their owners.
Each fund is run by a subsidiary of the PE company that has full authority to invest the fund’s money, known as a “managing partner.” The other investors are considered “limited partners.” PE partnership agreements specify that limited partners have no formal say in investment decisions or the management of companies bought by the fund. Although there are techniques to pierce the veil, the limited partners’ identities are generally kept secret.
The shadowy structure benefits everyone except the public. PE managers have free rein to invest as they see fit. The limited partners reap profits from investments in controversial industries, like fossil fuels and payday lending, behind a shroud of secrecy. If an investor’s stake in a shady deal leaks, “limited” partners disclaim responsibility, because they are just “passive” investors, who cede full authority to the expert managing partner.
The structure is especially valuable to wealthy nonprofit “charities,” who value both secrecy and passivity. Investing directly in controversial industries might create embarrassing headlines. Moreover, “active” ownership in an unrelated business potentially exposes their share of the profits to taxation.
This post is a sidebar to John Canham-Clyne’s piece “Private Equity ‘Takeover’ Is Not Driving Healthcare Crisis.”
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