Elizabeth Warren, the 2020 Democrat presidential hopeful and former Harvard professor, believes private equity companies are parasites on the economy. The Massachusetts senator describes the business model of private equity firms as being “like vampires — bleeding the company dry and walking away enriched even as the company succumbs.”
Who knew that investing growth capital in promising businesses or working capital in struggling businesses was a blood-sucking endeavor?
According to Warren, private equity firms like Eberhart Capital are engaged in “legalized looting” when we roll the dice and risk our own money to help others realize their vision. This somehow makes the investor Dracula reincarnated, which I guess is a step up from being a “vulture capitalist.”
It is easy enough to make bogeymen out of Wall Street and private equity professionals, blaming them for the perceived inequities of capitalism. It’s the Left’s version of populism, and it’s a dog whistle that politicians like Warren use often.
Warren’s “The Stop Wall Street Looting Act” is supposed to eliminate corporate greed and make us all equal in the eyes of the financial system by using the power of government to collect new taxes, regulate investment, and expand the legal liabilities of private equity firms.
The problem is that Warren’s solution, which seeks to discourage “excessive risk-taking and speculation,” would reduce the availability and the affordability of capital to struggling or underperforming businesses.
Warren refers to these government-sanctioned cost-raising measures as “economic patriotism,” but the problem with the “take-from-those-who-make” model of government is that you ultimately run out of other people’s money to spend.
Politicians like Warren, who have spent their entire careers in academia or government, display a lack of basic understanding of how the economy works. Risk is inherent in the market. No one is going to place a bet on a business if there’s not a relatively good chance of earning a profit.
Warren’s bill would tie private equity firm profits to the success or failure of the companies they invest in and hold them responsible for those companies’ debt and pension obligations. But sometimes, businesses fail despite everyone’s best efforts and highest hopes. To blame investors for such failures would merely deter them from taking risks on marginal companies in the first place.
Recall that Warren was also the originator of President Barack Obama’s “if you’ve got a business — you didn’t build that” quote. Warren said it in 2011 while running for the Senate for the first time.
The practice of investing in a company using borrowed money in the hopes of making a return has been blamed for closing businesses and putting workers on the unemployment line. But that’s a very distorted picture of the industry. When a private equity firm buys an underperforming company, jobs can be lost in the short run. Cost-cutting is often part of the process of making a company more efficient and more profitable. But as private equity-backed companies become better at what they do, they are also able to hire more workers at higher wages.
A 2010 study by Steven Davis at the American Enterprise Institute found that companies acquired by private equity groups experienced higher job creation and higher job destruction rates than other firms. In many cases, initial job losses are offset by hiring as a company becomes more successful.
Attempting to punish the financial sector as a populist way to pay for social programs will ultimately translate to fewer jobs, reduced opportunities, and less prosperity for everyone, including those at the very bottom of America’s socioeconomic ladder.
Restructuring the private equity model would have consequences for more than just troubled companies looking for equity. It would also hurt the beneficiaries of state pension funds and university endowments, which have turned to private equity funds in search of higher returns than stocks and other investments.
In the Bay State, where Warren has represented in the Senate since 2012, private equity firms play an integral role in the state’s economy. In the five years from 2013 to 2018, private equity firms invested $199 billion in 840 Massachusetts-based businesses, which combined employed nearly 400,000 workers.
Warren’s home state pension fund, the Massachusetts Pension Reserves Investment Trust, enjoyed the highest return on private equity investments of any state in the country, amounting to $7.7 billion in assets. Is Warren comfortable pushing a plan that would hurt a sizable number of her constituents?
The reality is that private equity firms have a net positive impact on the economy by infusing capital into needy businesses and helping them perform better and grow. According to the American Investment Council, 5.8 million Americans are employed by 35,000 private equity-backed businesses across the country.
From 2013 to 2018, private equity firms invested $3.4 trillion in U.S. companies, allowing these businesses to grow and contribute both revenue and jobs to the overall economy. Without the private equity firms willing to take a risk on many of these companies, there would be less revenue to tax and fewer people employed.
That’s not exactly the description of a “blood-sucking vampire.”
Dan K. Eberhart is managing partner of Eberhart Capital and CEO of Canary, LLC, one of the largest independent oilfield services company in the United States.
