I wrote a comprehensive answer to this in response to a question about how private equity firms like Bain make money bankrupting companies like Toys R Us. Warning: It's long.
I will add that PE will also often pilfer the assets of the target company. For example, if the target company owns real estate, like office space, factories, restaurant facilities…the PE firm will have the target company sell those off but enter into long term debt obligations in the form of leasing those properties back. The PE firm receives the proceeds from the sale of the property but the target company now has a new liability in the form of a lease payment.
Furthermore, PE firms will often have the target company sell the real estate to another one of the companies they own. For example, many years ago the PE firm that owned Darden restaurants (Olive Garden, Red Lobster, etc…) had Darden Restaurants sells off ownership of the physical real estate to a REIT (real estate investment trust) that was 100% owned by the PE firm. So the PE firm can then sell Darden Restaurants but still own the land and buildings and get payments from Darden.
Well I wouldn't consider that leeching because it is using assets in a more efficient manner.
In the Darden case, PE firms are unlocking capital that would otherwise remain tied up in real estate, allowing businesses to reinvest in higher-return initiatives like product development, technological advancements, or market expansion. Owning real estate does not inherently generate operational value for a restaurant chain; instead, it can be a drag on capital that could be deployed more effectively elsewhere. By shifting real estate assets to specialized entities like REITs, Darden was able to focus on its core business while transferring property management to those better suited for it. This approach aligns with broader economic principles—when capital is reallocated to its highest-value use, overall productivity and profitability improve.
Also, transitioning from ownership to leasing is viewed as a form of capital efficiency, as structured lease agreements can provide tax benefits and enhance financial flexibility. This allows PE firms to create value from real estate, redistribute profits to investors who can reinvest in new, high-growth opportunities. Since their primary goal is to generate high returns, selling off assets and restructuring financial obligations can be a strategic way to optimize resources.
Now, people will argue that such restructuring often leads to financial distress or bankruptcy for the target company. But PE is actually just accelerating the reallocation of underperforming assets. If a company cannot sustain profitability after a PE-driven restructuring, that may indicate that its business model was already inefficient or unsustainable. Rather than allowing struggling firms to limp along with suboptimal asset allocation, PE intervention forces a market correction, ensuring that resources flow to enterprises that can use them more effectively. Even in cases where the target company eventually fails, the assets—whether real estate, brand equity, or workforce talent—are redeployed into more productive ventures.
Basically, PE isn't a leech. They function to ensures that capital and resources do not remain trapped in underperforming enterprises.
There are benefits to leveraging the capital locked in assets. Those benefits could be leveraged thru banks where the assets are used as collateral.
The trouble with PE when they do it, is what they do with all that liquidity. Almost always, the balance sheet shows tons of revenue on those newly sold-off assets and so they pay themselves exorbitant bonuses and siphon off all that money. Now the company is left without its assets, without its cash, and saddled with long term debts.
PE investors making money isn't siphoning off money, they had to make the money in the first place. PE selling the assets benefited the party buying the assets. They already created the value. That isn't to mention that when PE pays themselves bonuses they typically invest that capital creating more value.
Historically PE sells off the assets below market value to an entity the PE controls (essentially stealing the asset) and then leases back the asset at a predatory term.
Now the original firm has a bunch of cash on hand and a long term lease. The PE executives spend the cash on their lavish compensation packages.
Now the PE executives have the cash and the assets and the original company is left without assets and stuck with debt to operate.
There’s a pretty sound reason why Venture Capital is referred to as “vulture capital”.
If assets were consistently being sold below market value, external buyers—REITs, institutional investors, or other firms—would eagerly purchase them at fairer prices. The fact that PE firms often sell to entities they own does not inherently mean they are devaluing the assets. Often they are leveraging their financial structures that allow for greater efficiency in asset management. Also, long-term leases that companies enter into are not imposed at gunpoint. These agreements are negotiated, and while they may involve financial risk, they also provide stability in occupancy and operational continuity.
Also, if a PE-backed company does fail, it is not solely because assets were sold but because of broader market forces, operational inefficiencies, or an inability to adapt to industry changes. Private equity doesn’t manufacture financial distress it accelerates necessary market corrections. Calling PE "vulture capital" implies that these firms prey on otherwise healthy businesses, but in reality, they target firms that are either underperforming or have untapped value, seeking to optimize their resource allocation.
This all makes an assumption that businesses don't have strong and lean quarters. If you use PE to make a company super "lean and efficient", it loses resiliency to ride out storms.
For instance, if a restaurant owns the land under their building, it can survive a COVID lockdown. Just furlow the staff and reopen later. Under a lease, they are cooked.
... and the property owner is cooked
... and the adjacent tenants are cooked
... and the city's property tax revenues are cooked
... and the residents' competitive market becomes a little less competitive
There are SO many downsides. Honestly, "inefficiency" is just the price of resiliency in business. And PE are too cheap to pay the actual cost a business requires.
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u/Fabtacular1 Feb 14 '25
I wrote a comprehensive answer to this in response to a question about how private equity firms like Bain make money bankrupting companies like Toys R Us. Warning: It's long.
https://www.reddit.com/r/explainlikeimfive/comments/84iz8v/comment/dvq9ck1/?utm_source=share&utm_medium=web3x&utm_name=web3xcss&utm_term=1&utm_content=share_button