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.
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.
263
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