Private Practice - Private Equity, Natural Disasters, and TD Bank
Private Equity
It is laughably easy to find examples of private equity overreach in practically any major service industry in the United States - just last week we talked about the companies driving up costs and slashing the quality of child care, endangering critical services to hundreds of thousands of parents.
PE firms have become synonymous with destroying rather than building things, despite their claims to the contrary. Even when they don’t run companies into bankruptcy, their goal is to ‘roll up’ a company, running it only long enough to reach a higher multiple and pocket a profit. Technically, growing a business and increasing its value should be the goal of any company’s management. The problem with PE is the how.
As this excellent piece on the history and modern perils of private equity details, the most malignant bit of buyout deals is the leverage:
A private equity firm pools cash from investors, then uses those funds, along with an extraordinary amount of money borrowed from other sources (the “leverage”), to take over a target company.
We have talked before about the LBO’s perversity - if you took out a home mortgage but had no legal responsibility to pay it back, you’d have little incentive to be a good homeowner. PE firms are often investing little of their own money for M&A, and are under no fiduciary duty to the former owners or employees of the businesses they buy. In theory, they have a duty to the banks who loaned them the money for the deal, but it often doesn’t work out that way either.
It is mind boggling that banks lend to PE firms with terms allowing them to sell off company assets and take on additional layers of debt to pay themselves fees, but they keep on doing it:
In a practice called “dividend recapitalisation”, private equity firms load companies with round after round of debt with the sole purpose of financing payouts to themselves and their investors, a form of capitalism so distasteful that even some private equity shops refuse to practise it. The billion-dollar dividend that Clayton, Dubilier & Rice, one of the world’s oldest private equity firms, extracted from Hertz, for example, was one of the debts that contributed to the rental car company’s eventual bankruptcy.
Businesses bought by PE firms go bankrupt at rates ten times higher than their privately owned peers. Not because they are distressed businesses - on the contrary, PE firms attract investors by touting the strengths of the companies they’re buying. They go bankrupt because when you’ve just borrowed a bunch of money promising short term, consistent investment returns, the way to deliver those returns is often to cut costs, slash jobs, and take on debt for either expansion or awfully-Ponzi-sounding recapitalizations.
An argument in favor of PE funds has long been that they generate stable investment returns for some of the largest financial funds in the country - public pensions. The California Teachers, and other state-run pension groups turn to PE to park their billions as a safety net for their millions of workers. PE firms insist they generate good returns for their investors. Do they? Of course not:
According to data from the industry’s own lobbying group, in the decade between 2010 and 2020, private equity as an asset class only outperformed the S&P 500, a basket of some of the largest stocks in the US, by half a percentage point annually, and public pension funds’ private equity investments did even worse than the benchmark.
The main beneficiaries of private equity bulldozing its way through the business landscape are the PE firms themselves:
Typically, private equity firms make 2% of the money under management plus 20% of the profits from each fund they run. That means a $100m fund that makes a “triple” – three times its investment – will net the private equity firm at least $2m in fees a year and $40m in profits
[…]
In May, a Financial Times analysis showed that over the previous six years, private equity had hoovered up from investors $1.5tn more than it had paid back – a worrying sign that there may not be enough returns to go around.
So, PE investments barely outperform a stock market index fund (if at all), create a multi-trillion-dollar wealth transfer to a tiny number of PE firm owners and bankers, for…what?
We could easily fix this, and tilt the scales back in favor of the investors and employees whose companies get bought up. Unfortunately, the revolving door from government into PE continues to spin:
“On both sides of the Atlantic, private equity’s relationships with lawmakers haven’t just been cozy, but in some cases symbiotic,” the industry-focused website PitchBook has written. “Many a firm’s employee rosters read like a who’s who of Capitol Hill and Whitehall heavyweights.”
It is understandable - if you are a striving capitalist, there’s hardly a better job than partner at a PE firm. You take almost none of the risk, reaping outsized rewards. One wonders when we’ll reach the breaking point - how many hospitals, nursing homes, psychiatric hospitals, apartment complexes, and daycares must fail until there is sufficient public outcry to rein in the unchecked scourge of vulture capital?
Private Equity, Part 2
I am going to do something unusual now and make a narrow case for private equity. I feel the need because - full disclosure - I work with some private equity firms and the companies they own as part of my day job. I believe there is a way to do M&A responsibly, without stripping or destroying companies in the process.
Here is a story about private equity buying up ‘trades’ businesses - think HVAC and plumbing companies - achieving efficiencies of scale while not strip-mining them for short term gains. In some cases, the owners retain what is called ‘roll over’ equity - a way for PE firms to give sellers skin in the game by offering a stake in the newer, larger entity.
While I’m not willing to take PE executives quoted in the article at their word, I suspect these types of consolidations can be good for employees, because service businesses can provide more and better service if owners aren’t burdened with all the back office work small businesses struggle with. Also, a plumber or electrician doesn’t operate out of a storefront, so there’s no real estate to leaseback and no significant debt needed to lever up the deal.
Two owners interviewed in the piece discuss their desire to be able to cash out of the businesses they’ve built after years or decades of hard work. It may be hard to find sympathy for people receiving seven- or eight-figure paydays, but, as a long time entrepreneur myself, it can be difficult to think about or plan for any sort of stable retirement. You can aside a certain amount of your yearly income pre-tax, at the cost of depleting free cash flow that may be needed for emergencies. For a long time, tradespeople who built successful businesses had no way out if they couldn’t pass them on to future generations. Private equity offers an option, without having to close and lay off staff.
Another industry private equity is keen to roll up is clinical research, where I currently work. Much ink has been spilled (some of it by me) discussing whether PE can create economies of scale in research trials, the idea being that if sponsors (drug companies) can fill a large percentage of their study budget working with a centralized group of research sites, said studies will complete faster, new cures and treatments will be developed, et cetera.
And, indeed, my firm’s data shows that research site ‘networks’ took in forty-five percent of payments last year, up from thirty-eight the year before. That much consolidation of a multi-billion dollar industry within a single year might be worrisome, if not for the nature of clinical research.
Drug and device trials are extremely tightly regulated by the FDA, one reason they are so expensive to run. Even if private equity wanted to strip research sites for parts and cut staff, such disruptions would risk the ability to perform research up to the required standards, which could lead to costly violations and jeopardize relationships with the drug companies who make up the entirety of their income.
The only path for PE firms to conquer the lucrative research industry is to consolidate, buying up smaller sites across the country and improving the quality and capacity by centralizing operations. They imagine a world where a single, hive mind Super Site could run an entire clinical study across dozens or hundreds of locations around the world.
The problem with this fantasy is that too much consolidation creates a single point of failure, violating the spirit of the FDA’s new (long overdue) guidance on diversity in research. Drug companies are unlikely - according to study feasibility people I’ve spoken to - to give entire studies over to single companies, no matter how many sites they operate. There are exceptions, such as in-patient cancer or psychiatric trials, but the point of clinical research is to capture a representative sampling of a broad population, which is why there are thousands of independent sites across the country and many more around the world.
This is a lot of words to say there are industries where PE can play a role, either to help blue collar entrepreneurs sell off their businesses and retire, or help move clinical research forward more rapidly, but we see a lot less of the slash-and-burn mentality in industries that are constrained by talent or (critically) regulated by the government.
A benevolent private equity industry could exist to help small businesses and their owners, to create efficiencies at modest scale, or to provide funding for capital-intensive projects. What we have, instead, is a free-for-all capitalist orgy, with firms wreaking havoc across industries they should play no part in. As with most things we talk about in these pages, the government could (and must) step in to stop the excesses, but at the moment PE has largely succeeded in its most important roll-up: regulatory capture.
Natural Disasters
Now that I’ve exhausted my stores of optimism, here’s a story about how PE is elbowing its way into natural disaster cleanup:
Done by experts, a typical mold-remediation job can cost upwards of $3,000, and the cost of clearing an entire house can go up to $30,000. And private equity is taking notice: Threshold Brands, launched by private-equity firm Riverside, purchased the Pennsylvania-based Mold Medics franchise last year and aims for expansion across the continental US.
It’s not so much that private equity is only just learning about the business, since industry giants Belfor and Servpro have been making billions in property cleanup for decades. What’s changed, of course, is that storms and climate catastrophes are getting worse, which means bigger payouts, which has the vultures circling.
Unlike plumbing, disaster cleanup is dirty, dangerous work. Whether it’s repairing roofs (legitimately or otherwise) or remediating damaged buildings, the actual labor tends to be done by vulnerable populations:
Resilience Force, a group that advocates on behalf of the disaster-restoration workforce, said that this kind of work is dominated by immigrants, currently and formerly incarcerated people, and US-born people of color. The work can be dangerous and struggled with wage theft in the past. The group’s report last year, “Private Equity Profits from Disaster,” found 194 OSHA violations from private-equity-owned restoration companies between 2015 and 2022.
No surprise that PE is drawn to an industry heavily subsidized by both insurers and the government, with an easily-exploitable workforce of immigrants and the formerly incarcerated.
We talk about it all the damn time these days, but as climate change gets worse and more property is damaged by stronger storms, everyone pays the price. Whether it’s taxpayers funding FEMA who backstops billions in damage in states propping up their own creaky insurance funds, or the homeowners and insurance companies paying inflated bills to PE-backed cleanup companies, we’ve created a system by which the same people who invest in the industries cooking the planet also profit from the consequences.
TD Bank
Often when we read about money laundering at banks it involves shady webs of international entities sending and receiving money from all over the world. So it is…refreshing? to read about some good old fashioned money laundering here in the United States, at TD Bank branches:
In one example cited by the authorities, a Queens man who had earlier pleaded guilty to several crimes provided bank workers with more than $57,000 in gift cards in return for permitting the laundering of more than $470 million.
Such behavior was somewhat of an open secret inside the bank, prosecutors said. “How is that not money laundering?” one branch employee asked another after a customer was permitted to buy more than $1 million in bank checks with cash.
“Oh, it 100 percent is,” the second employee responded, according to the charging documents.
In another instance, a branch manager emailed a colleague, “You guys really need to shut this down LOL.” They didn’t.
Boy oh boy oh boy. One funny thing in any sprawling court case like the one unveiled by the DoJ detailing the historic $3 billion dollar guilty plea by TD is that bank employees know that these emails are saved on servers, in case the Feds decide to investigate the widespread money laundering happening at your bank. Come on!
If you are in the AML (anti-money laundering) unit at a bank I am begging you to not have conversations like this on company-issued devices:
Employee 1: :P why all the really awful ones bank here lol
Employee 2: because… we are convenient hahah
Employee 1: bahahahaha
Though, in their defense, the government found that the primary issue with TD’s money laundering procedures was the bank cheaped out on technology to detect it and did not prioritize AML staffing or investment over many years.
So, after years of turning a blind eye to money laundering in pursuit of profits, the bank is paying billions in fines and has been capped against future growth. Also, the CEO is resigning, the DoJ has criminally charged a number of bank employees and insiders, and TD will be required to have an independent monitor and invest more in AML. I am not sure this is adequate punishment for a bank not properly scrutinizing over eighteen trillion dollars’ worth of bank activity over six years, but the government thinks it is.
Short Cons
WIRED - “One of JD Vance’s key policy advisers, Aaron Kofsky, has for years posted extensively on Reddit about using a variety of drugs, including cocaine and opiates, under the username PsychoticMammal.”
Boondoggle - “The opening of the first Walmart Supercenter in a county leads to an increase in poverty of around 2 percentage points, and poverty is 3 percentage points higher 10 years after the Walmart opening.”
WIRED - “Newly obtained data reviewed by WIRED shows how a tool originally intended for traffic enforcement has evolved into a system capable of monitoring speech protected by the US Constitution.”
NBC News - “Fresh off the one-two punch of Helene and Milton, hurricane victims in Florida — even those with insurance — face a challenging recovery.”
Bloomberg - ““Has extraterrestrial solar power finally found its moment?” Henri Barde, former head of the European Space Agency’s division for power systems, electromagnetic compatibility and space environment, wrote in a column published in May by IEEE. “I think the answer is almost certainly no.””