The classic critique of private equity is that it employs financial engineering tricks, such as increasing leverage and minimizing tax liabilities, rather than making real operational improvements.
Venture capitalist Michael Moritz of Sequoia recently claimed, for instance, that PE is akin to "making a small down payment on your neighbors' house; paying for the balance by taking out a mortgage secured by their savings, jewelry, silverware and car; selling off the contents of their property; and then siphoning off some of the loan for yourself."
Similar invectives were hurled around during the 2012 electoral campaign of Mitt Romney, who helped create Bain Capital. Like any industry, PE is occasionally corrupt – as for instance when it charges inmates high rates on interstate phone calls, in partnership with crony state governments.
But the image of private equity as a parasitic form of business completely misses the point.
The primary way to make money in private equity is to make portfolio companies more efficient and healthier in the long run. If a PE firm saddles a portfolio company with such a heavy debt burden that the company is unable to return a profit, it is the PE firm which ultimately suffers. Private equity firms are fundamentally incentivized to improve and strengthen the operations of the companies they control, not to cripple them.
Furthermore, enabling companies to do more with less allows workers to specialize in other areas, and frees up wealth with which investors and management can capitalize internal improvements or ventures in other regions of the economy. PE firms succeed to the extent that their portfolio companies succeed, and to the extent that their portfolio companies succeed, America prospers.
Another conventional critique levelled by Moritz is that PE destroys millions of jobs when cutting costs at portfolio companies. This is empirically false – the private equity industry as a whole is responsible for large job creation as well as destruction, with only modest net job losses.
But the deeper fallacy with this argument is that full, constant employment is falsely seen as the ultimate good in America's economy.
If we wanted to create full employment it would be easy: we could simply ban 20th century agricultural technology, immiserating millions of Americans and forcing them back into farm labor. It's easy to intuit that this would be a bad idea, but it's harder to imagine the economic progress that layoffs and labor migration imply.
In truth, creative destruction of antiquated jobs and invention of new forms of labor drives productivity growth, and PE firms are integral to this process.
Finally, some argue that PE only enriches a select few at the expense of ordinary Americans. In fact, the largest investors in PE are American pension funds, which have committed hundreds of billions of dollars to the American private equity industry.
PE assets make up 9% of CALPERS' portfolio, for instance, and have generated an annualized net return of 12.3% over the last ten years. When private equity firms succeed, every state government pension plan, university endowment, and large philanthropic endowment shares in their profits. It's no stretch to say that the primary beneficiary of the private equity industry is the American public.