(Financial News) The private equity industry is used to political abuse. A decade ago a leading German politician likened buyout firms to “locusts” swarming over European industry. In the run-up to the US presidential election in 2016, many of the candidates, including Donald Trump, threatened to clip the locusts’ wings.
Now it is Democratic presidential hopeful Elizabeth Warren who is targeting the firms she says are “vampires” sucking the blood from corporate America. The former Harvard law professor has published proposed legislation to curb the industry with a title that doesn’t mince words: the Stop Wall Street Looting Act.
Some in the industry shrug this off and predict that, just like previous campaigns, it will amount to little. David Bonderman, the TPG Capital founder, recently declared that Warren would never get such a measure through Congress, whichever party was in control. Which is perhaps why he felt safe to endorse Warren’s presidential bid.
But some rival private equity titans are much less relaxed. “It would be existential for private equity. She could get to the White House and she could get it through. This is serious,” says one industry billionaire.
Such talk may seem alarmist, given that Warren is not even the frontrunner for the Democratic nomination. But the senator from Massachusetts is closing the gap on former vice-president Joe Biden in the Democratic race and, with Donald Trump trailing badly in national polls, her winning the presidency is no longer seen as a long shot. Bookmakers were recently quoting her at 9/2. That is remarkable for a candidate whose programme is so radical by American standards. Not as radical as Labour Party leader Jeremy Corbyn’s, perhaps, but then the odds of Labour winning a majority in the upcoming UK general election were recently put at 40/1.
Warren’s attack has proved popular partly because of mounting public concern over a string of bankruptcies of private equity-owned retailers that led to heavy job losses. In a number of cases, Warren claims the retailers were stripped of cash and loaded with debt . When the businesses failed, the buyout firms walked away, leaving others, particular the staff, to pay the price.
Warren’s bill takes aim at a number of familiar targets, clamping down further on the favourable tax treatment of debt in highly leveraged companies, restricting private equity firms’ ability to extract fees from portfolio companies, and closing the carried interest “loophole” that allows managers to treat much of their earnings as capital gains, attracting a lower tax rate.
But the centrepiece of the proposals, which Warren says will ensure firms have “skin in the game”, is to force them to take on the liabilities of portfolio companies that run into trouble. It is this one, industry leaders say, that will “kill all private equity”. Critics say this is a fundamental attack on the concept of limited liability that has been the bedrock of the western financial system since the 19th century.
Private equity firms complain that it is unfair to undermine an entire industry because of a few rogue operators. In a recent earnings call, Stephen Schwarzman, the founder of Blackstone, pointed out that his firm has significantly reduced the amount of debt involved in its average deal and that of the 700 portfolio companies its funds have controlled, only one has ended in bankruptcy.
This is where the industry’s argument starts to look a bit wobbly, however. It may well be that the likes of Blackstone are not guilty of any of the practices Warren highlights. But that should also mean they would be less affected by the proposed curbs. Highly leveraged acquisitions of struggling businesses might become too risky. But Blackstone does not do many of those, anyway.
“If Blackstone is so good that only one of the 700 companies failed, what do they have to worry about?” asks Adam Levitin, a law professor at Georgetown University, who helped draft the Warren bill.
As for the claim that the reforms would undermine private equity per se, Levitin insists it is merely aimed at curbing abuses in those cases where firms control a portfolio business although they have put in only a tiny sliver of equity.
It would not, for example, affect Warren Buffett’s Berkshire Hathaway, which buys businesses through an insurance company, or private equity firms that use their own balance sheets, such as 3i.
If private equity firms have real management expertise, they have little to fear, he says. “The weaker players might not be able to compete. But boohoo. That’s capitalism.”
That said, the changes would clearly hit the profitability of even the most successful firms and Warren could have an even bigger impact on the personal finances of partners. In addition to the carried interest move, she is proposing a wealth tax of 2% a year on assets over $50m and higher rates above $1bn. No wonder current and aspiring private equity billionaires are up in arms.
