- Paul Constant is a writer at Civic Ventures and the cohost of the "Pitchfork Economics" podcast.
- He spoke with Jim Baker of the Stakeholder Project about how private equity firms take over retailers.
- Baker says these firms buy struggling retailers, default on loans, and then cash in profits by shutting the company down.
- This is an opinion column. The opinions expressed are those of the author.
Many Americans were shocked when popular American toy retailer Toys R Us shuttered its 800 American stores and moved all retail business online in 2018, putting roughly 33,000 employees out of work.
Under pressure from cheaper online retailers like Amazon, Toys R Us had declined in popularity in the two decades prior, but even when the chain filed for bankruptcy in 2017, it also reported annual sales of over $11 billion. How could a retailer moving millions of dollars of product every day just disappear overnight?
The answer is private equity firms. In this week's episode of the Pitchfork Economics podcast, Jim Baker, the executive director of the Private Equity Stakeholder Project, explained the mechanism of so-called "vulture capital" firms. These private equity firms sell companies off for scrap and put employees out of work in order to pocket millions — even billions — of dollars in profit.
Baker said private equity firms invest capital raised mostly through institutional investors (like foundations, endowments, and pension funds) in companies in struggling sectors like brick-and-mortar retail and print media. Over a period of four to six years, the private equity firms will then try to "dramatically grow cash flow at that company for their own and their investors' benefit, and then will sell the company and keep the profits," Baker said.
In theory, there's nothing wrong with investors purchasing a struggling business in the hopes of eventually turning a profit. Why would they invest if they couldn't eventually make money? But Baker argues that private equity firms often act as extractive bottom-feeders — sucking all value out of a company, damaging stakeholders in exchange for a quick buck, and leaving economic devastation in their wake.
In the years after private equity firms KKR and Bain Capital bought Toys R Us in 2005, Baker said they took "hundreds of millions of dollars in fees and dividends and interest payments out of the company," extracting funds that could otherwise have been reinvested into the struggling retailer to reinvigorate their business model.
"So workers had their severance terminated, and creditors and others lost money, but the private equity firms — because they had collected fees along the way — made money," Baker said.
A 2019 report from the Stakeholder Project also found that private equity firms profit from an elaborate shell game that pumps companies full of debt, bankrupts them to default on the loans, and then shuts the companies down. The report found that private equity-owned companies are "twice as likely to go bankrupt as public companies," with 10 of the 14 largest retailer bankruptcies between 2012 and 2019 happening at private-equity owned companies.
This causes real pain in the real world: As a result, stores that once dominated shopping malls, like Payless ShoeSource, The Limited, and Gymboree, have all but gone extinct — and their employees have been summarily dismissed.
According to the Stakeholder Project's 2019 report, "a staggering 597,000 people working at retail companies owned by private equity firms and hedge funds" lost their jobs in the decade prior. By contrast, the report estimates that private equity-owned retail firms only added around 76,000 jobs in that time — despite the fact that the retail sector as a whole was thriving and added over a million jobs.
Those job losses aren't solely contained to the retailers, either. The Economic Policy Institute estimates that for every 100 retail jobs lost, an additional 122 additional jobs are indirectly lost.
For example, when Toys R Us closed in 2018, the two largest toy manufacturers in the world, Mattel and Hasbro, experienced considerable losses — an 8% drop in annual total sales for Mattel and a 13% plunge in 4th quarter revenues for Hattel. The manufacturers directly tied a significant portion of their losses, which led to hundreds of layoffs, to Toys R Us' collapse.
That misery has not gone unnoticed, and leaders are beginning to promote solutions to the private equity job-killing spree. One piece of legislation, the Stop Wall Street Looting Act, was introduced late last year by Senator Elizabeth Warren. The act would ensure that private equity firms carry some of the responsibility for the debts, employee pensions, and legal fees of their acquired companies.
The Act also bans the awarding of dividends to investors for the first two years after purchase to stop the wholesale extraction of resources from newly acquired companies and prioritizes worker pay during bankruptcy proceedings, ensuring that employees are at least partially compensated before investors get their cut of the profits.
These kinds of policy solutions, which limit the profits a private equity firm can extract and make ensure they're "on the hook to some degree for the liabilities that their portfolio companies incur," would put an end to the wholesale extraction of profits, Baker said.
Investors should be rewarded for innovating and reinvigorating troubled industries — not for killing jobs, manipulating debt, and selling once-beloved brands for scrap.