Private Equity Leeches Are Hungrier Than Ever

Here is what a private equity firm does: it borrows money to buy a company; then it has the company borrow money to pay rich fees to the private equity firm, for providing the service of... sucking the company coffers dry like a voracious leech. This practice is currently bigger than ever.

It is a pretty great business model, assuming you are a private equity fund executive. You risk just a little cash to buy, say, a big huge hardware store chain. Then you have that hardware store sell a bunch of bonds— borrowing money from outside investors. What does the hardware store do with all of the money it just borrowed? Does it expand to new locations, or redo its stores, or give employees raises? Not at all. It simply hands that money over to the private equity firm. The private equity executives put that money in their pockets. Now they have a lot of profits, and the company they bought has a lot of debt to pay back, without getting any benefit from that debt. One expert quoted in the Wall Street Journal compares this practice to "taking out a home-equity loan and then using the money to go on vacation." It differs only slightly from the scene in Goodfellas where the mobsters burn down the restaurant after completely maxing out its credit.

And right now, with the economy still booming but the bond market looking ever shakier, private equity firms are soaking companies for all they're worth at a record pace. The Journal reports:

So far this year, $47.4 billion of new loans and bonds have been sold by companies to pay dividends to the private-equity firms that own them, according to data provider S&P Capital IQ LCD. That is 62% more than the same period last year, which wound up being the biggest year on record, with $64.2 billion sold to fund private-equity payouts.

If everything goes perfectly, the PE guys will "reorganize" the company and then sell it off again, pocketing a new profit on top of their hefty fees. Of course, if business drops off, the company is stuck with a huge amount of debt, and that is how companies sometimes implode and have to lay all their employees off after being drained by private equity mosquitoes. Not to worry, though: even in this "doomsday" scenario, the private equity guys will keep their money.

[WSJ. Photo: OakleyOriginals/ Flickr]