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Private Equity Firms Are Catalysts of Creative Destruction

Despite the hype about private equity and job loss, they have little net effect on employment levels.

December 7, 2012
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Leveraged-buyout firms of the 1980s are forebears of today's private equity companies, and much of the criticism of the industry centers on the way the firms sometimes fund their deals through "leverage"—or borrowing money to pay for a target company. This can result in crushing debt service payments for the acquired company and corresponding cuts to head count, salaries or benefits.

Another controversial private equity practice is to take out special "dividend" payments from firms they've bought. Such practices, along with tales of executives brought into firms with little experience in the relevant industry and the failures of numerous companies taken over by private equity feeds criticism of the field as "vulture capitalism."

The private equity industry disputes this view. The Private Equity Growth Capital Council trade group claims its members are "committed to developing long-term value by investing in and building enduring companies through the alignment of interests between investors and management, and providing financial, operational and strategic resources and direction."

But independent studies of the field conclude that neither the darkest nor the sunniest portrait of private equity is accurate. Financial returns of private equity firms do not appear to be astounding. Earlier this year, the business magazine of the Wharton School of the University of Pennsylvania cited research indicating that private equity investors earned 18 percent more than a similar investment in the Standard & Poor's 500 benchmark over 10 or 12 years. "While that is a good margin," the online magazine said, "an 18% edge over 10 or 12 years is not [a] jaw-dropping reward for tying money up for so long."

And private equity also appears to have a negligible overall effect on jobs. In a study last year, researchers from the University of Chicago, Harvard University, the University of Maryland and the U.S. Census Bureau found that private equity-owned firms are more active in the "creative destruction" process than companies in a control group. Firms bought by private equity both create more jobs and destroy more jobs than similar firms. Overall, the authors found that "employment shrinks by less than 1 percent at target firms relative to controls in the first two years after private equity buyouts."

Ed Frauenheim is senior editor at Workforce. Comment below or email editors@workforce.com.

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