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Imagine buying a house, not with a mortgage based on your own income, but by taking out a massive loan against the house itself. You then force the house to pay the monthly instalments. While you live there, you charge the house a “management fee” for your presence. When the plumbing fails because you sold the copper pipes to pay yourself a dividend, you declare the house bankrupt, walk away debt-free and leave the neighbours to deal with the rubble. In the housing market, this would be fraud. In high finance, it is the standard operating model of predatory private equity (PE).
For decades the titans of private equity have marketed themselves as the grim reapers of inefficiency. They claim to take over sclerotic public companies, trim the fat and return them to the market leaner and more profitable. There is some truth to this: capital markets need discipline. Yet as the industry has swelled—managing trillions of dollars the world over—a darker pattern has emerged. For a growing subset of firms, the goal is not value creation, but value extraction. The business model is less about engineering better companies than it is about financial alchemy: turning corporate health into private wealth, regardless of the cost to the host.
The mechanism of this extraction is the leveraged buyout (LBO). When a PE firm acquires a target, it puts down a sliver of its own cash—often as little as 1% or 2%—and borrows the rest. Crucially, this debt is loaded onto the books of the company being bought, instead of the PE firm. The target company, struggling under a new and heavy burden of interest payments, must cut costs aggressively to survive. This means sacking workers, freezing wages, halting investment in research and development, delaying supplier payments or slashing customer service budgets. If the company succeeds in paying down this debt, the PE firm reaps a windfall. If the company fails, the PE firm is protected by limited liability laws. It is a classic case of moral hazard: heads the investors win; tails the company, its workers and its creditors lose.
But the extraction does not stop at debt. PE owners are adept at layering fees upon their portfolio companies. There are transaction fees for buying the company, monitoring fees for running it and advisory fees for telling it what to do. These payments flow upstream to the PE firm regardless of the company’s performance. In the most egregious tactic, known as “dividend recapitalisation”, a PE-owned company takes out a new loan just to pay a cash dividend to its owners. It is akin to using a company credit card to withdraw cash at a casino, leaving the company to pay the bill.
The consequences of this financial strip-mining are visible in the wreckage of retail and services. When Sun Capital acquired Friendly’s, an American restaurant chain, it followed a predictable path. After years of aggressive management, the chain entered bankruptcy. This allowed the owners to shed pension obligations, shifting the burden of retirement costs onto government insurers—and eventually, taxpayers—while the investors walked away with their fees intact. In the nursing-home sector, where PE ownership has risen sharply, the results are grimmer still. Studies suggest that in pursuit of short-term margins, staffing levels are cut and quality of care plummets, leading to higher mortality rates among residents.
One might ask why this is legal. The answer lies in a combination of regulatory arbitrage and political influence. PE firms tend to operate in the shadows of the “shadow banking” system, subject to lighter disclosure rules than public corporations. Their complex ownership structures (usually a maze of subsidiaries) insulate the parent firm from liability when a portfolio company creates harm. Furthermore, the industry is a colossus of lobbying. In America and Europe, they have successfully defended the “carried interest” loophole, which allows billionaire fund managers to pay a lower tax rate on their earnings than a schoolteacher pays on their salary.
For emerging markets, specifically those in the Himalayas, these are cautionary tales. Nepal’s private-equity scene is currently in its infancy. As data from PitchBook and local analysts suggest, the market is dominated by impact funds and hydropower investments: sectors backed by development finance institutions rather than corporate raiders. This is “patient capital”, largely focused on building infrastructure and expanding financial inclusion.
However, as the Nepali market matures and seeks commercial returns, the wolves may arrive in sheep’s clothing. The temptation to import the aggressive LBO model will grow. Already, private equity-backed companies are collapsing, leaving a trail of “out of business” signs that expose the deadly volatility of firms unable to survive beyond their first round of funding. Some of the companies that have gone bust include Sinduli Agro Company, Redmud Coffee and Gandaki Urja.
Without strong bankruptcy laws and strict rules on debt-loading, as well as protections for workers’ pensions, the extraction economy could take root in Kathmandu just as it has in New York and London.
Private equity at its best provides the fuel for companies to grow. At its worst, it is a looting machine that privatises gains and socialises losses. As regulators in developing economies write the rules for this new asset class, they would do well to remember the difference between a doctor who cures the patient and a parasite that feeds on the host. ■
