Termite Capitalism: how private equity is undermining the economy
From care homes to our high streets, private equity is corroding the foundations of society from within. It must be stopped before it’s too late.
In recent decades corporate ownership in the UK and the US has undergone a dramatic transformation. Although private equity has been acquiring corporate assets since the 1980s, its dramatic growth since 2008 has changed the ownership of companies to an extraordinary extent. Currently more than 3,000 UK companies are owned by private equity; in the US private equity accounts for assets totalling more than $5 trillion.
Why does this matter? The problem is that the private equity model of takeover and ownership is akin to inviting termites into your house. The basic model is as follows: private equity acquires a company using loans, usually from banks but also increasingly from pension funds, insurance companies, sovereign wealth funds etc. The old management is replaced, the workforce cut, and assets such as land and buildings are sold, often to an entity registered in an offshore tax haven. The new company must pay interest on the debt, repay the debt over time, pay rent for the premises, management fees to the private equity owners.
Costs will also include payment to linked third-party suppliers, at prices which are not arm’s length. The taxable capacity of the new company is thereby reduced, and tax liabilities are shifted towards capital gains tax away from corporation tax. The company can only be financially viable in a booming market or where revenue streams continue to rise.
In general, private equity does not actually create anything – it engages instead in extracting resources from previously existing assets. Eventually, by excessive extraction of revenue flows, the companies are bound to fail. The termites eat away at the foundations until the house falls down.
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private equity does not actually create anything – it engages instead in extracting resources from previously existing assets.
Even before the economic shock created by COVID-19, many companies that had been subjected to private equity buyouts had gone bankrupt: in the US companies such as JCrew (14,000 jobs) and Neiman Marcus; and in the UK companies such as Debenhams, Pizza Express, Byron, Zizzi and Brighthouse. Of the fourteen largest US retail chains which have filed for bankruptcy since 2012, ten had private equity ownership.
The care home crisis
Perhaps the most startling example of private equity ownership in the UK is in the care home sector. The spotlight on the care home sector has become more intense during the COVID-19 crisis, but too little attention has been paid to the linkage between the care home crisis and the ownership structure of the care home 'industry'.
Research by the Centre for Health and Public Interest based on a forensic analysis of accounts of care homes has indicated the depth of the crisis resulting from private equity ownership: overall, of a total annual revenue of £15 billion, 10% (or £1.5 billion) leaks out of the sector in rent, dividends, interest, debt repayments and management/directors fees. Their research analysed the accounts of 830 adult care home companies, including the 26 largest providers. Between them they represented 68% of total estimated annual revenue to the sector.
The leakage of £1.5 billion is an average figure for all care home companies in the study. For private equity owned care homes, 16% of the weekly fee per bed is paid in interest costs alone i.e. interest on the debt taken on by private equity to buy the care homes. In addition, of the seven largest for-profit care home chains, between 15% and 32% of their annual income is spent on rent, this compares to the eight largest non-profit chains which spent 2% of their annual income on rent.
The private equity owned care homes generally have complex corporate structures, with profits hidden in management fees, lease agreements, interest and purchases from related-party companies. In addition, four of the five largest care home chains owned by private equity have owners based in tax havens.
The crisis in the care home sector has been with us for some time: since 2011 two major care home chains, Southern Cross and Four Seasons, who between them provided care for 45,000 residents, have gone into administration. In the case of Four Seasons this was undoubtedly because of cash extraction as a result of private equity ownership, which loaded the care homes with debt and rent obligations, all organized through a complex and opaque multi-level corporate structure. In the case of Southern Cross, also private equity owned, the collapse was also related to unaffordable levels of rent.
four of the five largest care home chains owned by private equity have owners based in tax havens
The resulting problems of leakage and opacity are problematic for many reasons, not least because around half of the income of care homes is paid by local authorities. The lack of accountability for public spending is evident. But the question of the adequacy or inadequacy of the level of expenditure on care homes by local authorities is also shown to be a complex one. If such high levels of leakage are common among care home chains subject to private equity ownership, how can there be a realistic assessment of the adequacy or inadequacy of the level of expenditure per resident?
During the COVID-19 crisis, the spotlight has been on the high rates of death among care home residents and staff, partly because of elderly people being discharged from hospital without testing, and partly because of the absence of protective equipment. But little attention has been paid to the links between ownership and the effects on rates of death.
The largest care home group, HC-One, which took over many of the care homes previously owned by Southern Cross, has 328 homes and 17,000 residents. These homes have experienced 700 COVID-related deaths. HC-One is now asking for a bailout from local authorities because of falling occupancy rates. But HC-One has a corporate structure in which well over £50 million has been siphoned off to the Cayman Islands in the last three years in the form of rent and interest payments, the latter at rates of up to 18% per year. They are also requesting a bailout from central government under the Business Interruption Loan Scheme, and deferral of tax payments. Why should UK taxpayers subsidise a company which exists purely to extract resources from the neediest members of society?
In one care home owned by HC-One on the Isle of Skye, 30 of 34 residents and half of the staff have tested positive for the coronavirus. The Scottish Care Inspectorate have launched legal action to take over the running of this home – but HC-One owns 56 care homes in Scotland. Because working conditions and pay rates are low in this sector, with zero hours contracts the norm, shortages of staff have been widespread, and it is suggested that the use of agency staff who move between care homes has been a factor in the transmission of the virus. This along with shortages of PPE and the discharging of elderly people into care homes from hospitals to make beds available for COVID-19 sufferers.
The case of HC-One is also interesting because the Executive Chairman, Sir David Behan, was formerly in charge of the Care Quality Commission – the body responsible for inspecting care homes. HC-One has a complex corporate structure like many private equity owned businesses, containing a web of more than 50 companies – six of which are registered in the Cayman Islands or Jersey. Despite declaring a loss every year except one since its creation in 2011, HC-one paid dividends of £48.5 million in 2017-2019.
Stopping the termites
Since 1980 local authorities have been denied the resources to invest in residential and nursing home provision, thus creating an opportunity for large corporations – and subsequently private equity – to enter the sector. Clearly major reform is needed: to ensure that public resources devoted to care homes are actually used for the care of elderly residents, a transformation of ownership is needed.
Local authorities need the resources to invest in their own care homes, with oversight committees from the local community and transparency rules about resource use. This is the only way to ensure appropriate use of public resources and also to ensure that elderly people are not being exploited by private equity and other for-profit companies located in tax havens, siphoning off resources intended for the care of the elderly. Indeed, it should become illegal for institutions in receipt of public funds to make any payments to companies registered in tax havens.
However the question of what to do about the termites in the foundations is a larger one: how do we ensure that viable companies are not taken over in order to maximise the short-term extraction of revenues, thus shortening the life of the company and reducing taxable capacity which finances public services? One vital aspect of the ease with which private equity has been able to massively increase its hold on UK (and USA) companies is that banks have lent them the money to do so – preferring to lend for what is ultimately destructive purposes, rather than lending to companies themselves for constructive purposes. Lending regulations need to be transformed in order to shift the structure of loans towards productive uses.
It is also necessary to significantly increase the level of capital gains tax, since capital gains are not the outcome of any effort or skill. The soaring levels of real estate values in the UK have been behind much of the private equity activity, making asset-stripping extremely profitable. Taxing away a larger share of the capital gains would help to reduce the incentives for asset stripping.
In recent years the number of private equity companies has continued to grow, fuelled by the funds made available through Quantitative Easing since 2008. If this is allowed to continue, and the termites keep munching their way through the building, there will be little left except a husk. They must be stopped before it's too late.
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