VULTURE CAPITALISM

The term vulture capitalism is used to refer to techniques used to extract profits from companies without regard to the health or survival of the companies. The term has come into widespread use to differentiate these financial strategies from venture capitalism, which refers to funding provided to new and innovative companies that are too small or new to get bank loans or other forms of investment (e.g., from the stock market). Although risky, venture capital investments can have very high returns if the companies become successful.

Vulture capitalists acquire companies in the hope of making profits from them through financial manipulation (aka financial engineering) without regard to the ultimate success of the companies. [1] Sometimes they work to increase the company’s value by aggressively cutting costs and then selling it for a profit. Sometimes they split the company into pieces, hoping they can sell the pieces for more than their purchase price.

Often, vulture capitalists extract profits from companies and then have the companies file for bankruptcy. Due to their aggressive techniques and methods, workers, customers, suppliers, and the communities where a company is based, as well as taxpayers in general, typically end up getting the short end of the stick while the vulture capitalists realize significant financial gains.

Companies that are destroyed – run into bankruptcy – by vulture capitalists are no longer available to consumers, so consumer choice is reduced. This plays into the hands of big corporations, such as Walmart and Amazon, when, for example, vulture capitalists buy supermarket chains and drive them out of business. Consumer choice and competition suffer while vulture capitalists get rich.

Recent examples of vulture capitalism include the bankruptcies of Sears, Toys R Us, the Hostess confectionery company (maker of Twinkies), and seven grocery store chains. Vulture capitalists have also targeted newspapers from the Denver Post and Boston Herald to small community papers. Vulture capitalists typically use hedge funds or private equity funds to raise money for their acquisitions. These funds pool money from large investors and, because they are not open to the public or publicly traded on a stock exchange, they are exempt from most regulations and oversight.

The vulture capitalist business model is an example of hyper-capitalism. It destroys viable companies and hurts our economy. [2] The vulture capital model typically works like this [3]:

  1. Buy all or a controlling share of a company by borrowing most of the money (typically 70%) you pay for it (which is why these acquisitions are called leveraged buyouts (LBOs): the borrowed money leverages the relatively small amount of money the vulture capitalist and/or his fund are spending).
  2. Assign the debt to the acquired company, requiring it to pay all the interest on the large loan. An advantage to this strategy is that interest payments are a deductible business expense for tax purposes. Therefore, the high level of debt and high interest payments reduce what the company must pay in federal and state income taxes.
  3. Sell off the company’s valuable assets such as real estate. Often a company’s real estate (e.g., store sites, factories, operational facilities) is sold to a real estate investment trust (REIT), an investment fund, often run by the venture capitalist, which is eligible for favorable tax schemes. The company typically leases back the facilities from the REIT in what is called a “sale / leaseback” arrangement that requires to company to pay rent for the facilities it used to own.
  4. Pay high levels of dividends to shareholders, including the vulture capitalist and his fund. This often requires the company to take out more loans (i.e., more debt and more interest payments).
  5. Buy back shares of company stock to boost its value for shareholders, including the vulture capitalist and his fund. This often requires the company to take out more loans (i.e., more debt and more interest payments).
  6. Charge the company for expenses and a wide range of fees (e.g., management, transaction, advisory, and monitoring fees) that often add up to millions or tens of millions of dollars a year. In addition, take a share of any profits the company earns.

    Note: Items 2 – 6 all result in mandatory expenses, primarily interest and rent, for the company. These use up most, if not all (sometimes more than all), of the revenue and cash flow the company generates. This reduces the financial stability and resilience of the company, which is further hurt by the removal of assets such as real estate that could serve as a buffer in hard times. The company is strangled by these new expenses and doesn’t have the resources to invest in innovation or other steps that would keep or make it competitive.

  7. With the company under financial stress, extract concessions from workers (e.g., cutting their pay and benefits) telling them that this is necessary to avoid shutting the company down or filing for bankruptcy. Similarly, extract price cuts from suppliers.
  8. Sell the company or file for bankruptcy. Filing for bankruptcy voids union contracts and responsibility to pay past and present workers the pensions and retirement benefits they were promised – and earned. (Note: The federal government and we as taxpayers often end up paying some or all of earned pension benefits after a bankruptcy through the Pension Benefit Guaranty Corporation.)

The mainstream (corporate) media and vulture capitalists typically and inaccurately report that the bankruptcies were due to factors such as greedy unions and a changing business environment. However, other companies in the same industries survive, some very successfully and some with difficulty.

In my next posts, I will share specific examples of how the vulture capitalism model has played out and then identify policy changes that would rein in vulture capitalists.

[1]      Wikipedia, retrieved 10/24/18, “Vulture capitalist,” https://en.wikipedia.org/wiki/Vulture_capitalist

[2]      Kuttner, R., 10/16/18, “It was vulture capitalism that killed Sears,” The American Prospect (http://prospect.org/article/it-was-vulture-capitalism-killed-sears)

[3]      Appelbaum, E., & Batt, R., Fall 2018, “Private equity pillage: Grocery stores and workers at risk,” The American Prospect (https://read.nxtbook.com/tap/theamericanprospect/theamericanprospectfall2018/private_equity_pillage_grocer.html)

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