In Goodfellas, a restaurant owner has some problems with Joe Pesci’s character and goes running to the family boss, played by Paul Sorvino. He asks Sorvino’s character to step in, take an interest in the joint so maybe Joe Pesci won’t forget to pay his tab.
What ended up happening was Sorvino and the family loaded up the restaurant with debt and when they couldn’t get any more credit, they torched the place and collected on the insurance. It’s illegal when the mob does it, so why isn’t it illegal when private equity does it? I mean, that is essentially what Thomas H. Lee Partners did to Simmons Mattress Company.
Twice after buying Simmons, THL borrowed more. It used $375 million of that money to pay itself a dividend, thus recouping all of the cash it put down, and then some.
A result: THL was guaranteed a profit regardless of how Simmons performed. It did not matter that the company was left owing far more than it was worth, just as many people profited from the mortgage business while many homeowners found themselves underwater.
Investors who bought that debt are getting virtually nothing in the new deal.
“From my experience, none of the private equity firms were building a brand for the future,” said Robert Hellyer, Simmons’s former president, who worked for several of the private equity buyers before being asked to leave the company in 2005. “Plus, the mind-set was, since the money was practically free, why not leverage the company to the maximum?”
Just as with the housing market, the good times ended when the economy fell into recession and the credit markets froze. Simmons is now groaning under a huge amount of debt at a time when its sales are slowing. And this time there is no escaping by finding yet another buyer willing to shoulder its entire burden.
Simmons is one of hundreds of companies swept up by private equity firms in the early part of this decade, during the greatest burst of corporate takeovers the world has ever seen. Many of these deals, cut in good times, left little or no margin for error — let alone for the Great Recession.
Now, to some people, making an enormous profit is all good even when it’s destroying whole companies, jobs and the fortunes of investors dumb enough to buy the debt (I am not one of those folks, so don’t think I’m coming from there). However, I think we can all agree that while it’s good for a very small number who are actually doing the deals, for the rest of society and the economy, it’s really bad in a black and white, unmitigated kind of way.
So how do we stop it? How about changing tax policy to asses a special tax against special, one time dividends paid to owners on companies that have acquired control of those companies in the last 10 years if the dividend is to be paid by issuing debt. And set the tax at 90%. While this won’t completely stop the looting, it will at least make sure that companies aren’t eaten alive with debt.