By Gabriel Wigny
Private equity (PE) grew dramatically after the financial crisis, bolstered by a decade of ultra-low interest rates, but the story is different today. The industry is now struggling due to the post-Covid era of high-interest rates across the UK, Europe, and the US. In 2024, buyout funds cashed out just half the value of their typical investments, marking the third consecutive year in which payouts to investors have fallen short because of a deal drought.
Central to the PE business model is the leveraged buyout, or LBO. PE funds borrow large amounts of money — the so-called leverage — to buy non-publicly traded companies. Then, they restructure these companies to improve profitability and finally exit the deal by selling them — the so-called buyout. Higher rates are hitting private equity firms’ ability to finance new deals and have also increased borrowing costs at some businesses they already own. For many companies, the weight of their debt has almost doubled in just a couple of years.
In a recent analysis, Moody’s indicated that recent increases in interest rates have put PE groups under financial strain. For instance, more than half of the companies in the portfolios of Platinum and Clearlake (two major PE firms) are at heightened risk of default (i.e., failing to meet debt obligations, such as interest or principal payments on a bond, as agreed with lenders).
Similarly, an S&P study shows that a record number of 110 venture capital and private equity-backed companies filed for bankruptcy in 2024. Bankruptcies in the US have reached their highest level since the financial crisis, emphasising that high interest rates combined with weak consumer demand have taken a toll across the US corporate landscape.
The IMF has warned that PE represents a systemic risk to the global economy. Echoing these fears, the Bank of England escalated warnings about PE’s transparency. UK banks are leaving themselves open to “severe, unexpected losses” by failing to properly measure how exposed they are to the $8tn private equity industry. The BoE warned of systemic risks and said the issue was partly due to the fact that banks had not previously been exposed to a private equity downturn. Additionally, BoE executives highlight that a creeping sense of complacency and lack of data are increasing lenders’ vulnerability, putting them at risk.
The shadow banking sector (which includes hedged funds and private credit and equity funds) faces little to no regulation compared to traditional lenders. Indeed, private equity is, well, private, and under much less stringent obligations to disclose information. For many years, private markets have raised more in equity than public markets. This means that a rising proportion of the economy and equity markets is opaque to the public, investors, and policymakers.
Nevertheless, the Financial Conduct Authority is not as alarmist as the BoE. As Nikhil Rathi, chief executive of the FCA, puts it: “There are risks in the private market, there is work to be done, but I don’t think we should go into overkill regulatory mode where we put leverage limits on all of this activity, if actually, we haven’t got the evidence for it.” Rakhil does not believe PE poses systemic risk however, he agrees evidence must be built. But by the time we gather enough data, will it be too late?
Nowhere in the world has private equity found a more welcoming playground than in the UK. Over the last 20 years, the volumes of buyouts have weighed more in the overall economy than in any other advanced market, including the US, where the industry was born, data shows. The BoE is concerned that risks in private equity spill over to the rest of the economy, particularly as 10 percent of workers in the UK private sector are employed by PE-owned companies. Asda and Morrisons are two of the most famous UK businesses financed by PE groups, which has led to controversies. Moody’s downgraded Morrisons’ credit rating because PE ownership led to a higher debt burden and fewer profits. Asda’s PE owners have enjoyed a £44m payout despite poor performance.
Some would argue that if PE crashes, many citizens will suffer. Usually, PE funds raise cash from institutional investors such as insurance companies, pension funds, and sovereign wealth funds. Private equity’s focus on maximizing returns aligns with the interests of investors, including pension funds and endowments, which in turn benefits retirees and beneficiaries.
Others might also add that PE funds are the blood of capitalism and play a crucial role in the economy. They emphasize the ability of private equity firms to infuse capital into struggling companies, potentially saving them from bankruptcy and preserving jobs. These firms have the financial resources and strategic expertise to carry out changes needed by whoever owns them while streamlining operations and driving growth.
However, many point out that the fall of PE could be beneficial in the long run. Yes, the immediate impact of this is likely to cause a lot of disruption as many lose their jobs. Nevertheless, in the long run, an economy with less private equity could be more sustainable and responsible. Indeed, in comparison to publicly traded firms, by nature of being private, they are less accountable to a wider variety of stakeholders. For PE financiers, economies of scale, low wages, minimum staffing and cost-cutting are the order of the day to increase profits.
According to one frequently cited analysis, one in five private equity-owned companies go bankrupt within 10 years of acquisition — a rate 10 times higher than that of publicly owned companies. And it’s not because private equity tends to target companies that are already weak; often these businesses were thriving before being bought. PE-owned firms also tend to deliver lower-quality goods and services.
For instance, Lina Khan, the recently resigned chair of the US Federal Trade Commission, believes that private equity groups pose a threat to the US healthcare system. A Harvard Study about the quality of care in hospitals acquired by private equity shows a worsening of fall and infection risk. In the UK, PE-owned healthcare groups are also delivering lower quality services. They open larger and larger care homes, often built on cheap land, well away from local communities. These silos of residents, many of whom live out their last few months in loneliness and isolation, pay tens of thousands of pounds a year for the privilege.
In conclusion, private equity is under growing pressure, and its struggles could have far-reaching consequences for the global economy. Unlike in 2008, when systemic risks went unnoticed until the housing bubble burst, today we can at least see the cracks forming. Regulators are scrutinizing PE’s risks, and discussions about transparency and oversight are gaining momentum. But some important questions are yet to be answered. Will Trump’s tariffs cause inflationary pressures and hence prolong high interest rates? What impact will decoupling monetary policy between the Fed and the ECB have on PE? How much longer can PE hold in a high-rate setting? Crises often unfold in slow motion—until they don’t. Will regulators act in time?
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.