The Role of Private Equity

Private equity firms are regularly mentioned but not readily understood. Often, they are included as a throwaway line in an article, either considered “corporate raiders,” buying up companies only to strip them down for parts. Or as a corporate lifeline, bringing in money and expertise that helps businesses survive tough times.

Over time, private equity has become a central force in the American economy. It touches everything from retail chains to nursing homes to manufacturing plants. Sometimes the results are positive, and companies find the resources and direction they need to grow. At other times, the story ends with layoffs, bankruptcy, or a decline in the services people rely on.

Understanding private equity is essential context for today’s economy, encompassing not only its definition but also its workings and evolution over the decades.

What Private Equity Actually Does

At its most basic, a private equity firm is an investment manager that gathers money from investors, such as pension funds, college endowments, insurance companies, and wealthy families, to pool those dollars into a fund. That fund is then used to acquire companies, some of which are private and others are public firms that have been delisted from the stock market.

A firm’s goal is to improve the company’s performance and eventually sell it for a profit, either to another buyer or by taking it public again. There are several approaches to accomplishing this. The most notable and leveraged buyouts are those in which a firm acquires a company using a combination of its own funds and substantial amounts of borrowed capital. The borrowed money increases potential gains if the company does well, but it also creates risk if the company struggles. Growth equity is another model, where a firm invests in a business that is already established but needs capital to expand. Some firms focus on distressed companies, buying them at low prices and trying to turn them around.

What these strategies share is that private equity is not a passive investment. Investors do not simply write a check and wait for results. They often replace leadership, restructure debt, or change the way a company operates. Their involvement nearly always signals change, sometimes welcomed, sometimes resisted.

How the Industry Took Shape

The modern form of private equity originated in 1946 with the founding of the American Research and Development Corporation. Its goal was to provide capital to young companies with promise but without access to traditional financing. One of its most notable successes was Digital Equipment Corporation, which grew into a pioneer in the computing industry.

The industry gained notoriety in the 1980s during the wave of leveraged buyouts. The 1988 purchase of RJR Nabisco was the largest buyout of its time, symbolizing both the creativity and excess of that era. The deal was so emblematic that it became the focus of the book and later the movie Barbarians at the Gate.

Since then, private equity has grown into a global powerhouse. Bain & Company estimated in 2024 that the industry was worth more than $8 trillion worldwide, with approximately $3 trillion based in the United States. Pension funds, university endowments, and other institutional investors now rely on it as a key component of their strategies, often because its returns have historically outperformed those of the stock market.

This growth, however, has not quieted criticism. The sheer size and influence of the industry raise questions about transparency, accountability, and its broader social impact.

When Private Equity Adds Value

The part of private equity that receives less attention is its role in helping small and mid-sized businesses, which often face financing gaps and are too small to attract Wall Street attention but too large to depend solely on bank loans. For them, private equity can make the difference between stagnation and growth.

That support can come in the form of access to capital for a new product line, an acquisition that broadens reach, or investments in updated technology. It can also bring in experienced managers who know how to scale a company.

In 2024, the American Investment Council reported that 85% of private equity-backed businesses in the U.S. employed fewer than 500 people. Workers at those businesses earned an average of $85,000 in wages and benefits, about 6% more than workers at similar companies without private equity involvement. Taken together, private equity-backed companies contributed nearly $2 trillion to the U.S. economy that year, which is approximately 7% of total GDP.

Hunter Fan Company, a brand with over a century of history, found new life after receiving an investment from MidOcean Partners. The firm helped modernize the company’s supply chains and expand its online sales, keeping it competitive in a changing market. Examples like these rarely appear as headlines, but they demonstrate how private equity can provide the resources companies need to thrive.

The Other Side of the Ledger

Of course, not all outcomes are positive, and some of the sharpest criticisms of private equity stem from job losses and the use of heavy debt.

A study by Harvard and the University of Chicago found that companies acquired by private equity firms reduced their workforce by an average of 4.4% within two years. Behind that number are real consequences, such as workers losing their jobs, families struggling to adjust to sudden income loss, and communities witnessing the closure of long-standing employers.

The retail sector has been brutally hit. Toys “R” Us is perhaps the most well-known example. After being acquired in 2005, the company was saddled with more than $5 billion in debt, which limited its ability to compete with the rise of e-commerce. By 2018, the company had filed for bankruptcy, resulting in the loss of over 31,000 jobs. While online competition was undoubtedly a factor, the debt made recovery nearly impossible.

Healthcare has revealed another dimension of risk. A 2021 study found that mortality rates in nursing homes rose by 10% following private equity buyouts. Other research has shown a twenty-five percent increase in preventable conditions, such as infections and falls, in hospitals owned by private equity firms. The pressure to cut costs may be manageable in some industries, but when it affects patient care, the consequences become far more serious.

Part of the challenge lies in timing. Most private equity funds are designed to exit investments within five to seven years. That short horizon works for specific industries, but does not always align with businesses like hospitals or schools, which depend on long-term stability.

The Tax Advantage

Another piece of the conversation is how private equity managers are compensated and how that income is taxed. Most firms earn a 2% management fee on assets under management, plus approximately 20% of the profits, commonly referred to as carried interest. That carried interest is taxed as capital gains at roughly 20%, rather than as ordinary income, which can be taxed at higher rates.

This tax treatment has been a subject of debate for years, yet it remains in place. Warren Buffett has described it as unjustified, and critics argue that it gives private equity firms an unfair advantage, while supporters say it encourages investment and risk-taking.

The Securities and Exchange Commission has raised additional concerns. In recent examinations, more than half of the firms reviewed had issues with fee disclosures or internal controls. For ordinary people whose pensions and retirement accounts often serve as a source of capital, the lack of transparency can erode trust.

Regulation in Action

Some of the strongest regulatory responses have emerged at the state level, particularly in the healthcare sector. California passed legislation prohibiting private equity firms from influencing medical decisions in physician practices, after several high-profile bankruptcies in PE-backed hospital systems. Massachusetts has begun reviewing healthcare deals more closely and requires reports when profits appear to come at the expense of patient care. At least 15 states have passed or proposed laws that increase oversight of healthcare acquisitions.

At the federal level, progress has been slower. The Dodd-Frank Act of 2010 expanded the SEC’s oversight of private funds following the financial crisis. Amendments to the Investment Company Act of 1940 closed some reporting gaps. In recent years, the SEC has proposed new rules to increase transparency around fees and conflicts of interest. Still, regulation often struggles to keep pace with financial innovation. As one regulator put it, “For every rule, there are ten new workarounds.”

Opening the Doors to Everyday Investors

For most of its history, private equity has been limited to accredited investors. That meant individuals with a net worth of at least $1 million or an annual income above $200,000. The reasoning was that private equity is risky, illiquid, and complex, so participation should be limited to those with the resources to absorb potential losses.

That barrier may be shifting. The Equal Opportunity for All Investors Act, which passed in the House, would allow people to qualify as accredited investors by passing a financial literacy exam instead of meeting wealth thresholds. The Department of Labor has also considered rules that could enable retirement accounts, such as 401(k)s, to include private equity allocations by 2026.

This kind of access may sound appealing, but it comes with risks. Private equity funds often lock up capital for a decade, charge higher fees than traditional investments, and offer limited liquidity. Without safeguards, ordinary savers could find themselves in investments they cannot easily exit or fully understand.

Weighing Value Against Risk

When considering the role of private equity, it is helpful to keep both sides of the story in view. On one hand, the industry provides capital and expertise to companies that may otherwise struggle. It supports jobs, contributes trillions to the GDP, and has helped preserve or grow businesses that might not have survived otherwise.

On the other hand, reliance on debt can leave companies vulnerable, short-term profit goals can lead to layoffs or service declines, and preferential tax treatment raises concerns about fairness. In sectors such as healthcare, the consequences extend far beyond financial statements.

The picture is neither good nor bad. It is a question of alignment. When the goals of investors align with the needs of the businesses and communities they impact, private equity can create genuine value. When they do not, the costs can outweigh the benefits.

A Way Forward

Private equity does not need to disappear, but it must adapt and provide greater transparency around fees and performance, enabling investors and the public to more effectively evaluate its results. Revisiting the tax treatment of carried interest could reduce perceptions of unfair advantage. Stronger protections in sensitive industries such as healthcare, education, and infrastructure would help safeguard the public interest.

There are also opportunities to encourage more responsible investment, such as funds that focus on supporting smaller businesses rather than extracting value from distressed giants, which can provide capital where it is most needed. And if retail investors gain broader access, plain-language disclosures and limits on allocations would help protect them from unexpected risks.

Final Thoughts

Private equity is a financial tool. Like any tool, its impact depends on how it is used. It can revitalize companies and provide jobs, or it can contribute to instability and loss. The industry has evolved into a powerful force, and its impact on workers, communities, and even public services is too significant to be ignored.

The debate about private equity centers on whether the incentives driving these firms align with the long-term health of businesses and the people associated with them. Capital itself is neutral; however, the outcomes depend on decisions, priorities, and accountability.

If transparency improves, if incentives are better balanced, and if safeguards are in place where human well-being is most directly at stake, private equity can be a source of growth and innovation rather than extraction. There is a lot at stake in getting this right, which makes it critical for us to pay close attention.