April 19, 2019
It’s widely understood that private equity firms make money for themselves and their investors by loading the companies they buy with debt, selling off assets, and gaming the tax system. But, there is another, less well-known way that private equity enriches itself when it takes over a traditional company.
While relations between management and labor in traditionally managed companies are generally built on low-trust and an acknowledged divergence of interests, managers have needed to build minimum levels of trust and reciprocity to ensure the ongoing commitment of those who actually produce the company’s products to the survival and success of the business. Managers have used earnings generated by company operations to pursue strategies aimed at inducing a diverse group of stakeholders to contribute to the enterprise.
Private equity owners have no such commitment to the long-term success of the companies they acquire. Their commitment is to making returns for themselves and their investors that exceed normal market returns by 15 to 20 percent. Managerial strategies to enhance performance and assure the company’s future are viewed as reducing profits. They see defaulting on these implicit contracts that govern relationships between management and other stakeholders as a quick way to increase the returns to the company’s owners.
This, in short, is what is happening today between Writers Guild of America (WGA) and the major talent agencies that dominate the representation of writers in Hollywood. An agreement between the WGA and the Association of Talent Agents trade group, in place for 43 years, is coming apart. A group of financial investors, including private equity firms TPG and Silver Lake, have taken over the three largest Hollywood talent agencies.
No longer do talent agents make money for their agencies by doing a good job of representing the interests of the writers; now they are expected to generate the abnormally high profits private equity owners expect by breaching the implicit contracts with writers for immediate gains. In place of loyalty to the ongoing success of the talent agencies and their writers, talent agents must now demonstrate loyalty to the private equity firms and other financial interests that own the agencies. Agents are pursuing lucrative deals for the talent agencies at the expense of the interests of the writers they represent.
This is not the first time a private equity firm thought it could make money at the expense of the creative talent that built an organization it acquired. Private equity firm Terra Firma’s takeover of the music company EMI stands as a cautionary tale. Breaching norms of trust and reciprocity with its artists allowed Terra Firma to increase the profits it could take out of EMI, but in the end, EMI lost the loyalty of talented artists the company represented. Terra Firma and its investors lost millions on the deal.
The business model in the recording industry rests on the trust of established artists in corporate management. Trust encourages these artists to remain with the label, deliver saleable albums, and remain satisfied with their pay and the agreed release schedules for their work. Not understanding this, Guy Hands, Terra Firma’s founder, saw the norms governing relations between management and artists at EMI as “wasting” money that he could capture for his firm and its investors.
He moved quickly to breach the trust with the company’s artists and suck money out. Terra Firma did increase the cash it could take out of EMI, and things looked good for a while, but it also alienated its top talent — EMI’s most valued asset. Major artists, including The Rolling Stones, Radiohead, and Paul McCartney left; others were slow to deliver albums or to create new material. In the end, the buyout of EMI was a failure. Breaking existing norms and profiting at the expense of its artists jeopardized the future revenue stream of the company. The pursuit of short-term gains led to a failure to invest in EMI’s future and to the alienation of the talented artists who left.
There are clear lessons here. The agencies have made out well with their private equity owners, and the private equity firms have seen their stakes grow. But this entire edifice is built on the talent of the writers who originate the story ideas, write the scripts, and produce words on paper. The agencies are worthless without the talent they represent, as Terra Firma found to its chagrin. If the writers stand together, they have a chance to win a better situation for themselves, and to teach financial capital who really produces value.
