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American Firms Invested $1 Billion in Chinese Chips, Lawmakers Find

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A congressional investigation determined that U.S. funding helped fuel the growth of a sector now viewed by Washington as a security threat.A congressional investigation has determined that five American venture capital firms invested more than $1 billion in China’s semiconductor industry since 2001, fueling the growth of a sector that the United States government now regards as a national security threat.Funds supplied by the five firms — GGV Capital, GSR Ventures, Qualcomm Ventures, Sequoia Capital and Walden International — went to more than 150 Chinese companies, according to the report, which was released Thursday by both Republicans and Democrats on the House Select Committee on the Chinese Communist Party.The investments included roughly $180 million that went to Chinese firms that the committee said directly or indirectly supported Beijing’s military. That includes companies that the U.S. government has said provide chips for China’s military research, equipment and weapons, such as Semiconductor Manufacturing International Corporation, or SMIC, China’s largest chipmaker.The report by the House committee focuses on investments made before the Biden administration imposed sweeping restrictions aimed at cutting off China’s access to American financing. It does not allege any illegality.In August, the Biden administration barred U.S. venture capital and private equity firms from investing in Chinese quantum computing, artificial intelligence and advanced semiconductors. It has also imposed worldwide limits on sales of advanced chips and chip-making machines to China, arguing that these technologies could help advance the capabilities of the Chinese military and spy agencies.Since it was established a year ago, the committee has called for raising tariffs on China, targeted Ford Motor and others for doing business with Chinese companies, and spotlighted forced labor concerns involving Chinese shopping sites.We are having trouble retrieving the article content.Please enable JavaScript in your browser settings.Thank you for your patience while we verify access. If you are in Reader mode please exit and log into your Times account, or subscribe for all of The Times.Thank you for your patience while we verify access.Already a subscriber? Log in.Want all of The Times? Subscribe. More

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    Private Equity Is Starting to Share With Workers, Without Taking a Financial Hit

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    In 2018, Anna-Lisa Miller was working with agricultural cooperatives in Hawaii, helping them reinvest in their communities through shared ownership.Ms. Miller, who had gone to law school and had planned to do civil rights litigation, loved the principle of workers partaking in the financial success of their employers, and the next year joined Project Equity, a nonprofit that helps small businesses transition to worker ownership. But it was slow going, with each transaction requiring customized assistance.Then she came across an investor presentation from a different universe: KKR, one of the world’s largest private equity firms. In it, a KKR executive, Pete Stavros, discussed a model he had been developing to provide employees with an equity stake in companies it purchased, so the workers would reap some benefits if it was flipped for a profit. When all goes according to plan, KKR doesn’t give up a penny of profit, since newly motivated workers benefit the company’s bottom line, elevating the eventual sale price by more than what KKR gives up.In 2021, the two met up to talk about the idea. By that time, Mr. Stavros had decided to start an organization to promote his model more broadly, hoping to reach the 12 million people who work for companies that private equity firms own. Ms. Miller saw it as a way to move much faster.“Me, as Anna-Lisa working at Project Equity — zero ability to influence private equity in any way — I thought, ‘Oh, gosh, maybe this could be a really efficient scale lever,’” Ms. Miller said. “And here’s Pete, not only doing it but wanting to start this nonprofit.”A few months later, she was the founding executive director of the new group, Ownership Works. The organization now has 25 employees working in a sleek New York office space a couple of blocks from KKR’s soaring headquarters at Hudson Yards. A couple of dozen private equity firms have signed on to give the idea a try.We are having trouble retrieving the article content.Please enable JavaScript in your browser settings.Thank you for your patience while we verify access. If you are in Reader mode please exit and log into your Times account, or subscribe for all of The Times.Thank you for your patience while we verify access.Already a subscriber?  More

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    Corporate America Has Dodged the Damage of High Rates. For Now.

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    Small businesses and risky borrowers face rising costs from the Federal Reserve’s moves, but the biggest companies have avoided taking a hit.The prediction was straightforward: A rapid rise in interest rates orchestrated by the Federal Reserve would confine consumer spending and corporate profits, sharply reducing hiring and cooling a red-hot economy.But it hasn’t worked out quite the way forecasters expected. Inflation has eased, but the biggest companies in the country have avoided the damage of higher interest rates. With earnings picking up again, companies continue to hire, giving the economy and the stock market a boost that few predicted when the Fed began raising interest rates nearly two years ago.There are two key reasons that big business has avoided the hammer of higher rates. In the same way that the average rate on existing household mortgages is still only 3.6 percent — reflecting the millions of owners who bought or refinanced homes at the low-cost terms that prevailed until early last year — leaders in corporate America locked in cheap funding in the bond market before rates began to rise.Also, as the Fed pushed rates above 5 percent, from near zero at the start of 2022, chief financial officers at those businesses began to shuffle surplus cash into investments that generated a higher level of interest income.The combination meant that net interest payments — the money owed on debt, less the income from interest-bearing investments — for American companies plunged to $136.8 billion by the end of September. It was a low not seen since the 1980s, data from the Bureau of Economic Analysis showed.That could soon change.While many small businesses and some risky corporate borrowers have already seen interest costs rise, the biggest companies will face a sharp rise in borrowing costs in the years ahead if interest rates don’t start to decline. That’s because a wave of debt is coming due in the corporate bond and loan markets over the next two years, and firms are likely to have to refinance that borrowing at higher rates.Overall Corporate Debt Interest Payments Have PlummetedAlthough the Fed has rapidly raised interest rates, net interest payments paid by corporations are reaching 40-year lows.

    Note: Data consists of interest paid by private enterprises (minus interest income received) as well as rents and royalties paid by private enterprises.Source: Bureau of Economic AnalysisBy The New York TimesThe junk bond market faces a ‘refinancing wall.’Roughly a third of the $1.3 trillion of debt issued by companies in the so-called junk bond market, where the riskiest borrowers finance their operations, comes due in the next three years, according to research from Bank of America.The average “coupon,” or interest rate, on bonds sold by these borrowers is around 6 percent. But it would cost companies closer to 9 percent to borrow today, according to an index run by ICE Data Services.Credit analysts and investors acknowledge that they are uncertain whether the eventual damage will be containable or enough to exacerbate a downturn in the economy. The severity of the impact will largely depend on how long interest rates remain elevated.“I think the question that people who are really worrying about it are asking is: Will this be the straw that breaks the camel’s back?” said Jim Caron, a portfolio manager at Morgan Stanley. “Does this create the collapse?”The good news is that debts coming due by the end of 2024 in the junk bond market constitute only about 8 percent of the outstanding market, according to data compiled by Bloomberg. In essence, less than one-tenth of the collective debt pile needs to be refinanced imminently. But borrowers might feel higher borrowing costs sooner than that: Junk-rated companies typically try to refinance early so they aren’t reliant on investors for financing at the last minute. Either way, the longer rates remain elevated, the more companies will have to absorb higher interest costs.Among the firms most exposed to higher rates are “zombies” — those already unable to generate enough earnings to cover their interest payments. These companies were able to limp along when rates were low, but higher rates could push them into insolvency.Even if the challenge is managed, it can have tangible effects on growth and employment, said Atsi Sheth, managing director of credit strategy at Moody’s.“If we say that the cost of their borrowing to do those things is now a little bit higher than it was two years ago,” Ms. Sheth said, more corporate leaders could decide: “Maybe I’ll hire less people. Maybe I won’t set up that factory. Maybe I’ll cut production by 10 percent. I might close down a factory. I might fire people.”Small businesses have a different set of problems.Some of this potential effect is already evident elsewhere, among the vast majority of companies that do not fund themselves through the machinations of selling bonds or loans to investors in corporate credit markets. These companies — the small, private enterprises that are responsible for roughly half the private-sector employment in the country — are already having to pay much more for debt.They fund their operations using cash from sales, business credit cards and private loans — all of which are generally more expensive options for financing payrolls and operations. Small and medium-size companies with good credit ratings were paying 4 percent for a line of credit from their bankers a couple of years ago, according to the National Federation of Independent Business, a trade group. Now, they’re paying 10 percent interest on short-term loans.Hiring within these firms has slowed, and their credit card balances are higher than they were before the pandemic, even as spending has slowed.“This suggests to us that more small businesses are not paying the full balance and are using credit cards as a source of financing,” analysts at Bank of America said, adding that it points to “financial stress for certain firms,” though it is not yet a widespread problem.Corporate buyouts are also being tested.Carvana renegotiated its debt this year to defer mounting interest costs.Caroline Brehman/EPA, via ShutterstockIn addition to small businesses, some vulnerable privately held companies that do have access to corporate credit markets are already grappling with higher interest costs. Backed by private-equity investors, who typically buy out businesses and load them with debt to extract financial profits, these companies borrow in the leveraged loan market, where borrowing typically comes with a floating interest rate that rises and falls broadly in line with the Fed’s adjustments.Moody’s maintains a list of companies rated B3 negative and below, a very low credit rating reserved for companies in financial distress. Almost 80 percent of the companies on this list are private-equity-backed leveraged buyouts.Some of these borrowers have sought creative ways to extend the terms of their debt, or to avoid paying interest until the economic climate brightens.The used-car seller Carvana — backed by the private-equity giant Apollo Global Management — renegotiated its debt this year to do just that, allowing its management to cut losses in the third quarter, not including the mounting interest costs that it is deferring.Leaders of at-risk companies will be hoping that a serene mix of economic news is on the horizon — with inflation fading substantially as overall economic growth holds steady, allowing Fed officials to end the rate-increase cycle or even cut rates slightly.Some recent research provides a bit of that hope.In September, staff economists at the Federal Reserve Bank of Chicago published a model forecast indicating that “inflation will return to near the Fed’s target by mid-2024” without a major economic contraction. If that comes to pass, lower interest rates for companies in need of fresh funds could be coming to the rescue much sooner than previously expected.Few, at this point, see that as a guarantee, including Ms. Sheth at Moody’s.“Companies had a lot of things going for them that may be running out next year,” she said.Emily Flitter More

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    Biden to Restrict Investments in China, Citing National Security Threats

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    The measure to clamp down on investments in certain industries deemed to pose security risks, set to be issued Wednesday, appears likely to open a new front in the U.S.-China economic conflict.The Biden administration plans on Wednesday to issue new restrictions on American investments in certain advanced industries in China, according to people familiar with the deliberations, a move that supporters have described as necessary to protect national security but that will undoubtedly rankle Beijing.The measure would be one of the first significant steps the United States has taken amid an economic clash with China to clamp down on outgoing financial flows. It could set the stage for more restrictions on investments between the two countries in the years to come.The restrictions would bar private equity and venture capital firms from making investments in certain high-tech sectors, like quantum computing, artificial intelligence and advanced semiconductors, the people said, in a bid to stop the transfer of American dollars and expertise to China.It would also require firms making investments in a broader range of Chinese industries to report that activity, giving the government better visibility into financial exchanges between the United States and China.The White House declined to comment. But Biden officials have emphasized that outright restrictions on investment would narrowly target a few sectors that could aid the Chinese military or surveillance state as they seek to combat security threats but not disrupt legitimate business with China.“There is mounting evidence that U.S. capital is being used to advance Chinese military capabilities and that the U.S. lacks a sufficient means of combating this activity,” said Emily Benson, the director of project on trade and technology at the Center for Strategic and International Studies, a Washington think tank.The Biden administration has recently sought to calm relations with China, dispatching Treasury Secretary Janet L. Yellen and other top officials to talk with Chinese counterparts. In recent speeches, Biden officials have argued that targeted actions taken against China are aimed purely at protecting U.S. national security, not at damaging the Chinese economy.At the same time, the Biden administration has continued to push to “de-risk” critical supply chains by developing suppliers outside China, and it has steadily ramped up its restrictions on selling certain technologies to China, including semiconductors for advanced computing.The Chinese government has long restricted certain foreign investments by individuals and firms. Other governments, such as those of Taiwan and South Korea, also have restrictions on outgoing investments.But beyond screening Chinese investment into the United States for security risks, the U.S. government has left financial flows between the world’s two largest economies largely untouched. Just a few years ago, American policymakers were working to open up Chinese financial markets for U.S. firms.In the past few years, investments between the United States and China have fallen sharply as the countries severed other economic ties. But venture capital and private equity firms have continued to seek out lucrative opportunities for partnerships, as a way to gain access to China’s vibrant tech industry.The planned measure has already faced criticism from some congressional Republicans and others who say it has taken too long and does not go far enough to limit U.S. funding of Chinese technology. In July, a House committee on China sent letters to four U.S. venture capital firms expressing “serious concern” about their investments in Chinese companies in areas including artificial intelligence and semiconductors.Others have argued that the restriction would mainly put the U.S. economy at a disadvantage, because other countries continue to forge technology partnerships with China, and China has no shortage of capital.Nicholas R. Lardy, a nonresident senior fellow at the Peterson Institute for International Economics, said the United States was the source of less than 5 percent of China’s inbound direct investment in 2021 and 2022.“Unless other major investors in China adopt similar restrictions, I think this is a waste of time,” Mr. Lardy said. “Pushing this policy now simply plays into the hands of those in Beijing who believe that the U.S. seeks to contain China and are not interested in renewed dialogue or a ‘thaw.’”Biden officials have talked with allies in recent months to explain the measure and encourage other governments to adopt similar restrictions, including at the Group of 7 meetings in Japan in May. Since then, Ursula von der Leyen, the president of the European Commission, has urged the European Union to introduce its own measure.The administration is expected to give businesses and other organizations a chance to comment on the new rules before they are finalized in the months to come.Claire Chu, a senior China analyst at Janes, a defense intelligence company, said that communicating and enforcing the measure would be difficult, and that officials would need to engage closely with Silicon Valley and Wall Street.“For a long time, the U.S. national security community has been reticent to recognize the international financial system as a potential warfighting domain,” she said. “And the business community has pushed back against what it considers to be the politicization of private markets. And so this is not only an interagency effort, but an exercise in intersectoral coordination.” More

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    ‘The World’s Largest Construction Site’: The Race Is On to Rebuild Ukraine

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    Latvian roofing companies and South Korean trade specialists. Fuel cell manufacturers from Denmark and timber producers from Austria. Private equity titans from New York and concrete plant operators from Germany. Thousands of businesses around the globe are positioning themselves for a possible multibillion-dollar gold rush: the reconstruction of Ukraine once the war is over.Russia is stepping up its offensive heading into the second year of the war, but already the staggering rebuilding task is evident. Hundreds of thousands of homes, schools, hospitals and factories have been obliterated along with critical energy facilities and miles of roads, rail tracks and seaports.The profound human tragedy is unavoidably also a huge economic opportunity that Ukraine’s president, Volodymyr Zelensky, has likened to the Marshall Plan, the U.S. program that provided aid to Western Europe after World War II. Early cost estimates of rebuilding the physical infrastructure range from $138 billion to $750 billion.The prospect of that trove is inspiring altruistic impulses and entrepreneurial vision, savvy business strategizing and rank opportunism for what the Ukrainian chamber of commerce is trumpeting as “the world’s largest construction site!”Mr. Zelensky and his allies want to use the rebuilding to stitch Ukraine’s infrastructure seamlessly into the rest of Europe.Yet whether all the gold in the much-anticipated gold rush will materialize is far from certain. Ukraine, whose economy shrank 30 percent last year, desperately needs funds just to keep going and to make emergency repairs. Long-term reconstruction aid will depend not only on the outcome of the war, but on how much money the European Union, the United States and other allies put up.And though private investors are being courted, few are willing to risk committing money now, as the conflict is entrenched.Ukraine and several European nations are pushing hard to confiscate frozen Russian assets held abroad, but several skeptics, including officials in the Biden administration, have questioned the legality of such a move.Ukraine desperately needs funds just to keep going and to make emergency repairs.Maciek Nabrdalik for The New York TimesThe war, a profound human tragedy, is unavoidably also a big economic opportunity that Ukraine’s president, Volodymyr Zelensky, has likened to the Marshall Plan.Maciek Nabrdalik for The New York TimesNonetheless, “a lot of companies are starting to position themselves to be ready and have some track record for this time when the reconstruction funding will be coming in,” said Tymofiy Mylovanov, a former economy minister who is president of the Kyiv School of Economics. “There will be a lot of funding from all over the world,” he said, and business are saying that “we want to be a part of it.”The State of the WarVuhledar: A disastrous Russian assault on the Ukrainian city, viewed as an opening move in an expected spring offensive, has renewed doubts about Moscow’s ability to sustain a large-scale ground assault.Bakhmut: With Russian forces closing in, Ukraine is barring aid workers and civilians from entering the besieged city, in what could be a prelude to a Ukrainian withdrawal.Arms Supply: Ukraine and its Western allies are trying to solve a fundamental weakness in its war effort: Kyiv’s forces are firing artillery shells much faster than they are being produced.Prisoners of War: Poorly trained Russian soldiers captured by Ukraine describe being used as cannon fodder by commanders throwing waves of bodies into an assault.More than 300 companies from 22 countries signed up for a Rebuild Ukraine trade exhibition and conference this week in Warsaw. The gathering is just the latest in a dizzying series of in-person and virtual meetings. Last month, at the World Economic Forum in Davos, Switzerland, a standing-room-only crowd packed Ukraine House to discuss investment opportunities.More than 700 French companies swarmed to a conference organized in December by President Emmanuel Macron. And on Wednesday, the Finnish Confederation of Industries sponsored an all-day webinar with Ukrainian officials so companies could show off their wastewater treatment plants, transformers, threshers and prefabricated housing.“There’s so many initiatives, it’s hard to know who’s doing what,” said Sergiy Tsivkach, the executive director of UkraineInvest, the government office dedicated to attracting foreign investment.Mr. Tsivkach sipped a beer a couple of blocks from Lviv’s central square. He is glad for the interest but emphasized a crucial point.“They all say, ‘We want to help in rebuilding Ukraine,’” he said. “But do you want to invest your own money, or do you want to sell services or goods? These are two different things.”Most are interested in selling something, he said.Long-term reconstruction aid will depend on how much money the European Union, the United States and other allies put up.Maciek Nabrdalik for The New York Times“There’s so many initiatives, it’s hard to know who’s doing what,” said Sergiy Tsivkach, the executive director of UkraineInvest, the government office dedicated to attracting foreign investment. Maciek Nabrdalik for The New York TimesFor businesses, a crucial issue is who will control the money. This is a question that Europe, the United States and global institutions like the World Bank — the biggest donors and lenders — are vigorously debating.“Who will pay for what?” Domenico Campogrande, director general of the European Construction Industry Federation, said while moderating a panel at the Warsaw conference.Representatives from both Ukrainian and foreign companies were more pointed: Who will decide on the contracts, and how do they apply?“Hundreds of companies have been asking me this,” said Tomas Kopecny, the Czech government’s envoy for Ukraine.Ukraine has made clear there will be rewards for early investors when it comes to postwar reconstruction. But that opportunity carries risk.Danfoss, a Danish industrial company that sells heat-efficiency devices and hydraulic power units for apartment and other buildings, has been doing business in Ukraine since 1997. When the war started last February, Russian shelling destroyed its Kyiv warehouse.Danfoss has since focused on helping with immediate needs in war-torn regions and in western Ukraine, where millions of people displaced from their homes have been forced to settle in temporary shelters.“For now, all efforts are going toward maintaining a survival mode,” said Andriy Berestyan, the company’s managing director in Ukraine. “Right now, nobody is really looking for major reconstruction.”Things had been going better for the company since last summer as Ukraine pushed back Russian advances. By October, new orders for Danfoss’s products were rolling in, and Mr. Berestyan restored Danfoss’s distribution center in Kyiv. Then Russia started dropping bombs en masse. Power and water were widely cut off, forcing Ukraine — and businesses — to swing back to dealing with emergencies.Even so, he said, Danfoss is keeping its eye on the long term. “Definitely there will be rebuilding opportunities,” he said, “and we see a huge, huge opportunity for ourselves and for similar companies.”Andriy Berestyan, the managing director of Danfoss in Ukraine. The Danish company sells heat-efficiency devices and hydraulic power units for buildings. Its Kyiv warehouse was destroyed last year.Diego Ibarra Sanchez for The New York TimesThe question of who will control the money invested in Ukraine is one that Europe, the United States and global institutions like the World Bank are debating.Maciek Nabrdalik for The New York TimesThat groundwork is being laid in places like Mykolaiv, one of the hardest-hit regions, where numerous Danish companies have been working. Drones operated by Danish companies have mapped every bombed-out structure, with an eye toward using the data to help decide what reconstruction contracts should be issued.The information would help companies like Danfoss evaluate the potential for business, and eventually bid on contracts.Other governments that are expected to contribute to Ukraine’s reconstruction are also offering financial support for domestic firms.Germany announced the creation of a fund to guarantee investments. The plan will be overseen by the global auditing giant PwC and would compensate investors for potential financial losses if businesses were expropriated or projects were disrupted.France will also offer state guarantees to companies doing future work in Ukraine. Bruno Le Maire, the finance minister, said contracts worth a total of 100 million euros, or $107 million, had been awarded to three French companies for projects in Ukraine: Matière will build 30 floating bridges, and Mas Seeds and Lidea are providing seeds for farmers.Private equity firms, too, have an eye on business opportunities. President Zelensky sealed a deal late last year with Laurence D. Fink, the chief executive of BlackRock, to “coordinate investment efforts to rebuild the war-torn nation.” BlackRock, the world’s largest asset manager, will advise Kyiv on “how to structure the country’s reconstruction funds.” The work will be done on a pro bono basis, but promises to give BlackRock insights into investors’ interests.Mr. Fink was brought into the effort by Andrew Forrest, a gregarious Australian mining magnate who is the chief executive of Fortescue Metals Group. Mr. Forrest announced a $500 million initial investment in November, from his own private equity fund, into a new pot of money created for rebuilding projects in Ukraine. The fund would be run with BlackRock and aims to raise at least $25 billion from sovereign wealth funds controlled by national governments and private investors from around the world for clean energy investments in war-torn areas.Andrew Forrest, the chief executive of Fortescue Metals Group, in 2021. Mr. Forrest announced a $500 million initial investment in a pot of money for rebuilding projects in Ukraine. David Dare Parker for The New York TimesMr. Zelensky and his allies want to use the rebuilding to stitch Ukraine’s infrastructure seamlessly into the rest of Europe.Maciek Nabrdalik for The New York TimesMr. Forrest has courted Mr. Zelensky, wearing a Ukrainian flag pin in his lapel and presenting the Ukraine president with an Australian bullwhip during a visit to Kyiv last year. But in a sign of how cautious investors remain, Mr. Forrest said capital would be made available “the instant that the Russian forces have been removed from the homelands of Ukraine” — but not before.Eshe Nelson More

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    When Private Equity Came for the Toddler Gyms

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    Tiffany Cianci spends most of her days in socks, padding around the fitness studio she operates in Frederick, Md., about an hour outside Washington. Her clients are young: kids ranging from 4 months to 12 years old. They come to learn somersaults, try the monkey bars, sing some songs. (“Little Red Caboose,” complete with a train whistle accompaniment, is one of her favorites.)Ms. Cianci, 41, spent the first part of her career as a sommelier, specializing in sake. In 2017, wanting to leave the hospitality industry for something that allowed her to spend more time at home, she and her husband bought their facility as part of a franchise chain called The Little Gym. Its slogan: “Serious fun.”They got what generations of franchise owners have gotten out of similar deals, with brands like McDonald’s or Jiffy Lube: a known brand name and detailed business plans in exchange for an initial fee and a cut of the revenue. For Ms. Cianci, it was more than just a business.“I love it. I really love it,” said Ms. Cianci, a mother of three who studied dance. “I love my students, and I love that it lets me make a difference.”In the last year and a half, since The Little Gym was acquired by a private equity-backed firm called Unleashed Brands, her work has felt far less idyllic.According to legal filings, internal documents, and interviews with more than half a dozen other franchisees — most of whom requested anonymity so as to avoid retaliation — Unleashed began to demand higher fees and institute more stringent requirements, which the independent owners thought would threaten their profits. The day after Ms. Cianci organized her fellow franchise owners into an association to push back against the changes, the corporate office told her it was terminating her license on the grounds that she was chronically late in paying her fees. Given the timing, Ms. Cianci maintains in the legal filings that it constituted retaliation.Tiffany Cianci, the owner of Teeter Tots, is fighting a court battle against Unleashed Brands, which bought the company that originally franchised her business.Lexey Swall for The New York TimesAlong the way, Unleashed Brands surveilled Ms. Cianci’s business with undercover shoppers, met with her landlord and disparaged her to fellow franchisees. When she tried to salvage her business under a new name — it’s now called Teeter Tots Music n Motion — the company sued, accusing her of violating its trademarks and a noncompete clause in her franchise agreement.The episode has plunged Ms. Cianci about $300,000 into debt and enmeshed Unleashed in a nasty court battle not long after it acquired multiple new brands. The outcome will be a test of just how much a franchisor can unilaterally change the rules of a business relationship that has served as an on-ramp to entrepreneurship for hundreds of thousands of people.The legal fight — along with two others Unleashed has faced with franchisees at its other brands — also reveals the challenges of applying the private equity playbook to the unique world of franchises.Private equity has notched decades of high returns for investors by following a well-worn strategy: acquire distressed or undervalued companies or real estate, increase profits and then sell them. Greatest hits include foreclosed homes, highway rest stops and coal mines bought out of bankruptcy.Franchising has become one of private equity’s targets du jour. According to the research firm FRANdata, the number of franchise brands acquired by private equity firms and other investors rose from 52 in 2019 to 149 in 2021 and was on track to nearly equal that total in 2022.Private equity firms tout their ability to bring new ideas, technologies and efficiencies, and franchises, financially weakened by the pandemic, appeared ripe for those kinds of changes.But the reality is not so straightforward. The nation’s franchisees — 237,619, according to FRANdata — like Ms. Cianci, think of themselves as independent small businesses, who have often sunk their life savings into the enterprise. That’s why Little Gym owners are resisting Unleashed’s attempts to squeeze their profits to pad its own.Unlike, say, factory workers, who can be laid off at will, franchisees are supposed to be protected by legal documents that prescribe a certain business model for years at a time. Moreover, Unleashed — and its investors — need franchisees to stay motivated so they can keep generating revenue and recruit others to keep expanding the franchise system.Ms. Cianci, who is now in arbitration with Unleashed Brands, has been working to change state laws to better protect franchisees who might find themselves in her position down the line. The Federal Trade Commission, meanwhile, is reconsidering federal regulations on franchisors, which haven’t changed for more than a decade.Direct inquiries to Michael Browning Jr., Unleashed’s chief executive and founder, and other executives were not returned. Instead, a public relations firm answered detailed questions via email, saying the company’s changes have improved business across the board. “The financial impact and franchisee benefit of these efforts is undeniable,” the spokesman wrote.Many of the changes, however, are simply not what franchisees say they’d signed up for.“What this reflects is a conflict between the private equity firm that bought this and what they actually bought,” said Francine Lafontaine, an economist at the University of Michigan who specializes in franchise relationships. “In their due diligence, they didn’t seem to think too much about who they were going to be working with once they owned this chain.”‘Candy Land board of life’Ms. Cianci helps Mariah Strawley move her daughter, Brynlee Strawley, 19 months, through an obstacle course during a class.Lexey Swall for The New York TimesMr. Browning, the son of a real estate developer with a background in health care investing, viewed The Little Gym as a perfect part of his vision: He was building a conveyor belt of activities for kids.Mr. Browning spent the 2010s building a franchise called Urban Air, a chain of trampoline parks where parents could spend $700 on a birthday party to remember for their seventh grader. The venture was staked by Mr. Browning and his father and eventually Urban Air formed Unleashed.Private equity was also interested in the Brownings’ growing business. While a company spokesman did not clarify the company’s relationship with private equity, on the websites of the private equity firms AHR Growth Partners, Mantucket Capital and MPK Equity Partners, Unleashed or its brands are listed among their current or recent investments.In 2021, Mr. Browning decided to scale up, following a hot new trend in private equity: building “platforms” to consolidate several brands in a similar industry that could then cross-sell a range of services to their customers, as well as sell more franchises to their existing franchisees. Mr. Browning would often mention Neighborly, a roll-up of home services offerings that had been bought by the private equity giant KKR, as his model.“If I have five home services brands, I can pitch all those services to the same customer,” said Ritwik Donde, senior research analyst at FRANdata, which helps investors vet potential acquisitions. “Those complementary systems lower the cost of customer acquisition. ”Mr. Browning’s company, Unleashed Brands, began buying other youth enrichment chains. Parents — always moms, in Mr. Browning’s conception — could then spend money at his companies from the birth of their kids through high school graduation.Ms. Cianci was immediately skeptical of Mr. Browning’s vision for rapidly collecting children’s services and integrating their sales, operations and marketing.“That might be OK when you’re cleaning a dryer vent, but it’s not when you’re throwing around a 4-month-old and you need them to be safe,” Ms. Cianci said. “He was moving faster than he would need to get to know the business.”Ms. Cianci helped organize a group of Little Gym franchisees to contest some new requirements imposed by Unleashed Brands.Lexey Swall for The New York TimesTo kick off the new program, Unleashed invited all of its newly acquired franchisees to a conference in Orlando in October 2021, including Little Gym’s approximately 175 owners. The company rented out the Wizarding World of Harry Potter and held a fireworks show. And Mr. Browning treated attendees to a speech he called “vision casting,” in which he articulated his plans for building a family of children’s brands that families could spend money on from birth to age 18.The “Candy Land board of life,” he called it. He promised new tech tools that would make their lives easier. “Auto-magic,” he called it.Changes didn’t take long. Within weeks, long-tenured headquarters employees started leaving. In conversations with franchisees across the country, numerous owners expressed frustration that the support they depended on had evaporated; instead of calling a trusted adviser whenever they wanted, they had to file an online ticket. (Unleashed said that it “never sought to cut access” to its staff and that the ticket system was instituted to make sure they were responding in a timely fashion.)The company tried to impose a new payroll vendor that caused unending headaches. Certain activities, such as karate, were eliminated as Unleashed acquired businesses with similar programming; the company said it trimmed services with low enrollment to “streamline” the offerings. The company also outlined a process by which franchisees could lose their licenses if they failed to meet brand standards, which set a sour tone among some of the operators. To people who’d just made it through a pandemic and operated on thin margins even in good times, the changes felt unnecessary and destabilizing.In the fall of 2021, the company required all franchisees to sign a new agreement allowing Unleashed to automatically debit their bank accounts. Ms. Cianci noticed that it also contained broad language allowing the company to extract any other fees that might be owed, which she believed went beyond her franchise agreement.Under the advice of a lawyer, she refused to sign it and started to send her royalty payments via paper check. But she worried that most franchisees would simply accept the new arrangement, along with another requiring them to use — and pay for — a shared call center.To sound the alarm to others, Ms. Cianci held conference calls, often with a lawyer present. As concerns spread, in May a group of Little Gym franchisees formed the Happy Handstands Franchisee Association, which ultimately reached more than 90 percent participation from across the system. Ms. Cianci was elected president. The company started sending warning notices to franchisees who hadn’t signed the new agreements.On May 19, 2022, Happy Handstands’ lawyers sent Unleashed a cease-and-desist letter on behalf of the membership. The very next evening, an email popped up saying Ms. Cianci’s franchise had been terminated. When she tried to check it, her email account was gone, too. Unleashed said the company didn’t know she was the association’s president when they decided to terminate her. Ms. Cianci said it was widely known across the system and mentioned in a Facebook group visible to lower-level corporate executives.To save her business, Ms. Cianci went before an arbitrator and filed for a preliminary injunction decrying the termination as retaliatory; the arbitrator ruled that she hadn’t cleared the high legal bar necessary to stop the process. After that, she started tearing down all her Little Gym branding and adapting her curriculum so as not to violate the company’s trademarks. She paused when Unleashed’s lawyers wanted to discuss a settlement, which she said she rejected over its harsh terms. When they demanded she finish the process of “de-identifying” as a Little Gym immediately, she had difficulty getting started again because she had surgery on a broken foot.In June and July, the company sent undercover shoppers, including one who was a licensed private investigator, who posed as parents and asked Ms. Cianci’s employees what kinds of lessons they offered and whether they overlapped with The Little Gym’s programming. In early July, Unleashed, with the help of outside counsel DLA Piper, sued her in the superior court of Arizona for Maricopa County, where The Little Gym is based. The company accused her of failing to eliminate all branding fast enough, offering declarations from the investigators as evidence — the color scheme looked the same, for example, and a Wi-Fi network was still “TheLittleGym,” password “SeriousFun.”Soon after, the company’s lawyers also visited her landlord in Frederick, which Unleashed said was “part of a standard process to inquire as to the status of the lease.” According to Ms. Cianci’s notes from her subsequent conversation with the landlord, the lawyers told him that she was in legal trouble and wouldn’t be able to keep paying rent.Her landlord then sent her a letter, which was filed as evidence in court, declining to renew her lease and demanding more than $275,000 in back rent, including real estate taxes, most of which Ms. Cianci thought had been forgiven during the pandemic. Unleashed then exercised its option to take over the lease, although the building remains empty. (Her landlord declined to comment.)In mid-July, Unleashed Brands’ chief legal officer, Stephen Polozola, sent all Little Gym franchisees an email titled “Friendly Reminder on Confidentiality.” In it, without naming Ms. Cianci, he warned them not to share any information with a certain former franchisee, who he said had been terminated for not paying royalty fees on time.Further, he wrote that the company had received reports from “no less than seven” former employees who said that the unnamed franchisee had underpaid them and created a hostile work environment. The email finished with a grainy screenshot of a Facebook post containing a vulgar message that Mr. Polozola said had come from that same franchisee but didn’t have her name attached.The battle has put Ms. Cianci about $300,000 in debt and enmeshed Unleashed in a nasty court battle just as it tries to get its investment strategy off the ground.Lexey Swall for The New York TimesMs. Cianci, who had taken her son to a water park for his birthday, immediately started getting messages from other franchisees. None of it was true, she told them. As she would detail in court documents, the company allowed late payments for nearly all franchisees during the pandemic, and her gym had been closed by local ordinance for longer than most. She had continued to send her royalties in the mail, even after she refused to sign Unleashed’s new payment form, she said, and she was current on all her accounts when she was terminated. And the inappropriate Facebook post? She said she hadn’t written it.The allegations by Ms. Cianci’s former employees that Mr. Polozola referred to in his “friendly reminder” email sprang from messages that were sent by the workers in April 2021, before the Little Gym changed hands. After an investigation, no action was taken. The Unleashed spokesman said the company had relied on Ms. Cianci’s assurance that she would resolve the matter with the Maryland Department of Labor. Ms. Cianci said she made no such assurance.In response to an inquiry from The New York Times, the Department of Labor provided records showing a total of five complaints against Ms. Cianci for unpaid wages since 2017, two of which she resolved by paying her former employees; two were dropped; and one is still pending.But the emails from the former employees, which Unleashed supplied to The Times in unredacted form, detail complaints other than unpaid wages — such as dealing pills and mistreating children — that would seem to merit more immediate action by corporate headquarters, and which Ms. Cianci strongly denies.In late summer of 2021, when one of the former employees contacted Unleashed again, Mr. Polozola told Ms. Cianci to ignore it, according to an email exchange she provided — until he brought the complaints back up to discredit her nearly a year later.Arguing that such tactics seemed far outside the norms of legal practice, in September Ms. Cianci’s team filed a defense of so-called unclean hands, making the case that Unleashed Brands’ conduct had so tainted the proceedings that the judge should rule in their favor.But their motion never went anywhere. Before the judge could rule on it, Unleashed filed to dismiss its own case, arguing that its complaint that Ms. Cianci was essentially operating an unauthorized Little Gym was moot because her landlord had evicted her.The upshot of all this legal wrangling is that the fight between Ms. Cianci and Unleashed continues in arbitration in Arizona. In arbitration, potential damages are more limited, proceedings are sealed, and no precedent is created for other cases.Unleashed is fighting to stop Ms. Cianci from running what it says is a competing gym. Ms. Cianci is fighting for the chance to keep her new business and recoup the hundreds of thousands of dollars she has now spent on lawyers.One of them, Peter Lagarias, began his career at the F.T.C., enforcing the agency’s then-new franchise rule in the late 1970s, and spent most of his career advocating for franchisees both in the courtroom and the California statehouse. He took her case for a low rate, but arbitrators, whose cost must be split by both parties, can run tens of thousands of dollars, too.“They don’t want money,” Ms. Cianci said of Unleashed. “They want to destroy my life.”‘You can’t treat every business the same’Bill Walenda, 55, also got into running Little Gyms as a second career. After years as a financial planner, he wanted to buy a franchise — maybe a McDonald’s or a Dunkin’ Donuts — and his wife suggested The Little Gym, since he loved working with children. He opened a gym in New Jersey in 2002 and bought another in Illinois in 2009.After Ms. Cianci’s franchise was terminated, the Happy Handstands Franchisee Association fractured over strategy. Another group of owners started an association with a different approach: working “collaboratively” with the corporate office to provide feedback on changes. Mr. Walenda was elected president, and he has had limited success.He has been fighting a new point-of-sale system with a credit card processor controlled by Unleashed, which franchisees say is keeping customer payments for more than a week before sending them to gym owners, creating a cash flow crunch for owners. (Unleashed said the system keeps money for only two or three days.)The company also continues to try to make everyone use its new shared call center, which Mr. Walenda said would “take us out of the equation of dealing with our customers” — something that might work for a business like Urban Air, which processes thousands of people a week, but not the familial relationships on which The Little Gym operated for decades.“You can’t treat every business the same,” Mr. Walenda said. “And that’s really what’s causing all of this strife.”In November, Unleashed introduced a revised operations manual that lays out new rules and fees. It specifies the hours the businesses must be open, how quickly they must return customer calls, which architect they must use and what company meetings they must attend. Staff salaries were only supposed to make up 30 percent of revenue. The technology fee can rise to $399 from $119.The national advertising fee can rise to 5 percent of gross sales from 1 percent; part of that will go to a fund that supports other Unleashed properties. New fees appeared, including a $30,000 fee to renew the franchise agreement, and a fee of about $15,000 to relocate the facility. For some owners, the changes seem to mean that they can no longer operate profitably and will have to sell rather than renew.Unleashed said the changes only apply to new franchisees, and Mr. Walenda said his group has been able to negotiate away some of the fees even for them. But other fees remain, including a $100,000 payment if the franchise is terminated, and Mr. Walenda said the company continues to try to force everyone to use its call center and point-of-sale system. As much as he believes in the collaborative approach, he’s willing to litigate to stop the attempts to extract more money.“That’s all private equity cares about, as far as I’m concerned,” Mr. Walenda said. His business is doing well, which he credits to the postpandemic desperation for children’s activities; he said Unleashed’s new systems have mostly just taken more time for his managers to deal with.“We’re not people, we’re not businesses, we’re just numbers to them,” Mr. Walenda said. “And that’s a problem. Because ‘Let’s just keep squeezing everything we can out of them until we can’t squeeze anymore’ — it’s a good way of making money. It’s not a very good way to run a business.”Ms. Cianci says she hopes to prove that it’s possible to resist a franchiser’s efforts to impose its will outside what are supposed to be legally binding agreements.Lexey Swall for The New York TimesAfter a year of owning The Little Gym, Unleashed Brands says that average gym revenue rose 36.8 percent in 2022 over 2019. And its franchisee recruitment has focused on people who want to open multiple units, such as Cody Herndon, whom Unleashed provided as an example of a Little Gym owner with a more positive view of management.An Urban Air operator who sold one of his two parks to another private equity investor, Mr. Herndon bought the rights to open three Little Gyms in Texas last year. He said he was drawn by the opportunity to have longer-term relationships with families and thought the new systems Unleashed was pushing would work out in the end.“There are going to be so many massive benefits to any change that’s been asked,” Mr. Herndon said.While disclosing few other metrics, the company told Axios in May that it expected to generate $160 million in revenue in 2022 and was shopping for a buyer. It appears to have found one.Unleashed’s current private equity investors are selling their stakes in the company imminently, according to a company spokesman. But the company declined to disclose the buyer or the terms of the deal.Whoever the buyer may be, they’ve got significant franchisee rancor on their hands — even beyond the Little Gym.At Mr. Browning’s original chain, Urban Air, a franchisee association representing more than 50 owners tried to bring a lawsuit in 2020 over what it viewed as unfair changes that had revealed the “terms and provisions of the franchise agreements upon which investment decisions were made to be illusory and meaningless.” But a Texas court threw the case out on technical grounds, and with individual arbitration the only path forward, the effort fell apart.In late 2022, Unleashed was also sued by 54 franchisees of its Premier Martial Arts brand who said in legal filings that the franchisor gave them an unrealistic impression of the cost of running a martial arts studio, leaving them with dead-end businesses and debt.Michelle and Peter Silberman of Wexford, Pa., depleted their retirement savings, maxed out their credit cards and took out a home-equity loan to acquire three Premier Martial Arts territories in 2020.Ross Mantle for The New York TimesMichelle and Peter Silberman depleted their retirement savings, maxed out their credit cards and took out a home-equity loan to acquire three Premier Martial Arts territories in March 2020, before Unleashed owned the franchisor. The first opened near their home in the Pittsburgh area in May 2022. Mr. Silberman said Premier Martial Arts told them that they could expect profit margins as high as 48 percent, while running the studios as “semi-absentee” owners who had to run the business as little as 10 hours a week.The couple was charging parents $138 a month, which included two classes a week. The Silbermans, who had no experience with martial arts, said they relied on the company’s assurances that it would help them manage the business.But when attendance began to decline and expenses were piling up — the couple spent $370,000 acquiring the territories and operating the one facility — Mr. Silberman said Premier Martial Arts offered little additional help. Their studio closed this past fall. Although the trouble began long before Unleashed announced that it had bought Premier Martial Arts in early 2022, the lawsuit states that after the acquisition, “the same false statements were still made and the same bogus model was pitched.”In response, the Unleashed spokesman said the company is “not a party to any contract” with a Premier Martial Arts franchisee.As for the Silbermans, they have been trying to pay down their debts.“We are, hopefully, going to avoid bankruptcy by the skin of our teeth,” said Mr. Silberman.New rules for franchisesMs. Cianci’s case is winding its way through arbitration. Her new gym in a suburban mall next to Macy’s has only about 74 members, compared with the 275 she had before her termination by Unleashed. She said her husband, a federal trademark attorney, is working long hours to support them.In the meantime, she’s trying to prevent future franchisees from being put in the situation she found herself in.As the F.T.C. reviews the rules governing franchising, advocates have urged the commission to add stronger protections, such as more disclosure of how the average franchise location performs. The International Franchise Association — whose board Mr. Browning recently joined — has lobbied hard to avert those changes.In Congress, Senator Catherine Cortez Masto, a Democrat from Nevada, has done extensive research on problems with the franchise system and introduced two bills seeking to give franchisees more leverage. But their fate is uncertain.That’s why Ms. Cianci is focused on the states. Specifically Arizona, where The Little Gym headquarters is based. Lawmakers have introduced a bill that would protect franchisees’ right to form associations, require changes to their agreements to be presented in contractual form, and limit the circumstances under which their licenses could be terminated.At the very least, she hopes her case will ultimately prove that it’s possible to resist a franchisor’s efforts to impose its will outside what are supposed to be legally binding agreements, whether it’s how many birthday parties to offer or which insurance company to use.“That’s exactly what went wrong here,” Ms. Cianci said. “He’s buying companies where people had rights.” More

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    Fed Frets About Shadow Banks and Eyes Treasury Liquidity in New Report

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    The Federal Reserve is watching the government bond market and investment funds as rate increases ricochet through finance.The Federal Reserve warned in its twice-annual report on America’s financial stability that the government bond market could be primed for disruption, and cautioned that financial firms that operate outside of traditional banks could increase fragility in the system.Investors have been warning that market conditions are becoming increasingly fraught nine months into the Fed’s fastest rate-increase campaign since the 1980s. While the central bank is determined to push ahead with its effort to slow the economy as it tries to choke off rapid inflation, officials are keeping a careful eye on market conditions. A financial meltdown would make the Fed’s job more difficult — potentially even forcing it to deviate from some of its tightening efforts.Financial stability issues are in focus as central banks around the world raise interest rates in synchrony and other markets around the world — including the government bond market in Britain — offer early warning signs that cracks are beginning to emerge.The Financial Stability Report, released on Friday, delved into widely discussed challenges that have been plaguing Treasury markets and detailed less prominent vulnerabilities. Those included elevated leverage at financial institutions beyond banks, what is often referred to as the “shadow banking” system.The ease of trading Treasury securities, called liquidity, has been strained in recent months, which is making analysts and investors nervous that the market could be primed for disruption. The Fed attributed the decline in liquidity “primarily” to volatility in interest rates and economic uncertainty.What the Fed’s Rate Increases Mean for YouCard 1 of 4A toll on borrowers. More

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    The Carried Interest Loophole Survives Another Political Battle

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    The latest effort to narrow the preferential tax treatment used by private equity executives failed after Senator Kyrsten Sinema objected.WASHINGTON — Once again, carried interest carried the day.The last-minute removal by Senate Democrats of a provision in the climate and tax legislation that would narrow what is often referred to as the “carried interest loophole” represents the latest win for the private equity and hedge fund industries. For years, those businesses have successfully lobbied to kill bills that aimed to end or limit a quirk in the tax code that allows executives to pay lower tax rates than many of their salaried employees.In recent weeks, it appeared that the benefit could be scaled back, but a last-minute intervention by Senator Kyrsten Sinema, the Arizona Democrat, eliminated what would have been a $14 billion tax increase targeting private equity.Lawmakers’ inability to address a tax break that Democrats and some Republicans have called unfair underscores the influence of lobbyists for the finance industry and how difficult it can be to change the tax code.In addition to doing away with the carried interest provision, the deal Democratic leaders cut with Ms. Sinema included a 1 percent excise tax on stock buybacks and changes to a minimum corporate tax of 15 percent that favored manufacturers.On Friday, the private equity and hedge fund industries applauded the development, describing it as a win for small business.“The private equity industry directly employs over 11 million Americans, fuels thousands of small businesses and delivers the strongest returns for pensions,” said Drew Maloney, the chief executive of the American Investment Council, a lobbying group. “We encourage Congress to continue to support private capital investment in every state across our country.”Bryan Corbett, the chief executive of the Managed Funds Association, said: “We’re happy to see that there is bipartisan recognition of the role that private capital plays in growing businesses and the economy.”Carried interest is the percentage of an investment’s gains that a private equity partner or hedge fund manager takes as compensation. At most private equity firms and hedge funds, the share of profits paid to managers is about 20 percent.Under existing law, that money is taxed at a capital-gains rate of 20 percent for top earners. That’s about half the rate of the top individual income tax bracket, which is 37 percent. A tax law passed by Republicans in 2017 largely left the treatment of carried interest intact, after an intense lobbying campaign, but it did narrow the exemption by requiring executives to hold their investments for at least three years in order to enjoy preferential tax treatment.An agreement reached last week by Senator Joe Manchin III, Democrat of West Virginia, and Senator Chuck Schumer of New York, the majority leader, would have extended that holding period to five years from three, while changing the way the period is calculated in hopes of reducing taxpayers’ ability to take advantage of the lower 20 percent tax rate.What’s in the Democrats’ Climate and Tax BillCard 1 of 6A new proposal. More

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    Carried Interest Is Back in the Headlines. Why It’s Not Going Away.

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    Changes demanded by Senator Kyrsten Sinema will preserve a tax loophole that Democrats have complained about for years.For years, Democrats and even some Republicans such as former President Donald J. Trump have called for closing the so-called carried interest loophole that allows wealthy hedge fund managers and private equity executives to pay lower tax rates than entry-level employees.Those efforts have always failed to make a big dent in the loophole — and the latest proposal to do so also faltered this week. Senate leaders announced on Thursday that they had agreed to drop a modest change to the tax provision in order to secure the vote of Senator Kyrsten Sinema, Democrat of Arizona, and ensure passage of their Inflation Reduction Act, a wide-ranging climate, health care and tax bill.An agreement reached last week between Senator Chuck Schumer, the majority leader, and Senator Joe Manchin III, Democrat of West Virginia, would have taken a small step in the direction of narrowing carried interest tax treatment. However, it would not have eliminated the loophole entirely and could still have allowed rich business executives to have smaller tax bills than their secretaries, a criticism lobbed by the investor Warren E. Buffett, who has long argued against the preferential tax treatment.The fate of the provision was always in doubt given the Democrats’ slim control of the Senate. And Ms. Sinema had previously opposed a carried interest measure in a much larger bill called Build Back Better, which never secured the 50 Senate votes needed — Republicans have been unified in their opposition to any tax increases.Had the legislation passed in the form that Mr. Schumer and Mr. Manchin presented it last week, the shrinking of the carried interest exception would have brought Democrats a tiny bit closer to realizing their vision of making the tax code more progressive.What is carried interest?Carried interest is the percentage of an investment’s gains that a private equity partner or hedge fund manager takes as compensation. At most private equity firms and hedge funds, the share of profits paid to managers is about 20 percent.Under existing law, that money is taxed at a capital-gains rate of 20 percent for top earners. That’s about half the rate of the top individual income tax bracket, which is 37 percent.The 2017 tax law passed by Republicans largely left the treatment of carried interest intact, after an intense business lobbying campaign, but did narrow the exemption by requiring private equity officials to hold their investments for at least three years before reaping preferential tax treatment on their carried interest income.What would the Manchin-Schumer agreement have done?The agreement between Mr. Manchin and Mr. Schumer would have further narrowed the exemption, in several ways. It would have extended that holding period to five years from three, while changing the way the period is calculated in hopes of reducing taxpayers’ ability to game the system and pay the lower 20 percent tax rate.Senate Democrats say the changes would have raised an estimated $14 billion over a decade, by forcing more income to be taxed at higher individual income tax rates — and less at the preferential rate.The longer holding period would have applied only to those who made $400,000 per year or more, in keeping with President Biden’s pledge not to raise taxes on those earning less than that amount.The tax provision echoed a measure that was initially included in the climate and tax bill that House Democrats passed last year but that stalled in the Senate. The carried interest language was removed amid concern that Ms. Sinema, who opposed the measure, would block the overall legislation.Why hasn’t the loophole been closed by now?Many Democrats have tried for years to completely eliminate the tax benefits private equity partners enjoy. Democrats have sought to redefine the management fees they get from partnerships as “gross income,” just like any other kind of income, and to treat capital gains from partners’ investments as ordinary income.Such a move was included in legislation proposed by House Democrats in 2015. The legislation would also have increased the penalties on investors who did not properly apply the proposed changes to their own tax filings.The private equity industry has fought back hard, rejecting outright the basic concepts on which the proposed changes were based.“No such loophole exists,” Steven B. Klinsky, the founder and chief executive of the private equity firm New Mountain Capital, wrote in an opinion article published in The New York Times in 2016. Mr. Klinsky said that when other taxes, including those levied by New York City and the state government, were accounted for, his effective tax rate was between 40 and 50 percent.What would the change have meant for private equity?The private equity industry has defended the tax treatment of carried interest, arguing that it creates incentives for entrepreneurship, healthy risk-taking and investment.The American Investment Council, a lobbying group for the private equity industry, described the proposal as a blow to small business.“Over 74 percent of private equity investment went to small businesses last year,” said Drew Maloney, chief executive of the council. “As small-business owners face rising costs and our economy faces serious headwinds, Washington should not move forward with a new tax on the private capital that is helping local employers survive and grow.”The Managed Funds Association said the changes to the tax code would hurt those who invested on behalf of pension funds and university endowments.“Current law recognizes the importance of long-term investment, but this proposal would punish entrepreneurs in investment partnerships by not affording them the benefit of long-term capital gains treatment,” said Bryan Corbett, the chief executive of the association.“It is crucial Congress avoids proposals that harm the ability of pensions, foundations and endowments to benefit from high-value, long-term investments that create opportunity for millions of Americans.”Jim Tankersley More