Childcare’s Private Equity Crackdown Has a Blind Spot

Nearly two years ago, I began following a pattern of closures among Guidepost Montessori schools — a network that at the time had more than 130 Montessori-inspired childcare programs, most of which focused on children younger than age 6. The situation worsened, with the network’s parent company, Higher Ground Education, eventually declaring bankruptcy and shuttering close to half of Guidepost’s locations.

In September, The New York Times ran a feature story on Guidepost Montessori’s dramatic collapse. The article detailed the aggressive growth strategies that Guidepost’s CEO Ray Girn employed, which included leveraging advances from landlords to seed new site development instead of improving existing ones. Seven former employees independently described the business model as a pyramid scheme, the Times reported.

Over the past two years, there has been a substantial push to regulate the role of private equity in childcare, including proposed legislation in Congress and in several states that would limit access to public funding for private equity-backed childcare chains, or add safeguards against profit-seeking practices that harm children and families. There have also been a number of federal investigations into the behaviors and structures of these chains.

Regulatory focus on private equity

However, the current reform push is built around a specific financing model — private equity — which only addresses some for-profit childcare chains. None of these reforms would have touched Guidepost Montessori, which was funded differently and failed differently. Its parent company was backed by millions of dollars in venture capital funding, which would be excluded by most existing reform efforts.

And Guidepost isn’t the only chain that would be left out. A number of large U.S.

childcare chains are funded by models that would be exempt. That’s why it’s important to establish guardrails around all large for-profit childcare chains, regardless of who pays for them and who runs them. The clearest mechanism for such guardrails is for states to establish a new license type for large chains.

Financing models for large chains

Large for-profit childcare chains differ in who funds them and who owns them. Here are four common models.

Private equity (PE) funding involves a private equity firm rolling up money from investors into a distinct fund or funds that buy a childcare chain. The private equity firm then directly manages the chain’s operations, often by sitting on the board of directors, helping hire leadership and weighing in on other key business decisions. More than half of the 10 largest for-profit childcare chains are backed by private equity, according to my analysis of Exchange Press’s most recent annual report on for-profit childcare, which ranks chains by the number of children they’re licensed to serve.

Those include Learning Care Group (the nation’s second largest chain that is the umbrella of 11 brands including La Petite Academy and Childtime), Cadence Education, Primrose Schools and The Goddard School. Some of these chains have corporate-run sites, meaning they are directly managed by a home office, while others work off of a franchise model where an independent owner operates autonomously under a private equity-owned franchisor.

Publicly traded companies are chains that are traded on a stock market, meaning that institutions and individuals can buy shares. The two current publicly traded U.S.

chains are KinderCare and Bright Horizons. Both chains previously had private equity owners before going public. KinderCare’s previous owner, the Swiss private equity firm Partners Group, has a controlling majority share, meaning they can still deeply influence company operations via shareholder votes and shaping board membership.

Bright Horizons was previously owned by Bain & Company, but no single investor presently has a controlling share.

Venture capital (VC) funding involves a firm pooling money from investors and then offering capital in exchange for an ownership stake. The venture firm is not generally looking to have a majority of the equity or to directly oversee day-to-day operations. Venture capital groups tend to focus on early-stage startups and look for explosive growth opportunities.

After the collapse of Guidepost Montessori, no major U.S. chains are currently venture-backed, although there are smaller VC-backed chains like The Nest Schools and Vivvi as well as several technology companies focused on early childhood, like Wonderschool.

Family ownership is a model in which an individual or family owns a company and generally does so without institutional investors. That doesn’t mean there are no investors, but the family retains ownership and control. Kiddie Academy, a franchisor with more than 375 sites, falls into this category.

Whether the money that supports a childcare chain comes from private equity, venture capital, the public or a family, the risk comes when investors’ timelines and return expectations don’t fit a low-margin, high-stakes sector.

Limitations of PE‑only reforms

While it is heartening to see Congress finally taking the issue seriously, the fact that most proposed legislation zeroes in on private equity is quite limiting. Consider the Protecting Childcare from Private Equity Act, introduced in July by Rep. Josh Riley, a Democrat from New York.

The legislation would require the Securities and Exchange Commission to collect ownership information from private equity funds that take over childcare programs and, for four years after acquiring a childcare company, would not allow the firm to sell the company or use the company’s funds to pay a dividend or conduct a stock buyback (which is when a company buys its own stock, enriching stockholders). These provisions are promising, but would only apply to investment firms of a certain size and only when the firm controls more than 50% of a childcare chain or more than 50% of its stock — in other words, firms that can dictate chain operations.

That language does cover most chains backed by traditional private equity firms and would cover KinderCare, due to the controlling share held by Partners Group. However, it leaves a number of others out. Bright Horizons, which has no majority shareholder, would be excluded. So would all family-owned chains with no investment company behind them, such as Kiddie Academy. Guidepost Montessori, too, would most likely have been excluded from this measure since they lacked a majority-owning venture capitalist.

One could certainly argue that the profit maximization motive is strongest among private equity firms. As one analysis from the investment management company AQR Capital Management puts it, “institutional investors widely expect PE to outperform public equity by 2%-3%,” but it’s a matter of degrees. Given this lack of a fundamental difference, all types of chain financing models warrant guardrails.

After all, when it comes to publicly traded companies, the stockholder wants the stock they hold to gain value, and the stock market is tracking financial outcomes, not child outcomes. One needs only to read the transcript of a KinderCare or Bright Horizons quarterly earnings call with Wall Street analysts to confirm this truism. The venture capitalist wants their bet to pay off. The family-owned chain wants to remain prosperous and grow.

Costs and outcomes across models

The reality is that when looking across chains backed by private equity and chains backed by other financing mechanisms, the day-to-day operations often function similarly. A recent paper from economists Chris Herbst and Jessica H. Brown found moderate differences between various chains, such as modestly higher teacher and student turnover and less willingness to accept subsidy vouchers for childcare chains funded by private equity.

The most notable differences, however, weren’t between chains backed by private equity and chains financed in other ways. They were between large for-profit chains and programs that aren’t part of a chain. This shows up most strikingly when it comes to the fees programs charge parents.

At PE-owned sites, Herbst and Brown wrote that “rates are about 30% higher overall than at non-PE providers and are consistently higher across all age groups.” But the researchers found that “these price differences are erased when compared to other large chain providers.” If the biggest gaps are between chains and non-chain programs, policies aimed only at private equity may miss the chance to improve the experience and financial stability of families who attend all types of chains.

There’s also a systemic risk that comes with size, and that risk does not change because a for-profit chain is funded a certain way. When a mom-and-pop childcare center down the street closes, it can harm a neighborhood; when a chain the size of Guidepost Montessori — or ABC Learning, an Australian-based chain that was the largest private provider of childcare in the world before its 2008 collapse — goes under, hundreds to thousands of families are impacted at once. By the same token, the business practices of such chains also implicate hundreds to thousands of children and staff on a daily basis.

Licensing for large chains

The public interest in large chains is simply higher — and that contention is not unique to childcare. A federal law passed in 1980 explicitly expresses this principle in relation to business more broadly. In that law, which required federal agencies to assess the economic impact of regulations on small businesses and organizations, Congress declared “the practice of treating all regulated businesses … as equivalent may lead to inefficient use of regulatory agency resources, enforcement problems, and, in some cases, to actions inconsistent with the legislative intent of health, safety, environmental and economic welfare legislation” and that regulation should fit “the scale of the business.”

Beyond the fact that the U.S. commonly regulates small business and large corporations differently, there is also precedent for regulating childcare programs differently based on their size. Several states, such as California and Colorado, have distinct licenses for small and large childcare programs, based on the number of children served. Each license type comes with different requirements. In Colorado, for example, the educational requirements for the director of a large childcare center, defined as serving 16 or more children, are higher than the requirements for a small center.

There’s no reason states couldn’t establish a license for large childcare chains as a new category for companies that own more than a certain number of sites or care for more than a certain number of kids. Such licenses could come with additional expectations, such as sharing information about the company’s financial health and working conditions (like staff turnover) with the state, and restricting the use of public money in ways that go against the public good, including to enrich investors.

Establishing a different license type may also be more politically palatable than proposing legislation that regulates only private equity-backed chains. While I personally find the argument uncompelling, private equity backers have so far successfully pressed the case in several states that singling out a particular governance type is unfair. Lawmakers and childcare advocates should consider sidestepping that debate altogether and simply focus on the size of chains.

It is difficult to argue that any chain with many hundreds of sites across the nation (or multiple nations) employing thousands of individuals and serving tens of thousands of children should be regulated exactly the same as a single-site childcare program serving 30 kids.

When it comes to protecting against the worst excesses of profiteering in childcare, licensing is the door, and size is the key.

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