Quantcast

Mitt Romney and Bain Capital: Are Private Equity Firms Evil?

The game is on. The presidential contenders are beginning to attack each other with spin and distortion. The latest is a confrontation relating to Romney’s tenure at Bain Capital.

NY Times story discusses a specific Bain deal that ultimately went bankrupt which the Obama campaign is using as fodder to point out Romney's weaknesses. The Times fairly points out that the company was in deep financial trouble when Bain purchased it, and that Bain injected capital into the company trying to save the business. Ultimately, the company failed, as did so many others in the steel industry, and jobs were lost. The Romney campaign almost immediately responded by bringing to light a different Bain investment that was a success.

Actually, the dichotomy portrayed in this debate is fairly realistic, with one major exception. PE entrepreneurs buy companies that are undervalued, need financing, or must be be restructured. The latter scenario applies to companies that will inevitably fail if they are not reconstituted from a financial and/or operating perspective. Sometimes this entails job cutting. These are risky situations that result in great benefits to the PE industry and the employees if the projects are successful. PE firms never intentionally suck the life out of acquisitions and force them into liquidation. It makes no sense and is not a profitable business model.

There are a few very important issues that critics conveniently dance around when they demonize the private equity industry. PE firms try to buy assets, conduct financial and operating restructuring, and sell the assets for a profit some number of years later. Axiomatically, that means PE firms try to improve companies they acquire, which ultimately benefits employees. In fact, in many situations, employees have an opportunity to invest along side of PE investors. This is the best outcome; not sucking the life out of companies for a short-term profit, the way Obama has portrayed the PE industry publicly.

One of the great myths that has been perpetuated by people who have never done a deal in their lives is that leverage (borrowed money) is evil. Sometimes leverage negatively impacts companies, and sometimes it is beneficial. PE executives spend most of their careers searching for the latter.

As an example, if a company has no debt, a huge market share and relatively insignificant risk in its business, it is operating inefficiently. Equity is far more expensive that debt. Consider that equity holders seek at least a 15% return on money invested in companies (even in the stock market). Lenders look for much lower returns ranging from low to high single digits depending upon their credit assessment of the borrower. Therefore, replacing some equity with debt would be a good strategy, as it will result in far greater returns to equity holders with a bit more overall risk associated with higher debt.

PE firms are backed by municipal pensions, universities, not-for-profits and the like. Many investors in PE firms are policemen, firemen, and teachers looking to increase the return on their retirement funds. The historical returns have been outstanding ever since PE firms began to pop up 40 years ago, and investor money is still plentiful.

The favorable tax breaks afforded PE investors is another issue altogether. I am referring to the capital gains treatment of their investment gains. Congress provided this benefit with the intent of turbo charging the economy many years ago. PE firms have lived up to this expectation and therefore deserved to be rewarded accordingly. If Congress believes the benefits should be rescinded, it should act accordingly.

The final subject is jobs. Do PE firms create jobs or kill jobs? The answer is, it depends. In situations where unions have destroyed companies or companies have not controlled expenses (including payroll), jobs may need to be cut. Consider corporate America today and our federal and state governments; they are cutting jobs regularly and eliminating waste. The same holds true in certain PE transactions. On the other hand, in many situations, jobs are created and employees become partners with PE firms as equity holders. Common workers have benefited greatly by cooperating with PE executives. Statistically, studies have shown that PE firms create and cut jobs at about the same rate as other companies in the U.S.

Like us on Facebook:
Join the Discussion
New Response

Be the first to comment

Top Responses ()
All Responses ()
Load More Responses Show All Responses

Loading Responses

CLOSE | X

Do you agree that our
generation needs a voice?