In an unbelievable turn of events, Republicans have attacked Mitt Romney’s activities at Bain Capital. In an effort to delay the inevitable — that is, the nomination of Romney — his ultra-conservative opponents are saying that leveraged buyouts by Bain and overseen by Romney were “job killers.” This is a totally senseless ploy by desperate candidates who are supposed to be supportive of free market activities; and they will be unsuccessful.
Leveraged buyouts are undertaken for many reasons. Generally, investors identify corporate assets that they believe are attractive. These investors may want to own the assets because they think they can manage them better than the current owners and increase profits. Or perhaps, the assets are not leveraged sufficiently and their existing profitability is too low. By replacing equity with debt, the equity returns can be increased dramatically.
As an example, if a company has $100 million of assets and $10 million of profits, and is financed with all equity, its return on equity is 10%. If the same company were to be purchased for $150 million and financed with $75 million of debt and $75 million of equity, the equity return would increase to 13%. So, by “leveraging” the company with debt (even at a higher purchase price), the new owners can increase equity returns.
If, in the same situation, new buyers determine that the company has too many employees or a union that has been too demanding, they may be able to increase the profits of the company. If the buyers eliminate a number of employees deemed to be redundant and/or negotiate a better deal with the unions resulting in $5 million more profits, the return to equity holders would increase from 13% to 20%.
In many buyouts, new investors identify companies that are owned privately, by a family or one or two people. Often, the profits generated by these companies have more than adequately sustained the owners over the years. But often the companies are not managed with great expertise or attention to detail and, to be frank, money is wasted. Perhaps, the owners have family members on the payroll who are not productive, or perhaps the operations are anything but streamline. Companies with bloated payrolls are ideal targets for buyout shops such as Bain.
By eliminating unproductive staff that for personal or sentimental reasons the existing owners cannot do, new buyers can create a successful buyout. The owners can then sell their business for a huge profit, because they are ready to retire or for any other reasons.
Corporations must continually eliminate excess expenses to remain profitable. If they fail to do so, they will not survive in the existing competitive environment. Corporations do not exist to hire people; they exist to earn profits for their owners. When the owner’s profitability is compensatory, owners and employees can have a mutually rewarding experience. When costs are out of control, people will eventually be terminated by existing owners or by new owners such as Bain Capital.
What is shocking about the attacks on Romney is that they come from people who have historically supported free market activity; the GOP has always personified this perspective. To violate free market principles for political gain is a recipe for disaster for the party. Mitt Romney, while at Bain, was a great businessperson. He and his partners searched for and found many “undervalued” companies to acquire and restructure. Subsequently, they sold the same companies and reaped outsized profits. This activity represents legitimate free market enterprise and should be applauded and not demonized by anyone.
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