There's been a lot of back-and-forth about Mitt Romney's record at Bain Capital and this has mushroomed into a larger debate about private equity ever since Cory Booker self-servingly defended it against that meanie Obama. Most people have only the faintest idea about what companies like Bain Capital do, so I thought it might be nice to give everyone a little background. The attacks on Mitt Romney's record at Bain Capital usually go something like, "he took over my company and laid us all off, and then the company went bankrupt" and they're going to keep coming because there's more than a pebble of truth in it. That being said, it's also a lot more complicated than that because private equity is a bit of an odd business.
The Why (Profits)
It helps to think of Richard Gere's character in Pretty Woman. He's a ruthless corporate raider who buys up companies and strips their assets to sell for a profit. Bain Capital, which Romney helped found, is a private equity company and also makes a lot of its money by buying weak companies. But Bain Capital doesn't usually look for companies to hack to pieces. Bain Capital was created by Mitt Romney and other management consultants from Bain & Company. And management consultants have jobs (at least in theory) because they're the best at optimizing operations and squeezing profits out of the business. So Bain Capital, true to its management consulting roots, buys companies it thinks can be made more profitable, and often looks to invest in its targets for the long haul. But remember that boosting profits means both growing revenue and cutting costs - and in most companies, the biggest cost is people. So laying off workers is one of the surest ways to increase an acquisition's value and that's what Bain Capital did innumerable times. This is not to say that Bain is evil; we're a market economy after all, and many of the companies it took over were very uncompetitive and badly needed restructuring, even if it means they had to jettison workers. And Bain actually had some pretty big success stories like Staples and other companies that have become household names after Bain stepped in.
The How (The LBO)
But private equity has a very particular, very ingenious way of raising the capital needed to buy up companies. It's called a leveraged buyout, and the "leverage" half of the term is finance jargon for "debt." Neither Bain Capital, nor its investors, actually front all the money needed to acquire a target through an LBO. Bain identifies a company that it thinks it can turn around, presents its plan to a bank, and takes out a big loan with a small downpayment. And then it uses the loan to purchase the target's capital.
To use a familiar investment analogy, your bank will let you take out a mortgage on a home, but you must put up the home as collateral in addition to making a downpayment, and the bank can foreclose on and sell the house in the event that you default on your loan. Similarly, Bain's investment might sour, and its bank can come in and liquidate the collateral. The twist in an LBO is that the target's assets, not Bain's assets make up the collateral for the loan. So when a private equity firm buys out a business, that business is immediately saddled with millions of dollars of new debts that will force it into liquidation if its new managers can't turn nurse it back to profitability. The private equity firm and its investors are only liable to the extent of the initial downpayment.
Long story short: when Bain's acquisition takes off, it has a profitable company that it can flip to a new owner for a lot of money. When Bain's investment turns out to be a dud, the company it acquired goes bankrupt and the bank comes in and tries to cut its losses by selling that company's assets at firesale prices.
Private equity is kind of a mixed bag, and you have to admit it can be pretty innovative. But for someone (*ahem* Cory Booker) to say that attacks on private equity are "nauseating," I have to assume that the good mayor simply has an oversensitive gag reflex.
The How (The LBO)
But private equity has a very particular, very ingenious way of raising the capital needed to buy up companies. It's called a leveraged buyout, and the "leverage" half of the term is finance jargon for "debt." Neither Bain Capital, nor its investors, actually front all the money needed to acquire a target through an LBO. Bain identifies a company that it thinks it can turn around, presents its plan to a bank, and takes out a big loan with a small downpayment. And then it uses the loan to purchase the target's capital.
To use a familiar investment analogy, your bank will let you take out a mortgage on a home, but you must put up the home as collateral in addition to making a downpayment, and the bank can foreclose on and sell the house in the event that you default on your loan. Similarly, Bain's investment might sour, and its bank can come in and liquidate the collateral. The twist in an LBO is that the target's assets, not Bain's assets make up the collateral for the loan. So when a private equity firm buys out a business, that business is immediately saddled with millions of dollars of new debts that will force it into liquidation if its new managers can't turn nurse it back to profitability. The private equity firm and its investors are only liable to the extent of the initial downpayment.
Long story short: when Bain's acquisition takes off, it has a profitable company that it can flip to a new owner for a lot of money. When Bain's investment turns out to be a dud, the company it acquired goes bankrupt and the bank comes in and tries to cut its losses by selling that company's assets at firesale prices.
Private equity is kind of a mixed bag, and you have to admit it can be pretty innovative. But for someone (*ahem* Cory Booker) to say that attacks on private equity are "nauseating," I have to assume that the good mayor simply has an oversensitive gag reflex.
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