[This is a slightly edited submission by reader DYNAMISM. All opinions here are commentary by the writer on a matter of important public interest, and are not submitted as statements of definite fact or law. Any inaccuracies in matters referred to in this or other posts will be corrected immediately upon request. Indeed, since this post is directed at the PE method which is in issue, any responses which indicate why the method referred to here is described incorrectly are encouraged.]
I also landed here via Professor Jacobson’s Legal Insurrection blog.
Glad to see a site on this topic. I figured I’d share a response:
Too many people are defending Romney as just being a good little capitalist, when this isn’t really the case—rather, it appears that he was a private equity manager playing shell games with investors. I think most would agree that there should be restraints against somebody selling watered-down gas… so why not against dishonest debt instruments? I think most agree that if a minority shareholder uses company money to issue himself a big paycheck, this is embezzlement from the other shareholders. But when Private Equity firms do this via multi-million dollar consulting fees, is the result different? (Note: These are rhetorical points on the business ethics involved—I’m not advocating that the government should step in and regulate any of this. I’d rather prefer they didn’t, and that such matters be resolved in civil courts as common law disputes, etc.)
Now the crux of this problem is of course the government. Their corporate limited liability laws unfairly rip up contracts between creditors and debtors. Making debt financing tax deductible, but not equity financing, has seriously skewed the corporate structure. And lastly, the Federal Reserve issuing so much debt (largely indirectly) and then bailing out said debt (→ moral hazard) is a significant problem in aiding and abetting the private equity craziness of reckless LBOs, etc.
Specifically how the system works: A bank overflowing with money they created from low Fed Reserve interest rates meets with a private equity firm to talk about taking over firm. The bank provides ~80/20 the money and they together purchase the take over target. The PE firm immediately loads up the acquired firm with debt for the bank to get their money. The debt is structured as a huge balloon payment set to self-destruct in about 5 years. The bank realizes this is ticking time bomb, so unloads this debt ASAP to other banks, hedge funds, insurance companies and pension funds. The smarter investors realize this is a hot potato and keep passing it around. Recently they’ve been hiding this bad debt in CLOs (almost identical in concept to real estate CDOs). Hidden amongst other debt, people have no idea the mess they purchased. The PE firm on the other hand wastes no time in borrowing HEAVILY again to finance corporate mergers (they don’t want to do it from the PE firm directly because they could be liable for the debt). They also borrow heavily to finance huge dividends that more than make up for what they paid for the firm. They justify the dividend legally by jacking up short term profits (price increases, job cuts, quality reductions) that threaten the long term health of the company, and by money saved from tax deductible interest as well. If possible, the PE firm tries to dump their acquired firm before the balloon payment comes up… but even if they’re stuck with the firm they usually do very well given all the consulting fees they charge and the huge dividends they give themselves.
“Lately, Bain founder and GOP presidential candidate Mitt Romney has found himself in a spirited defense of the private equity industry, doing all he can to spin decades of data which confirm, without failure, that PE Leveraged Buy Outs are nothing but “efficiency maximizing” transactions whose only goal is the “maximization” of EBITDA in the pursuit of dividend recap deals, IPOs or outright sales, while loading up the company with untenable amounts of leverage. All this with a 3-5 year investment horizon, which ignores the long-term viability of a company and seeks to streamline (read fire as many as possible) operations as quickly as possible in the goal of maximizing short-term returns. We wish him luck in his endeavor.”
A comparison of the 1999 Bain portfolio obtained by the Los Angeles Times to the information in the Subsidy Tracker database my colleagues and I at Good Jobs First created (as well as other sources), yields examples such as the following:
Steel Dynamics Inc. In 1994 this company, among whose financial backers at the time was Bain, got a $77 million subsidy package—including grants, property tax abatements, tax credits and reimbursement for training costs—for its steel mill in DeKalb County, Indiana (Fort Wayne Journal Gazette, June 23, 1994).
GS Industries. In 1996 American Iron Reduction LLC, a joint venture of GS Industries (which had been taken private by Bain in 1993) and Birmingham Steel, sought some $20 million in tax breaks in connection with its plan to build a plant in Louisiana’s St. James Parish (Baton Rouge Advocate, April 6, 1996). As the United Steelworkers union noted recently, GS Industries later applied for a federal loan guarantee, but before the deal could be implemented the company went bankrupt.
Sealy. A year after the 1997 buyout of this leading mattress company by Bain and other private equity firms, Sealy received $600,000 from state and local authorities in North Carolina to move its corporate offices, a research center and a manufacturing plant from Ohio (Greensboro News & Record, March 31, 1998). In 2004 Bain and its partners sold Sealy to another private equity group.
GT Bicycles. In 1997 GT, then owned by Bain and other investors, decided to move its manufacturing operations to an enterprise zone in Santa Ana, California. Being in the zone gave the company, which was later purchased by Schwinn, special tax credits relating to hiring and the purchase of equipment (Orange County Register, July 9, 1999).