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Last Wednesday a Pew Research Center poll revealed that 66% of respondents think class conflict in American society is "strong" to "very strong."
Now that Mitt Romney is increasingly likely to be the Republican challenger to Democrat Barack Obama this November, that same divide is likely to become even more inflamed.
In fact, Romney's career as the CEO of private equity company Bain Capital ensures the class warfare debate will only get uglier.
That's why it's important to understand what private equity companies really do, what role Romney played at Bain, and how class warfare combatants will size each other up.
The Truth Behind Private Equity
Bain Capital is a private equity shop. What you need to know is that "private equity" is a rebranded name. Private equity companies used to be known as leveraged buyout shops.
But, leveraged buyouts (LBOs) have a bad reputation, so the industry -- or club, which it more closely resembles -- began referring to itself as private equity. It's the same as junk bonds being rebranded as "high yield debt."
A leveraged buyout is really nothing more than a financing technique.
Typically, a public company, a division of a public company, or a closely held non-public company is taken "private" by a group of investors who put up some equity to demonstrate they have skin in the game, and who then hypothecate the target company's assets as collateral for debt they pile onto the target company.
Sometimes borrowed money is raised in the junk bond market. Since the acquirers are leveraging the target company's balance sheet by borrowing a lot of money against the company's assets, lenders demand high rates of return knowing the company is being "leveraged."
The borrowed money is then used to pay shareholders, or as is more often the case, to pay off the "mezzanine" lenders who float enough cash for the acquirers to buy the company initially, and whose short-term loans are paid off from the issuance of junk bonds.
Not all the debt is junk. Sometimes debt issues are better quality. It's all a matter of how much leverage is necessary to make the deal happen and to make it profitable for the acquirers.
Once the target is acquired it's up to management, which often includes existing executives who are part of the buyout team, to streamline the company and make it profitable.
Loaded Down With Debt
Since the target company is now buried in debt, expenses are cut as judiciously and quickly as possible.
For instance, maybe the acquired company has too many corporate jets that are a balance sheet drag. Or, maybe they have too many employees that add to expenses.
Usually it means laying off workers, which is what gave leveraged buyouts their bad reputation.
But, that's not all that creates controversy. LBO shops charge the target company all kinds of fees.
There are investment banking fees for doing the deal, financing fees for leveraging the company, and other fees that go directly to the LBO shop.
Sometimes, the company takes on even more debt to pay a dividend to its new owners. That's a way for the LBO shop to get its equity back quickly. So much for skin in the game.
The LBO shops also pay themselves a 2% management fee out of the capital that their backers, investors like pension funds, endowments and high net worth individuals put into them so they can scour the planet for target companies to leverage up and buy.
And, they take at least 20% of the profits they make, too. It's a nice club to be a member of.
But while leveraged buyouts are the bread and butter of private equity shops, they can also dabble in venture capital financing of start-ups and other capital raising and financing opportunities.
Mitt Romney's Bain Capital Problem
Mitt Romney was a founder of Bain Capital, which grew out of Boston-based global management and consulting giant Bain & Co. He ran the LBO shop from 1984 to 1999.
Romney was very successful running Bain Capital and amassed an estimated fortune of over $250 million.
Needless to say, as Romney gets closer to becoming the Republican nominee, his role at Bain and his claim to have created 100,000 jobs are going to be heavily scrutinized.
Now personally, I'm not against leveraged buyouts.
However, I do think it's fair game to question LBOs that end up turning to bankruptcy protection to shed themselves of their pensions (which are often taken over by the taxpayer funded Pension Benefit Guaranty Corporation) so they can re-emerge under the guise of becoming streamlined companies.
This class warfare debate will find fertile ground in the rich rewards bestowed upon LBO kings who claim to create jobs while simultaneously eradicating others through creative destruction.
In the real world, c reative destruction is just part of the natural and organic birth and death cycle of businesses.
But to claim that layering mountains of debt on the shoulders of companies (companies are people too, you know) to pay private equity companies fat fees so they can generate generous returns for themselves and their investors (many of whom are public sector pension plans) seems inordinately lopsided and more destructive than creative.
Not only will Romney be cast in that dark light, he's also going to have to face the added knock that private equity managers' earnings from their operations isn't ordinary income (obviously not based on how many mega-millionaires and billionaires there are in the PE club), but are taxed at the much lower capital gains rate.
Private equity guys are bankers. So, Romney will be the poster child for everything bad that bankers have been blamed for since time immemorial. Not that he's going to be the first or last banker ever to run for the presidency of the United States.
But, given the politically charged atmosphere in Washington and around America, drawing class warfare lines to make the case for political candidates will be front and center this year.
So far, President Obama and the Democrats haven't had to weigh-in for the fight. Republican candidates are doing a good job on their own bashing each other's capitalist credentials and throwing stones from inside their glass house to the dismay of traditionally stalwart pro-business Grand Old Party regulars.
According to the Pew poll, 55% of Republican respondents, 68% of Independent respondents and 73% of Democrat respondents think class conflicts are strong, or very strong.
You can expect that these political lines will only darken as Romney emerges.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
You fail to mention the benefits, if any, of the LBOs. It appears that the only one to gain in these ventures is the LBO shop!
While listening to chat about Bain Capital, my wife (who does not usually follow this business or political stuff) queried, "I wonder if that is what happened to Circuit City?" So I Googled CC and read a News Week article on how terribly it had been managed as it self destructed. I then checked Bain and found that CC had been "rescued" by Bain. Will anyone have enough guts and integrity to stop this kind of corruption?
You make it sound like the Capital Investment firms never risk anything, and it is all rewards for them? Do they not take over mostly faltering companies that are on the market because there are few others that really want to invest in them? Are there not successes that restore the companies to stronger financial status? We certainly need some venture/vulture capitalist to go through Washington…trimming the fat to restore/create efficiency.
AMEN!! Because Mitt Romney has helped "save" faltering companies and The Olympic Games; because he has served in top administrative positions in his church which reportedly has the most advanced and workable welfare program — you work for what you get — in the world; because he has helped thousands of people and is markedly altruistic; and because he has personally proven he knows how to be successful in private sector business; and he seems to be a man of principle and positive attitude for America, would you rather place the reins of a struggling government into the hands of Barack Obama or Mitt Romney? Case closed. Larry Cope, Irmo, SC
Romney was born on third base Larry, it didn't take much to steal home. Tell me again, what are his principles? I would need a quick response, because they could change, quickly.
He's a B-A-N-K-E-R !!! NOT a businessman !
Exactly! They act as though the companies are the "victims", and the people willing to put up capital in order to perhaps pull them out of their downward spirals the "villians". If these companies hadn't made poor decisions in managing their finances, they wouldn't be looking for this type of help. It's financial karma.
We certainly need some venture/vulture capitalist to go through Washington…trimming the fat to restore/create efficiency… That was Reagan — and that was the Bushes… Efficiency is when you destroy somebody else's job and finances to pad your bank acount. Vulture capitalism is when somebody else destroys YOUR job and finances and pads THEIR bank account. Reaganomics put America 17 trillion dollars in debt and sent our jobs overseas.
Good explanation of private equity (leveraged buy-out) operations, Mr. Gilani. And well-balanced without the political bias or spin.
To the point and very understandable but unfortunatley will not be read by most voters. The politicians have learned that the average American voter votes his emotions rather than his intellect, find an emotional issue and stir stir and you've got his vote.
Mr. Gilani,
Mike Milken would be proud of the way you described LBOs , short and clear!
It is interesting and sad that today Republicans (and later Democrats if Romney is nominated) are attacking a successful person. If he had broken any rules then not only should folks be critical of him, but he should be in jail!!! Apparently he ran a business legally and efficiently, which we would hope translates into a person who can legally and efficiently run our country. Our current president has not run a business. With some of his decisions over the past three years, he probably would not be successful in running a business. Solyndra, Fast and Furious, and others were definitely bad decisions by his administration (Management Team in business) and some possibly illegal!
Thanks again for a very interesting and informative work.
Mike B
You can run, but you can't hide. Taking LBO, which has become unsavory because of the practices involved and rebranding it as Private Equity just means you have the same trolls and troglodytes working under a new guise. In the 1970s and 80s I worked with a real estate firm that structured deals under the term syndication. These were leveraged to the hilt with a lot of them going south. The term syndication eventually lost its luster and you hear of no one in real estate using syndication today.
Good article overall, Mr. Gilani. But I'd like to see more information before I can agree or disagree with the following statement from your article: "But to claim that layering mountains of debt on the shoulders of companies (companies are people too, you know) to pay private equity companies fat fees so they can generate generous returns for themselves and their investors (many of whom are public sector pension plans) seems inordinately lopsided and more destructive than creative." It seems to me that only back-in-time analysis of many BAIN or other private equity firm transactions in which companies or portions of them were acquired, then reorganized, then sold can show whether or not the quoted general assertion is correct or not, whether the manner in which private equity firms conduct their business is "inordinately lopsided and more destructive than creative." I lean toward agreement based on my familiarity with what Sir James Goldsmith did to Goodyear Tire & Rubber Company, but that is merely one example. Needed is analysis of the number of employees, production, sales, revenues, etc. before and after private equity involvement. And, if there is shown to be an overall negative effect, it appears that structural changes in the tax code and perhaps SEC provisions are needed to prevent or reduce such negative effect.
Why do Bain and Romney have assets in the Cayman Islands? If he declares the income on his federal tax return, then it can't be to avoid taxes. Is it to add another layer of protection from collectors in case Bain were to declare bankruptcy?
A well-written concise summary of what LBO's (or private equity investing) is all about. It was never about the jobs. It is all about getting a return to investors; as the author noted, often the new company would be saddled with debt (and underfunded pensions or health and welfare plans) that could never be paid, unless the economy and industry the business was in performed flawlessly. Of course, the investors might be risking their capital (or their investors'), but they were not risking their jobs. Workers in these businesses had only 1 source of income and everything to lose, if these leveraged buyouts did not work. I saw the same merchant bankers work on these deals when the economy was flourishing and saw them again when the same companies were in bankruptcy and they were doing workouts. They collected outrageous fees all along the way, while the workers saw their wages and benefits diminish. Is it class warfare to question this way of doing business? Is this what our system of capitalism is all about?????
I was with Safeway in the 1980's when it underwent a LBO put together by KK&R. Basically an outside group was trying to take Safeway and would have "found" assets relating to the long term leases on store property. The stock went from the $20s to over $70. Without KK&R they would not be a Safeway left. As it was, following the LBO, the company went private for a period and was saddled with about $4B in debt. Some of the divisions were sold off, some of the manufacturing was dropped and the company was leaned out. In general, current employees stayed with those outfits that bought the divisions that were sold. Some employees were transferred to other divisions that were maintained by the company. So there was some disruption but the actual loss of jobs was quite small. In the end, Safeway came out a smaller but stronger company. Thanks KK&R and the Safeway management for keeping us from the wolves.
I am neither agreeing or denying Mitt's back ground. I don't have a complete track record to judge his past. However, what will be used to percieve his heart when the mud slinging starts between Obama and him will be weighed by many people on both sides of the political isle. He will have to have plenty of ammo to defend himself. It will boil down to Perception and who is doing the perciving.
Good article that did not go far enough to either give the reader an idea of whether LBO's help or hurt he overall economy and whether Mitt Romney and Bain Capital actually created (as Romney claims) or destroyed jobs and whether they did anything to improve the economy or just line their pockets. However that is not the real issue of whether Mitt Romney would make a good President. The real issue should be honesty and integrity and whether he is smart enough to bring back jobs to the American people and whether he is willing to tackle the real tough issues of the budget deficits and the shrinking middle class of the American workers. Since he has never been there I don't think he can relate to the "average" American citizen.
Much has been said about class warfare. And there will always be those who think they are better then the "rest of us" from the athlete who has to have the bigger million dollar salary, the "blue blood" society family, the rich and famous, or the smartest. The color of skin, the level of education, the biggest or most expensive house, car, or bank account all go to prove we are better than others. "Class" drives the classless to become devious and dishonest as they strive to show themselves to be better than the "common person". Yet I consider the honest street person or the honest low wage earner to be more "classy" than the millionaire who cheats on their taxes or lobbies their congressman for more loopholes to avoid taxes.
Greed has bread a brand of businessman, Congressman, or investor who has lost the honesty and integrity and compassion that puts people and patriotism above self interest. We have become a nation who accept our elected officials to "a little bit" corrupt, our business executives to be "devious and crafty" and our government to be uncaring and wasteful. It is time for a change in attitude in what we will accept from our leaders. And the best place to start the message is at the ballot box. And the best way to get that message across is to vote EVERY existing member of Congress out as they come up for reelection. It may take 4 to 6 years to get the message across, but they WILL get the message!!!
Your efforts to "explain what private equity companies really do" are just as confusing as the rumblings from the Gingrich campaign and MSNBC. Bain Capital is a highly respected firm and private equity is an essential element in business restructuring. The dynamic of a free market economy means that many otherwise good businesses will begin to struggle as markets shift and financial pressures mount. Private equity makes use of debt, but it also makes invetments that carry real risk – and accordingly higher rewards – for the managers and the financial backers of these ventures. One could argue that the problem with the US economy today is a dearth of this sort of risk taking behavior. Your argument is simply a polished up version of the line that private equity and venture capital are a handy way to pillage otherwise solid companies. Read the most recent Schumpeter column in the Economist on Romney's role in the growth of this essential business function. By the way, the colulmn's namesake – the Harvard economics professor who coined the term "creative destruction" – also argued that capitalism's success carried the seeds of its own destruction. Well meaning intellectuals such as the author of your article would undermine the foundations of the market system, eventually causing people and their political leaders to turn toward government as an arbiter who might "stabilize the ferocity of competition and make the system fairer and more "socially just." Because the capitalist sytem is so productive, government could actually take it over and make it work for a time. But the essential driver of progress – the risk taking entrepreneur – would die out and along with him or her would go the dynamic engine of economic progress, leaving decison making in the dead hands of government bureaucrats.
I don't think one can throw stones at one of the predators in the business jungle called Capitalism and think they have accomplished anything. Better to attack capitalism itself if you think purging the business world of half dead companies or companies that should be dead is a bad idea. But this information will be good for the politicians and the dolts that think they are hearing logic though it misses the mark when assessing a candidate for the Presidency. Better to pray for a good outcome.
Meanwhile I checked an article about gold and ended up here. Where's the gold?
Mexico Mike
As an outside observer, a Canadian, I can see one sound bite coming back to haunt Mitt Romney big time and to play favourably for Obama. That is when Romney said "I enjoy firing people" which will haunt him in an era of high unemployment. So even before the election, his fate may be sealed and he may be toast.
Anyone who thinks romney is any different than obama is delusional, they clearly have the EXACT same platform. Just look at their top campain contributors: goldman sachs and jp morgan.
Now do you think these banks would invest so much money in our elections if they werent getting anything out of it?
Basic game theory here folks.
Romney will continue with the EXACT same policies as obama because those policies benefit GS and JPM the most. If these policies didn't funnel money into those banks they would stop buying our elections.
Basic game theory…
Rombama and Obamney are both employees of GS and JPM, and neither will ever represent anyone other than GS and JPM while in office.
Ron Paul 2012
What's there to understand? Mitt Romney took over Bain Capital as a millionare and left as a mulitmillionaire while Bain Capital went bankrupt. Ben
I really appreciate this article. There is so much to learn and better understand these days, that even the 24/7 week isn't long enough.
Nearly everything in big business and national politics has been crafted by think tanks to keep the rest of us in the dark. " Private equity companies used to be known as leveraged buyout shops." Calling LBOs private equity companies, is like calling a call-girl your personal assistant. Obfuscation is the name of the game. Of course, unfortunately, that is pretty much true when it comes to most of corporatism. The public is brainwashed by these synthetic, obtuse names like private equity companies to intentionally keep the rest of us in the dark, so that big time, slick operators like Romney, Obama, and most others involved in corporatism can operate below the radar!
After reading Shah Gilani's informative article, I have more insight into Mitt Romney's cold, dehumanized demeanor. He has a lot more in common with the grim reaper than a warm puppy. He's had plenty of practice cutting down workers like so much chattel! I really regret that the biggest winner has taken so much with so little compassion for other people. Now I can see where my impression of Romney is a shark in a ken doll outfit!
All you greedy, consumed, and passionate capitalists out there need to remember what happened to this country back in 1929 and how long it took us and the kinds of sacrifices that had to be made to get us out of it all. Unfortunately, most of you all aren't old enough. If it hadn't been for some compassionate decisions made by some "government bureaucrats" who were, at least in those days, fairly elected by REAL people (ie, not corporations as Citizens United would have us believe), then it's very probable that the US wouldn't even be around anymore. And we'd all be citizens of some other country discussing something else. Kudos to Wayne above. I think he, at least, does understand what's going on. When we put self totally above others, and we teach our young to do nothing but be exploiters and not contributors to the overall good, it's eventually going to be to the detriment of all of us. The "positions" of these people we supposedly "elect" to represent us are all being bought by the "people" envisioned in Citizens United. And LBOs and PEs are just another euphemism for capitalism run amuck.
My question is…do we want a Banker as the president of the united states knowing what we know about banks and how the pillage in everyway possible this country and the american people? The Banks have truly been exposed as never before and that is what a Mitt Rommey would be in the white house.