Why private equity firms like Bain really are the worst of capitalism

Josh Kosman writes: By placing his career at Bain Capital at the center of his presidential campaign, former buyout artist Mitt Romney has put the private equity industry on trial.

About time.

Romney wants us to believe that critics of private equity are against capitalism. They’re not. They’re against a predatory system created and perpetuated by Wall Street solely to pump its own profits.

Defenders of private equity say firms like Bain, which Romney co-founded in 1984, exist to build businesses, creating jobs and prosperity all the while. “We started Staples, we started the Sports Authority, we started Bright Horizons children centers,” Romney said at one of the GOP presidential debates last year. “Heck, we even started a steel mill in a farm field in Indiana. And that steel mill operates today and employs a lot of people.”

And Romney also touts Bain’s success at taking struggling companies and putting them on a path to profitability. “Sometimes we acquired businesses and tried to turn them around — typically effectively — and created tens of thousands of new jobs,” he said at the same debate.

Romney’s whole election pitch turns on the story he tells about his time at Bain, which goes like this: I, Mitt, have a record of building businesses and creating jobs, and what I did for floundering companies, I’ll do for the U.S. economy.

There’s only one problem with Romney’s story: It doesn’t describe most of what private equity firms actually do. The companies Romney holds up as successes – Staples, Sports Authority et al. – were not Bain private equity deals; they were venture capital investments in companies that Bain neither owned nor ran. All well and good: Venture capital is a good thing – essential for funding the growth of new and developing companies. But Romney didn’t make his fortune through venture capital­; he made it through private equity – and private equity, as President Obama pointed out this week, is a very different proposition. “Their priority is to maximize profits,” the president said of PE firms, and “that’s not always going to be good for businesses or communities or workers.”

Here’s what private equity is really about: A firm like Bain obtains cheap credit and uses it to acquire a company in a “leveraged buyout.” “Leverage” refers to the fact that the company being purchased is forced to pay for about 70 percent of its own acquisition, by taking out loans. If this sounds like an odd arrangement, that’s because it is. Imagine a homebuyer purchasing a house and making the bank responsible for repaying its own loan, and you start to get the picture. [Continue reading…]

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