WASHINGTON — Did Republican front-runner Mitt Romney create jobs or destroy them when he ran the private equity firm Bain Capital? The question has dominated debate ahead of South Carolina's heated presidential primary Saturday, and the answer to both questions, oddly enough, is yes.
"You see private equity being demonized by people who want to ... hang that story around the neck of Mitt Romney. The defenders lionize him. How can both be true?" asked Colin Blaydon, the director of the Center for Private Equity and Entrepreneurship at Dartmouth University's Tuck School of Business in New Hampshire. "What's being missed is to ask the question, 'What is it that private equity does?' "
Private equity firms take pools of money — often from wealthy investors, pension funds, endowments and other big institutional investors — and put it to work retooling struggling companies. Romney's firm specialized in returning troubled companies to profitability.
Sometimes these ventures worked, as was the case with household names such as Domino's Pizza and the Staples office-supply chain. Both employ tens of thousands.
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Sometimes they didn't, as was the case in South Carolina with GS Industries, the parent of Georgetown Steel. Bain invested $24.5 million to acquire GS Industries in 1993 and had made $58.4 million off it by 2000, according to an investment prospectus obtained by the Los Angeles Times that McClatchy reviewed. The steel manufacturer cut more than 1,750 jobs, shuttered a century-old division, held $553.9 million in debt and declared bankruptcy in 2001. Romney was in charge of Bain during most of that time.
Still, looking at Bain Capital and private equity through the narrow prism of jobs misses the larger point of what this segment of the financial world does.
"The fact that you can find both job creation and a reduction in jobs, depending on the transaction ... should not be surprising if you understand what private equity is being asked to do, which is to create more valuable enterprises out of what they are starting with," Blaydon said.
Blistering attacks on Romney by former House Speaker Newt Gingrich and Texas Gov. Rick Perry, rival Republican presidential candidates, have portrayed him as a "vulture capitalist" who stripped and flipped companies with little regard for the welfare of workers, getting wildly rich in the process.
The term "vulture capitalist" applies to companies that invest in distressed assets, and Bain Capital clearly invested in under-performing companies. But the harsh term generally is used to describe investment funds that snap up the debt of developing nations, many in Africa, for cents on the dollar and then sue for tens or hundreds of times their initial investments when these nations seek debt relief. That wasn't Bain Capital.
Romney has countered his critics by charging that they're attacking the free enterprise system. Critics of private equity argue that the attacks on Romney miss the point, and that private equity isn't free enterprise in the conventional sense of the term.
"It's basically looking for holes in the system that you can exploit," said Dean Baker, a co-director of the Center for Economic and Policy Research, a liberal research center.
Private-equity deals generally involve loading up newly acquired companies with debt. As the companies pay that off, they pay off the investors who hold the debt. That's very different from more traditional free enterprise, where an owner puts so-called sweat equity into creating a business, then sells it or takes it public in a stock offering, in which ordinary investors can share in the success of a company and government gains revenue by taxing capital gains and corporate income.
"It's absolutely standard for private equity (firms) to load up on debt ... then all the earnings are paid out as interest rather than dividends. That's a gain at the expense of taxpayers," Baker said. "It's not that you've improved the company. It's that you reduced the tax liabilities."
To be sure, private equity companies and their investors can make lots of money. The prospectus offered to investors in 2000 for a fund that invested in Bain Capital's ventures makes that abundantly clear.
"Bain Capital's first five private equity funds achieved an average annualized rate of return of approximately 178 percent per annum on all realized investments, and 88 percent per annum on all investments through December 31 (sic), 1999," the prospectus noted. By comparison, a 401(k) plan invested in a retirement fund that tracks companies on the S&P 500 would have had an annual rate of return of 3.2 percent over the past 10 years, generally the period covered in a Bain Capital offering to investors.
The prospectus touted Bain Capital's relationships with "leading investment banks" on Wall Street and added that Bain leaders would invest huge amounts of their own money to ensure that incentives are "clearly aligned" with those investors.
For those who accuse Romney of being a job killer, the third volume of a World Economic Forum report about private equity provides some ammunition. "The Global Economic Impact of Private Equity" found mixed results for employment.
"The study suggested that employment falls more rapidly at target establishments post-transaction," the 2010 report's executive summary says, confirming that jobs often are lost and benefits cut as the new owners strive to achieve returns on investment.
The report also notes that private equity investors accelerate the pace of acquisitions and mergers, which themselves yield consolidation in a given sector and thus job losses. A review of Bain acquisitions during the late 1980s and early 1990s shows that purchases often were followed soon by other acquisitions and mergers.
The Government Accountability Office, the nonpartisan government watchdog agency, issued a voluminous report on private equity in September 2008. Its conclusion came in the title, "Recent Growth in Leveraged Buyouts Exposed Risks That Warrant Continued Attention."
"Academic research that we reviewed ... suggests that the impact of these transactions on the financial performance of these companies generally has been positive, but these buyouts have been associated with lower employment growth at the acquired companies," the GAO said.
But those conclusions are just half of the story. For the businesses in which restructuring proves successful, there's more innovation and new jobs, the World Economic Forum report says. These investors provide a broader economic spark as "catalysts for change in the economy."
Therein rests Romney's political problem with his private-equity deals. Like President Barack Obama with stimulus spending, Romney must argue the counterfactual: that things could have been even worse. That is, even more jobs would have been lost had there not been a private equity-led restructuring and the company instead had gone belly up. The companies that were restructured also created demand in the economy for services, supplies, equipment, office space and the like. This doesn't show up in the numbers of hires or fires.
Bain Capital's success didn't happen in a vacuum; to understand Romney's success there, it's important to take a detour and consider the evolution of American business.
During the 1980s, Wall Street and big finance embarked in a new direction with corporate America. The old America — in which investors bought shares of company stock or snapped up corporate bonds with buy-and-hold strategies — began giving way to a new era of finance. A driver of this shift, surprisingly, was under-funded pension plans, according to Blaydon, the Dartmouth professor.
In order to ensure that workers got the retirement money they'd been promised, the Employee Retirement Income Security Act of 1974 was passed, and by the 1980s that forced companies to set aside pools of capital to fund promised pensions. Pension fund managers hungry for returns began to grow the earnings of retirees and pushed for changes in laws to allow investment in riskier assets. This helped give capital to the nascent private-equity and venture capital industries.
Venture capitalists provide money to startup businesses that have attractive ideas but not enough money. These investors were vital to the creation of California's Silicon Valley and the tech boom that changed our lives over the past two decades.
Private equity firms invest in existing companies that are under-performing and reshape them in hopes of making them more profitable. Sometimes they shed employees to achieve that. If the companies succeed, they add workers later.
A study by the consultancy Greenwich Associates found that 43 percent of U.S. pension plans were invested in private equity deals in 2006, near the peak of the economic boom that preceded the Great Recession. Similarly, some 80 percent of large pension plans surveyed by trade publication Pensions & Investments had stakes in private equity deals in 2007.
Through last October, there were about 2,300 private-equity firms headquartered in the United States, according to the Private Equity Growth Capital Council, the industry's trade group. These firms collectively operated 260 buyout/growth expansion funds. About 14,200 U.S.-headquartered companies enjoy some backing from private equity firms, the council said.
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