Former Clinton labour Secretary and Professor Robert Reich has a quick, simple video out on how private equity partnerships make so much money buying, revamping and selling companies.
It’s all explained in 8 steps.
This all ties in to the hottest Wall Street topics of the day; Mitt Romney’s tenure at Bain Capital and NY Attorney General Eric Schneiderman’s probe into how PE firms (and hedge funds and venture capital firms) allegedly pay a lower rate on profits by paying a 15% capital gains rate rather than a regular 35% rate.
Before you check it out though, it’s important to reiterate that this quick tutorial is about “partnerships” (like Bain Capital) because some private equity firms don’t start with investor funds.
This entire debate is about risk and Reich is arguing that, bottom line, these firms don’t have enough skin in the game.
Here are Reich’s 8 steps (or you can skip down to the video below):
1. Build a PE fund of other people’s money.
2. Target a company they think they can “squeeze” profits from.
3. “Squeeze” those companies by cutting costs — firing workers, cutting benefits etc.
4. Use company as collateral to borrow money from banks. Interest payments from this debt are deducted so the company shows bigger profits.
5. “Get the company to issue a special dividend to pay the original investors so everything else is gravy” (this is a dividend recap).
6. Sell the company at a profit.
7. Pocket 20% of the gains for that sale.
8. Pay 15% tax (capital gains) on the profit from this sale.
Reich says that this is a “sham” because capital gains taxes are supposed to be for people who are risking their own money with their investments and private equity firms aren’t risking a dime. On top of that, he argues, it’s the American people who subsidise this because we take care of the people who are unemployed as a result of these private equity cuts and we make up for the lost government revenues.
Watch the video below: