Republican presidential candidate Mitt Romney is a very wealthy man.He says he’s worth $250 million.
He made most of that money as the CEO of Bain Capital, a private equity firm. Private equity firms, or “PE” firms, make their money in all kinds of ways. One type of deal they do is called a leveraged buyout or “LBO.”
Here’s how a LBO works, and how a firm like Bain makes money from them.
- Step one: The PE firm starts with $10 million.
- Step two: The PE firm borrows $90 million from a bank. This is the “leveraged” part of an LBO.
- Step three: The PE firm takes the combined $100 million, and buys a company with it. This is the “buyout” part of the LBO.
- Step four: The PE firm assigns the $90 million debt to the company it has acquired.
- Step five: The PE firm runs the acquired company to make it attractive for re-sale.
- Step six: A couple years later, the PE firm sells its stake in the acquired company for $15 million.
- Step seven: The PE firm counts its profits: $5 million, a 50 per cent return on invest for a couple years worth of work.
Those are just hypothetical figures. Normally, LBO deals involve much larger sums.But that’s how a lot of LBO deals work, and it’s how Bain—and by extension—Mitt Romney, made a LOT of money.
But sometimes Bain and other PE firms tweaked the way LBOs worked to make even more money. The difference is in step five.
Instead of merely re-organising the acquired company into shape for re-sale, some PE firms, including Bain Capital, will take the acquired company’s earnings and use them to pay dividends to the PE firm’s shareholders.
Critics of LBO deals call this “looting the company.”
The reason why?
Sometimes those dividends can leave the acquired businesses saddled with debt and low on cash—and sometimes, that can lead to bad consequences.
Sometimes, the businesses acquired by PE firms in LBO deals either go out of business or they have to fire a lot of people.
Sometimes this happened to the companies that Mitt Romney’s firm, Bain, bought.
Paying out dividends in this manner, is, in fact, the “one thing” that Mitt Romney says he regrets about his private equity career.
In 2007, he told The New York Times that if any payment to Bain caused a company it had purchased to go out of business and cost people jobs it “would make me sick, sick at heart.”
“It is one thing that if I had a chance to go back I would be more sensitive to,” Romney told the Times. “It is always a balance. Great care has got to be taken not to take a dividend or a distribution from a company that puts that company at risk.”
In their deeply reported biography of Romney, “The Real Romney,” Michael Kranish and Scott Helman detail an instance in Bain’s history that probably does make Romney sick at heart:
In 1996, Bain invested $27 million as part of a deal with other firms to acquire Dade International, a medical diagnostics equipment firm, from its parent company, Baxter International. Bain ultimately made nearly 10 times its money, getting back $230 million. But Dade wound up laying off more than 1,600 people and filed for bankruptcy protection in 2002, amid crushing debt and rising interest rates. The company, with Bain in charge, had borrowed heavily to do acquisitions, accumulating $1.6 billion in debt by 2000. The company cut benefits for some workers at the acquired firms and laid off others. When it merged with Behring Diagnostics, a German company, Dade shut down three U.S. plants. At the same time, Dade paid out $421 million to Bain Capital’s investors and investing partners.
We learned all this reading The Real Romney, a deeply reported and informative book by Michael Kranish and Scott Helman. You should read if want to know about the guy whom half the country wants to be our next president. Pre-order the up-coming, updated, paperback version here. Or buy the Kindle edition.
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