Robert A. Levine 1-19-12
Mitt Romney’s ascendancy in the Republican presidential sweepstakes has put his career at Bain Capital, a private equity firm, under the microscope, the result of attacks against him from other GOP candidates. Romney’s apparent strength, his business experience, has instead become a
possible liability. It would appear to be counter-intuitive to have Republicans assailing private equity firms, a part of the free-market system. But in the heat of political battle, adversaries strike at the perceived weak spots of a front runner, particularly when the polls are unkind to those in the back of the pack.
Newt Gingrich’s broadsides may partially be payback for the hatchet job Romney’s super-PAC has done on Gingrich. Given the electorate’s concern about unemployment, Gingrich has repeatedly claimed that Bain and Romney were responsible for firing employees while looting companies. Romney was also labeled as a predatory corporate raider by a pro-Gingrich PAC. And Rick Perry called Bain Capital’s business model “vulture capitalism” for destroying jobs. Many Republican Party figures, including Rush Limbaugh, have come to the aid of Romney and private equity, declaring that attacks against him have been divisive and will boost Obama in the general election. But are these attacks fact-based or merely opportunistic?
Private equity firms buy companies that are in trouble, or at least those they assess as undervalued, believing that by restructuring these companies they will be able to make money. The funds utilized in these purchases are mostly borrowed, usually from private pools of capital that are unregulated by the SEC or any government agency. By leveraging these funds with a small amount of their own capital, the private equity firms are able to lessen their own risks while
increasing possible profits from the companies they have bought.
Once the private equity firm owns and is managing a company, it strips away underperforming assets and excess personnel. This results in job losses and reduced worker benefits for those retained. However, companies previously on precarious ground may be returned to a firm footing, which can lead to job growth in the future. Those businesses that can not be salvaged are closed. Since the private equity firms are not subject to public scrutiny, it is not usually clear whether the jobs created offset those that are lost. One study of thousands of private equity buyouts suggested that about 6% of the workforce were downsized over a five year period. On the other hand, some of these firms that were restored to financial stability were able to expand their businesses and add jobs over time.
Whether or not job losses occur because of these private equity leveraged buyouts, there are aspects of the way they function that are troubling. Management fees for the private equity firms are taken out of the revenues of the purchased companies, or borrowed and added to the debt of these companies. This can make it more difficult for the businesses to be successful, since more cash is needed to service a high debt load. And even if the companies go under, the private equity firms often make money.
Another point of contention regarding private equity firms (and hedge funds) is the lowered tax burden for much of the partners’ compensation through so-called “carried interest.” The private equity firms charge 2% for investing people’s money and also extract 20% of any profits. The latter is taxed at a 15% rate as capital gains, instead of the 35% that would be due from ordinary income. Yet unlike capital gains, those who reap the tax benefits do not place any of their own capital at risk to warrant the lower taxes. While the reduced taxes on the “carry” are currently legal due to arcane rules in the tax code, attempts to change the regulations in regard to this issue have failed, having been blocked in the Senate under pressure from private equity lobbyists. Both Republicans and Democrats have been complicit in this action, enhancing the wealth of private equity and hedge fund partners. Over $6 billion annually is lost to federal government coffers because of this tax giveaway. (Mitt Romney has stated that he pays about 15% of his income in taxes.)
The lack of transparency in these private entities that borrow huge sums of money and are highly leveraged is another problem that has not been addressed. The economic repercussions of one or more of these major firms going under could be considerable.
The bottom line is that the emphasis on job losses because of the business models of Bain and other private equity firms may be inappropriate. Rapacious management fees by these firms, unwarranted tax benefits on carried interest and the lack of transparency are much more important concerns. These features will not be corrected until Senators and members of Congress are willing to resist the largesse offered by the firms’ lobbyists. We should not hold our breath waiting.
Resurrecting Democracy
www.robertlevinebooks.com
Mitt Romney’s ascendancy in the Republican presidential sweepstakes has put his career at Bain Capital, a private equity firm, under the microscope, the result of attacks against him from other GOP candidates. Romney’s apparent strength, his business experience, has instead become a
Newt Gingrich’s broadsides may partially be payback for the hatchet job Romney’s super-PAC has done on Gingrich. Given the electorate’s concern about unemployment, Gingrich has repeatedly claimed that Bain and Romney were responsible for firing employees while looting companies. Romney was also labeled as a predatory corporate raider by a pro-Gingrich PAC. And Rick Perry called Bain Capital’s business model “vulture capitalism” for destroying jobs. Many Republican Party figures, including Rush Limbaugh, have come to the aid of Romney and private equity, declaring that attacks against him have been divisive and will boost Obama in the general election. But are these attacks fact-based or merely opportunistic?
Private equity firms buy companies that are in trouble, or at least those they assess as undervalued, believing that by restructuring these companies they will be able to make money. The funds utilized in these purchases are mostly borrowed, usually from private pools of capital that are unregulated by the SEC or any government agency. By leveraging these funds with a small amount of their own capital, the private equity firms are able to lessen their own risks while
Once the private equity firm owns and is managing a company, it strips away underperforming assets and excess personnel. This results in job losses and reduced worker benefits for those retained. However, companies previously on precarious ground may be returned to a firm footing, which can lead to job growth in the future. Those businesses that can not be salvaged are closed. Since the private equity firms are not subject to public scrutiny, it is not usually clear whether the jobs created offset those that are lost. One study of thousands of private equity buyouts suggested that about 6% of the workforce were downsized over a five year period. On the other hand, some of these firms that were restored to financial stability were able to expand their businesses and add jobs over time.
Whether or not job losses occur because of these private equity leveraged buyouts, there are aspects of the way they function that are troubling. Management fees for the private equity firms are taken out of the revenues of the purchased companies, or borrowed and added to the debt of these companies. This can make it more difficult for the businesses to be successful, since more cash is needed to service a high debt load. And even if the companies go under, the private equity firms often make money.
Another point of contention regarding private equity firms (and hedge funds) is the lowered tax burden for much of the partners’ compensation through so-called “carried interest.” The private equity firms charge 2% for investing people’s money and also extract 20% of any profits. The latter is taxed at a 15% rate as capital gains, instead of the 35% that would be due from ordinary income. Yet unlike capital gains, those who reap the tax benefits do not place any of their own capital at risk to warrant the lower taxes. While the reduced taxes on the “carry” are currently legal due to arcane rules in the tax code, attempts to change the regulations in regard to this issue have failed, having been blocked in the Senate under pressure from private equity lobbyists. Both Republicans and Democrats have been complicit in this action, enhancing the wealth of private equity and hedge fund partners. Over $6 billion annually is lost to federal government coffers because of this tax giveaway. (Mitt Romney has stated that he pays about 15% of his income in taxes.)
The lack of transparency in these private entities that borrow huge sums of money and are highly leveraged is another problem that has not been addressed. The economic repercussions of one or more of these major firms going under could be considerable.
The bottom line is that the emphasis on job losses because of the business models of Bain and other private equity firms may be inappropriate. Rapacious management fees by these firms, unwarranted tax benefits on carried interest and the lack of transparency are much more important concerns. These features will not be corrected until Senators and members of Congress are willing to resist the largesse offered by the firms’ lobbyists. We should not hold our breath waiting.
Resurrecting Democracy
www.robertlevinebooks.com
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