Reporting from the New Hampshire primary, Fox News’s Carl Cameron observed that Bain Capital was “the venture capital company in which [Romney] both bought and grew companies and occasionally shut a few down.”
But Bain Capital is not, as Cameron said, a venture capital firm. He wasn’t the only reporter to mislabel Bain, either. When Newt Gingrich first ramped up attacks on Romney as a “corporate raider” at Bain, the news media covered the attacks by referring to the company alternately as a venture capital firm and a private equity firm. After a few days, private equity began to be used more often. However, looking over transcripts from Fox News, CNN, and MSNBC, TPM found that all three often continue to use the term “venture capital” to refer to Bain and Romney’s private sector experience.
For better or worse, a key feature of this campaign will be Mitt Romney’s record at Bain Capital. As a result, the understanding the difference between private equity and venture capital will help voters understand the man they may vote for in the primary, and possibly the general election. Because venture capital tends to be regarded as a job-creation industry, confusing the two terms will likely work to Romney’s advantage.
The term private equity simply refers to equity that is not public, like stocks. Venture capital — the practice of investing in the early stages of a company — uses nonpublic equity and is therefore a form of private equity. However, most similarities stop there.
“Venture capital and private equity obviously don’t have technical definitions,” said Edward Kleinbard, a law professor at USC’s Gould School of Law and former chief of staff to the Congress’s Joint Committee on Taxation. “But properly used, they point to different business strategies and different points in the life cycle of a business.”
Historically, venture capital is about investing in the early stages of a company in order to help it succeed. With a minority stake in the company, after several years, the venture capital firm will make money by merging the new company or taking it public. If the company doesn’t succeed, they lose their investment.
“Venture capital is all about feeding a toddler of a company; getting it from toddler to early adulthood,” says Kleinbard. Continuing this metaphor, private equity is about improving mature companies.
“Private equity is sort of the successor term to what 20 years ago we called leveraged buyouts,” says Kleinbard. The idea is that the private equity firm buys a company for the purpose of improving profitability and selling the company for a profit. A small percent of the money to buy the firm is raised from investors, but most of it is borrowed. The two pillars of private equity are, says Kleinbard, firstly removing the company from public ownership if they are publicly-traded, and - second - adding a substantial leverage component to the capital structure.
The fact that private equity takes out loans to purchase companies and then puts that debt on the companies’ balance sheets is what earns them criticism. In order to increase profitability, leveraged buyouts — what most private equity firms practice — strip assets from firms, sometimes jobs, in order to make more money. “When you have a ton of debt, particularly high-cost debt, you’re going to try to strip out assets as quickly as possible and extract that value,” says David Min, Associate Director of Financial Markets Policy at the liberal Center for American Progress.
Part of the outrage that Newt Gingrich, and Rick Perry until he dropped out, tried to stir up over Bain was the depiction of a “corporate raider” or “vulture capitalist.” And that is exactly how private equity’s critics see things.
“At its best, [private equity] is taking the weak and flabby and putting them on a diet and exercise regimen,” says Kleinbard. “At it’s worst, it’s just financial engineering: buy it, leverage it, hope the economy carries it and sell it in three years.”
Those more sympathetic see private equity as fixing companies in trouble. “I think private equity is an important institutional development that has enabled troubled companies to come back from the dead,” says Robert Litan, vice president for research and policy at the Kauffman Foundation.
“I don’t think private equity firms typically help businesses at all,” says Joshua Kosman, a finance reporter and author of The Buyout of America: How Private Equity Is Destroying Jobs and Killing the American Economy. Kosman says private equity firms like Bain Capital go for companies with “moderate growth” whose profitability can be increased. If you look at the press releases of the companies Bain bought that eventually went bankrupt, they don’t say these companies are in dire straights, Kosman points out, they say they are profitable companies.
To confuse matters more, Bain Capital does dip its toe into venture capital as well — but it only represents a fraction of the total business. Through a venture capital arm of the company called Bain Capital Ventures, Bain has investments in dozens of companies for a total portfolio of $1.5 billion — accounting for 2.5% of Bain Capital’s $60 billion portfolio, according to Bain’s website (Bain Capital did not respond to requests for comment on the size of Bain Capital Ventures). The Wall Street Journal’s assessment of Bain Capital found that “after its initial focus on small firms needing capital,” Bain “later shifted toward the potentially more lucrative business of leveraged buyouts — acquiring control of businesses by using investors’ money amplified by debt.”
Kosman, who has been researching Bain for years, says that during Mitt Romney’s time at the company, over 90% of dollars spent were on private equity projects, not venture capital.
Even though venture capital is a small piece of what Bain does, Mitt Romney is largely selling his Bain Capital experience to voters as venture capital. That’s because the main success stories Romney touts on the trail — and the source of his claim to have created 100,000 jobs at Staples and Sports Authority — were early venture capital investments. “I’m sure there are examples of people using leveraged buyouts to create jobs,” says Min, “but every finance major in America gets taught about leveraged buyouts as an important way to make money.”
“My personal view is that private equity plays a helpful role to some degree, but the explosion in private equity reflects a real shift in the economy that is fortunate for the very wealthy,” says Min. That’s the last thing Romney wants voters to think.
Pema Levy
Pema Levy is a News Writer at TPM covering the 2012 election. Before coming to TPM, Pema was an assistant editor at The American Prospect where she wrote about politics and the economy.
While we're at it you should also describe the difference between turn-around private equity and growth capital private equity.
Bain specialized in turn-arounds which involved the very risky strategy of investing your own money in a company that is quickly on its way or already in bankruptcy. A pretty close analogy is an ER patient in critical condition. You then do whatever you can to stabilize the company (stop the bleeding). In the ER, this may require an amputation. In a turn-around, it means a portion of the workforce may lose their jobs so that the company has a chance to survive and continue to employ a smaller workforce. Sometimes the company is beyond repair and all efforts to save it fail. In this case you lose your entire investment.
If you succeed in stabilizing the company, you must next improve it (rehabilitate the patient). To modernize assets and train the remaining workforce requires money, often in the form of bank loans. If the company fails to improve, you lose money. If it succeeds, the company grows, creates new jobs and you are obligated to return the profits to your investors (pension funds, university endowments, etc.) within a specified time frame. Your options are to replace your equity in the company with debt (dividend recap) or sell the company and use a portion of the proceeds to pay off the debt you accumulated (the new owner decides how much debt they want to put on the company). In an efficient market, you can't extract more value out of a company than you put into it unless you have created value in the company somewhere along the way.
After you cash in your equity, though, it is always possible that market conditions or the new owners cause the company to struggle, cut jobs, go through bankruptcy or even shut down. This is true for any company, but can hit companies still recovering from a near-death experience harder than others (I'd like to see an analysis of how Bain company's fared compared to company's in similar markets with similar debt ratings at the time of investment). That's how a market is supposed to work to make room for new innovative businesses.
The difference between Venture Capital and Private Equity is the deployment of risk. Venture Capital is supposed to invest before companies cross the chasm, private equity is post chasm investing.
But the lines blur, Venture Capital has over 20 years deflated risk to subprime (uniform) and is from a risk profile perspective currently investing using micro-PE in early stage companies, producing micro-PE returns. Venture Capital has produced on the whole negative IRRs which if Romney choses to attach his reputation to that will not give him more merit than investing in Private Equity.
During Mitt's reign at Bain, it was essential that all the assets of a targeted company be transferred in one way or another to the 'private equity investors' ("investors" , if you'll pardon the expression).
A company was 'hollowed out' - workers' salaries cut, workers' benefits gutted, workers' pensions destroyed, ... Huge loans were made to 'leverage' the company --- essentially, creating burdensome debt.
New buyers were found to 'un-load' the shell of a company that was left.
The 'private equity investors' ("investors" , if you'll pardon the expression) pocketed the money, shuffled off the crippled (by debt) company to others, left the workers with (1) lower pay, (2) fewer benefits, (3) no jobs, (4) no pensions.
That's the 'entrepreneurial spirit' represented by Mitt "in his day" "running things", as he likes to say, "in his day running things".
Mitt starting making his money the old fashioned way : He inherited it.
Mobility in this nation ranks 34th in world.
Coddling millionaires' children is one reason. A skewed tax structure is another. A meaningless inheritance tax another. And oodles of tax tricks to 'protect wealth' (i.e. avoid public responsibility) is another.
Mitt indulges in all of the above.
THANK YOU, Pema, for this; it's been driving me crazy ever since Bain became a hot topic. And thanks specifically for this:
"...the main success stories Romney touts on the trail — and the source of his claim to have created 100,000 jobs at Staples and Sports Authority — were early venture capital investments."
-- which I've also hoped people would start picking up on. (And Dominoes is hardly an unalloyed success story: anybody remember their ads acknowledging how crappy their pizza was? That was after Bain's involvement; a thriving company doesn't have to apologize for its product ...)
It's hard to get these things into a soundbite, but they're really not complicated distinctions. Essential story; thanks again.
Good idea of a story. Thanks for educating.
Please help us next understand why president obama is also a phony when he claims he is the guy in the room fighting for the 99%, since his economic policies have mirrored those that favor the 1% (and also discuss that he is itching to cut SS and medicare when there is no need to).
Last year, the president was dying to put in his SOTUS that he was going to cut social security and medicare. Someone calmly and wisely talked him out or it. He then tried to impose the cuts during the debt ceiling fiasco. By sheer luck, the gop had problems with other aspects of the offer, and it quietly died.
TPM once made a name for itself by taking the lead in the fight to stop bush from privitazing SS. Now that president obama wants to cut SS and medicare, TPM has pulled a Romney on us and won't even report on the impending cuts, let alone take the lead in fighting against them. I guess that's what happens when reporters become, or see themselves as, part of the ruling elite super-structure.
Private equity wrecks a company with little or no debt that is paying its bills as they become due. It does that by buying the company with borrowed money. The money is used to pay for the company and the fees of the private equity investors. The debt is secured by the assets of the company, which after the transaction typically has too much debt and unless things go great, soon lacks the money to pay its debts. Attempts to "save" the overburdened company include selling parts or all of it and cutting employees or their benefits. Bankruptcy frequently follows. This is not job creation, but job destruction. It's legal, but it's a scam without any social benefits. The ability to engage in this kind of activity does not recommend a person for political office, but it is a good recommendation for a position in organized crime.
Hey, you are correct on what the media does and is doing for their candidate. We must all remember that the media talking heads represent the 1%. The 1% wants Romney, their boy to win the WH. So they know they can distort and misinform about venture capital vs private equity. Who will know? Unless writers let us know since the 1% media will never tell us.
Now the big story is - how will the media stop Newt, and how much fun it will be to watch it unfold.
There are some who openly talk about the looting of companies using LBO/Private Equity as being a good thing. It's like Walmart talking about "driving the costs out of the system." LBO companies like Bain Capital claim that stripping out assets of under-performing companies and shutting them down improves the overall strength and efficiency of the economy, they say. Of course, since the health of the overall economy doesn't matter so much to people if their local major employer is gone with no replacement.
Romney, of course, can't openly say as a candidate for President that shutting companies down is a good thing and that he's proud of helping to get rid of under-performing and weak companies -- and by "weak", read "vulnerable to takeover." But you know he is.
Thanks for clarifying. It's been driving me nuts as I keep hearing media figures mixing up the terms, I'm sure having no idea. It would suck if venture capital was done away with because of the abuses of private equity, and it would be great if leveraged buyouts were banned. I consider them legalized fraud.
This all I've got to say about it.
Thanks for this. This is something I didn't realize before--appreciate the information.
i think the bottom line is that there are two approaches when it comes to private equity investment. 1 - you can invest in the truest sense, by trying to build, improve and create. 2- you can leech, sneak, squeeze, leverage and then bail, making the most cash for yourself as possible and minimizing long term exposure. Clearly, Bain has been doing a little of the first approach and mostly the second for years. Is this the America that we want? Is this the kind of leader that we want? hardly
The difference between venture capital and private equity is analagous to the difference between a foster mother who takes on nursing, and even child rearing, responsibilities for a weak infant and those parasitic wasps that inject their larvae into mature caterpillars to use as a living food source.
(Yeah, okay, I know "mature caterpillar" is kind of an oxymoron. Move past it and work with me here.)
NCSteve 3.0 Not sure the term really fits. For Romney to be seen as a parasitic wasp, folks would first need to think of him as Protestant.
Very worthwhile read. The distinction between venture capital and private equity funding of companies is critically important to understanding what these firms do. When using the private equity approach they not only get to strip the bones of the company but write off the debt they leveraged to do it. Incredible. We are such suckers.
Thanks for explaining this to those of us who have educations in other areas. Now I understand. Thanks.
"The idea is that the private equity firm buys a company for the purpose of improving profitability and selling the company for a profit." This is not accurate. The private equity firm doesn't care if it improves profitability, all it cares about is selling the company for a profit. And once the "vulture capitalist" has gained control, it can also do things like issuing a special dividend to itself and paying itself "management fees" that guarantee it will make a profit even if the purchased company goes belly up.
rp10007 I think if it had read "improving SHORT-TERM profitability" -- ie, long enough to allow for the company to be sold at a profit -- that'd be perfectly accurate. Although it's also absolutely true that, as you indicate, the LBO artist can make a profit regardless.
Mr. Romney is using technicalities to avoid taxation. His "off-shore" accounts will not show up in any tax form anywhere. Seems to me he is just another swindler in a nice suit.
Private equity really is the big brother to sub prime mortgage loans...They would find companies that could take on a lot of debt beyond their ability to pay - cash out the borrowed money and move on
Babsman Nice connection -- same mindset, same MO, same ethos.
Sorry, but this article is an exercise in hair-splitting. And most Americans have no clue what either term means, so it really doesn't make any difference anyway.
hrebendorf See "foster mother" vs. "parasitic wasp" analogy above. It's not a little difference. It's a huge difference.
hrebendorf Actually it's a big difference, and not all that complicated -- to spin off NCSteve, it's the difference between the sincere foster parent who takes in a child in need of care in order to help that child grow and thrive, and the scumbag who takes in foster kids for the monthly check and doesn't give a crap about how the kids'll do once they've dumped them back into the system.
The corporate owners of the MSM want romney to win, so they use the less volatile adjective to make RAWmoney more appealing to the sheep.
I don't think Faux News counts as "the media," as this headline says. More like "Faux News promotes Romney by inaccurately calling him a venture capitalist."
fnacalgal Lots of journalists have been calling him that, including on the 3 broadcast networks that most people still get their news from.
NPR had an interesting segment this morning on what private equity firms do. Of course, they had on an actual private equity industry dude on to talk about it.
(I don't understand why NPR is labeled the "liberal bastion" when if they really were, they'd be hammering Mitt like gangbusters and try to undermine a positive story about his former "job")
invisible It isn't a "liberal" bastion. Its a real news organization that provides a level of reporting unmatched in the Western world. Real news that is fact driven has always been suspect in the empty minds of most US conservatives today, who think that reading or owning a passport is as un-American as it gets.
jsdc007invisible Actually, I think if you want "unmatched in the Western world," you're going to have to go with "BBC." NPR is a pale, underfunded and cowed imitation. But it's what we got.
jsdc007invisible Yeah, sorry...NPR has devolved into the false equivalency mess and has too often been serving up dictation instead of reporting. Now, hey, I like the Car Guys and all the rest, but as a news outlet, NPR has increasingly pissed me off beyond belief, simply repeating conflicting claims and lies and just leaving it at that, which ends up elevating the lies and dissembling to the level of "valid argument" or "some portion of the truth."
In the days when the FBI was after the mob, federal agents called the type of conduct described above as a "Bust-Out Scheme" It was illegal, buying a company for the purpose of saddling it with debt and stripping it of its assets. Frank Lorenzo engaged in the identical behavior in his takeover of Eastern Airlines and Congress thought his conduct so illegal he was banned from ever owning an airline again. Now it's an accepted business practice. Sigh.
I wonder if Frank Lorenzo ever concluded that the things he did in the pursuit of wealth somehow qualified him to be president?
Thanks. Important distinction.
John D. Burns Agreed. Good article, Pema.
The phrases “leveraged buyout”, “LBO”, “Kravis, Kohlberg and Roberts”, “KKR” used to strike true fear and anxiety in many, many Americans. Companies like KKR really were viewed as barbarians at the gate, a sort of supra-national entity that could come into a community and destroy, for profit, with impunity. I think most people tend to view Romney as more like a Silicon Valley venture capitalist than lord of the LBO. If I were opposing Romney I’d do everything I could to associate him with “leveraged buyouts”. As innocuous as it sounds I’ll bet that phrase carries a lot of baggage for a lot of middle-aged Americans, and as this article makes clear, it’s the appropriate lens to view Romney through. Rightly or wrongly, I can’t think of a single phrase which is more evocative of “job destruction” for people my age, than “leveraged buyout”. Still gives me the shivers.
barbarians at the gate is a great book. it presaged Drexel and Milken and junk bonds. anyone remember the Predator's Ball?
No Exit A great book that made a great TV movie (I think early HBO) -- smart, mean, and funny.
President Romney's Private Equity Top Ten List
10. Place mortgage on White House
9. Take loan origination fee
8. Refinance debt
7. Take refi fee
6. Arrange sale/leaseback of White House
5. Take real estate commission and lease negotiation fees
4. Consider IPO
3. Take management fees
2. Flip government to new Private Equity leadership at 4-year mark
1. Take success fee
'Media' probably knows less about business than typical americans. And typical americans like my parents no clue what venture capital is. Unless you have ties to start up businesses why would you know.
Napster Typical Americans confuse Adam Smith's invisible hand with Da Vinci's hand of God.
Turns out, what Romney and Bain Capital did is quite similar to homeowners who took out big loans and put up little of their own money to buy and flip a house, hoping that the value increasing over time would make up for the massive borrowing and actual equity up front.
jeffgee Nope, it's not like that. It's worse. Imagine that instead of fixing up a house to flip it, someone gutted all the fixtures and the wiring and sold them somewhere else, then installed a little low-end stuff and spackled over the rest, trusting to a rising market and their ability to find a naive buyers somewhere.
If I had to guess, I bet the media glommed onto "venture capital" to describe Bain because Perry niftily tagged it as "vulture capital". The media is too lazy to inquire whether Perry's pun is an accurate play on words, or just more dumb snark.
Venture capital helps a business grow. Bain helped them to shrink.
Whatever you call what Bain does, technically correct or incorrect, it seems that the public is getting the message that they are a rapacious company taking advantage of others misery. Only MBA people will care whether it is Private Equity or Venture, the others got the idea of what we are talking about.
juanboliche Most insidious are the Bain deals - common among PE raiders formerly known as LBO raiders (leveraged buy-out) where Bain buys a company, orders that company to borrow as much money as possible and sell valuable assets to raise a large amount of cash, then takes a huge dividend for Bain from that cash that is a multiple of the cash Bain paid to buy the company (thus locking in an impressive profit on its investment WITHOUT necessarily improving the target company's profitability), and then when the company stumbles under the crushing Bain-induced debt load Bain decides to walk away leaving the company's creditors, landlords, suppliers, customers and employees (management as well as line workers) royally screwed WHEN in many cases an injection of equity by Bain that it could easily provide could have allowed the company to stay out of bankruptcy and survive / work through its problems. Not all PE deals end that way, but PE is famous for not caring on bit when they do since they got a great return for themselves.
Orly Taitz tells us that [one of the lawyers challenging Obama's eligibility on Thursday] “is planning to challenge Romney as well. I will not be an attorney on the challenge of Romney, as there is no evidence to support such challenge. Even though Romney’s father was born in Mexico, he was a US citizen. Romney was born to two US citizens in the US. As I am still in CA, I have no control of what a client says to NBC in GA.”
Adrian Browne There's this contingency of the birthers, we used to have one here (David "Sudsy" Farrar) as a regular, who think that 'natural born' means that your parents have to be born in the U.S. too. I don't understand their argument, mostly because it's insane, but you gotta love people who even Orly Taitz say are going way too far in interpreting the law.
Continued:
A turn-around fund it not designed to succeed with every company it invests in because that would be impossible considering the risk. Instead, it needs to make a handsome profit on the investments that succeed in order to make up for the ones that don't. The service provided and value create by turn-around private equity groups such as Bain is clearly preferable to simply allowing every bleeding patient die on the emergency room floor. Likewise, you don't run the surgeon out of town every time a patient dies despite the surgeon's best effort or months later due to unforeseen complications.
Romney and Bain deserve credit for pioneering turn-around private equity. They were (still are) damn good at it and highly respected by their peers, investors, the managers they hired and the people that later bought the companies they fixed. Far more companies succeed than failed. With a history of dozens of investments, a few cherry-picked anecdotes provide a very distorted picture. Bain started the trend that led to the modernization of thousands of businesses and factories and reestablished America's economic dominance in the face of ascending Japan and Germany. They are the catalyst for "creative destruction," which is a very good thing (look it up).
Anyone who really cares how Romney made his millions should get a balanced education on the subject of private equity instead or relying on a painfully biased political propaganda piece. When did people start believing political ads anyways?
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