In my column "Why America Doesn't Need a CEO" a few weeks ago, I discussed why Mitt Romney's experience as CEO of private equity firm Bain Capital may not give him the right credentials for the White House. Based on reader feedback, I want to expand on this, specifically in the context of Bain.
There are two major private equity models in existence today. In the first one, a private equity firm invests its own money in a company and recovers that money over time from profits as well as through an eventual sale of the company. Returns are based on how much money the investor makes after recovering their original capital. This is a perfectly good model which has long served as a powerful engine for our capitalist system. New businesses require capital to grow and private equity firms provide that fuel.
Unfortunately, there is too much temptation for private equity firms to employ the second model, which is more lucrative but often destructive. Popularly dubbed the "Leveraged Buyout" or the "LBO" and glamorized by the famous practitioners of this dark art, especially in the '80s, the LBO is based on a dangerously simple idea -- buying a company using mostly debt and loading that debt onto the company's books. The concept is logical but also highly toxic, since the servicing of that debt puts a tremendous strain on the company's resources and can destroy its future. Not to mention that in the meantime, the private equity sponsor siphons off whatever profits the company makes through dividends to itself.
At the end of that process, companies usually wind up in one of two situations. Either the debt cannot be repaid and the company is forced into bankruptcy; or the private equity owner manages to sell the company (usually at a good profit) to another party, who promptly refinances the debt and rolls it over for another few years and till the next buyer emerges to continue this game... The net result of all this is a sort of indentured servitude for the company, which remains trapped under a debt overhang that retards its natural growth.
Another big consequence of the LBO is brutal cost-cutting that is imposed on the target company by the private equity owner in order to service the payments on the debt. There is simply no other way for the company to survive. In an ideal world, cost cutting should streamline a company's operations and make it more efficient but in reality private equity firms literally squeeze the life out of companies to support their buyout structure. This type of cost cutting leads to forced unemployment and a drastic reduction in productive business activities, which actually impedes the progress of the company rather than enhancing it. All the while, the private equity sponsor has taken minimal risk and even if the company is forced into bankruptcy, the owner can still come out ahead if it has sucked out enough cash in the meantime.
Not a bad business model if you are a private equity firm. Not so good though, for the company or the economy.
Which brings me back to Mitt Romney and Bain Capital, which utilizes the LBO model heavily in its business. For some perspective, according to a Wall Street Journal Report, Bain made 77 investments during Romney's tenure there. Of those, 22% either filed for bankruptcy reorganization (wiping out value for the lenders and leaving the companies as former shells of themselves) or outright shut down. Another 8% were just plain business disasters. Through all this, however, Bain made $2.5 billion of profit for its investors on a base of $1.1 billion. Handsome profits for some but dear losses for many.
Let's be clear. Romney does not need to apologize for being born rich or for making a lot of money. That is, after all, the American dream. But, how he made that money does matter, because the presidency of the United States is not just about a track record or success but about judgment. A person's judgment determines their choices and how Romney chose to make his money should be of utmost importance in the upcoming elections. Bain Capital may have been wildly successful with Romney as CEO but that success came at a heavy price for the companies that collapsed under the weight of Bain's investment methods.
In my previous column, I highlighted how the president must not just be an effective leader but a statesman with a broad view of the world. To demonstrate that quality, one needs to exhibit responsibility, judgment and sometimes personal sacrifice in many areas of life, including business. Mitt Romney chose to make his fortune in a way that might not be unethical but is still irresponsible and mercenary. He had a right to do that but the tradeoff is that he must now take responsibility for his choice. The philosophy that made Bain and its CEO wealthy is also destructive for our economy and nation, and that makes Romney a bad match for the White House.
Sure, he was governor, but the difference between that role and the presidency is vast. The powers of an American president and the impact his decisions can have on the direction of our country and the world cannot be compared to the smaller and more isolated dynamics of one state.
To sum it all up, if you relish the idea of electing someone who has made money through a business model that, in many instances, destroys value and has negative repercussions for our economy, then Romney is your man. But if you are looking for someone with the willingness to sacrifice personal gain for the sake of their nation's interests and whose judgment is sound, then Mitt Romney may be the wrong choice. Ironically, it is exactly his long and successful track record at Bain Capital that tells us who he is and what he believes, and those opportunistic beliefs run counter to the wider interests of our country.
Follow Sanjay Sanghoee on Twitter: www.twitter.com/sanghoee