Romney's Run Puts Entire Private Equity Industry Under the Microscope

Political attacks on Mitt Romney and his old day job have divided the normally pro-business Republican Party and are giving most Americans their first look at the mysterious world of private equity. 

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Political attacks on Mitt Romney and his old day job have divided the normally pro-business Republican Party and are giving most Americans their first look at the mysterious world of private equity. Few people outside of financial and business cricles (and even some inside them) truly understand what private equity firms do, but the reputation of PE is under assault, even from former champions of the market, like Newt Gingrich.

Private equity investing can take many forms, but the strategy getting the most attention right now (and the one pioneered by Romney while at Bain Capital) is to make money by taking control of existing companies for the purpose of re-organizing them and then re-selling them for a profit. These turnaround specialists often make use of leveraged buyouts, where most or all of the money used to purchase the company is borrowed, forcing the target company to take on large debts. Because the targets are usually mature, but struggling companies, the new owners will usually change management, sell off assets, and cut costs (that means layoffs) in order to make the firm financially stable again. If it works, the value of the company goes back up, then it's sold again and the PE investors take their profit.

Critics call these tactics "slash-and-burn" and "vulture" capitalism, claiming that already rich people are preying on weak companies and sacrificing rank-and-file workers to make a quick buck. Romney and his supporters say that layoffs are just the cost of doing business in a free enterprise system and that without the help of private equity these under-performing companies would simply wither and die. They're both right, of course. A successful turnaround can save more jobs than it destroys, while creating value and profits for troubled businesses, but that not always the way things turn out.

Some companies are left truly devastated after PE takeovers, even as the investors make off with healthy profits. Less savvy PE firms can and do make bad investments or mismanage their holdings, leaving companies worse off than when they found them. (Even some of the companies Romney invested in when bankrupt after Bain sold their stake and moved on.) Some don't care whether the company survives at all, as long they can take winnings out first. Another legend of the leveraged buyout industry, Ted Forstmann who passed away last year, often criticized his fellow travelers for violating "the rules of prudent investment" and abandoning wisdom for get-rich-quick schemes.

The problem is that when it comes to evaluating the truth of these arguments about private equity, the "private" part often gets in the way. Romney claims that he and Bain created a net of 100,000 jobs during his tenure at the firm and Bain success stories, like Domino's Pizza and Dunkin Donuts, make compelling cases for their work. But because the companies private equity deals with are usually not publicly traded, the numbers are nearly impossible to verify. And even if Bain "netted" a positive job creation number, that's small consolation to those on the losing end who found themselves out of work.

Private equity veterans are stepping up to defend their industry and hope Romney will do the same. After all, he's the one who made his business background the key justification for his presidency. They're people too, and there are great benefits for everyone when companies are saved that might otherwise fail. Still, it's not easy to sell your ability to create jobs when you're also personally responsible for cutting thousands of them. (And you can't "lay off" taxpayers because they aren't profitable.) He's now the face of a whole industry that will only face more scrutiny if he wins the nomination.

It also doesn't help to see stories about other private equity firms reaping gigantic rewards at time when income inequality has become an central focus of the political world. Gingrich and the Democrats backing President Obama will certainly try to stoke the fears of Romney as a cold and calculating slasher.

This article is from the archive of our partner The Wire.