Everything you always wanted to know about Bain Capital (but were afraid to ask)

Posted: 6 September 2012 in Uncategorized
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Lots of friends and students have been asking me how Mitt Romney and Bain Capital did it—how they managed to leverage other people’s money, siphon off a large chunk of the surplus of the corporations they took over, and then pay very little tax on the resulting profits.

As it turns out, their genius was in putting together a coalition of banks (who lent them most of the money), corporate managers (of the target companies), and politicians (who first passed and then decided not to repeal, on a regular basis, favorable tax laws), along with some of their own buyout money, to capture and then share with the banks and managers, but not the government, a large part of the surplus generated within the companies they managed to take over. The one major group that was not part of that coalition were the workers, who got screwed.

Matt Taibbi, in his inimitable style, takes readers through the “true story” of Romney and Bain Capital:

Here’s how Romney would go about “liberating” a company: A private equity firm like Bain typically seeks out floundering businesses with good cash flows. It then puts down a relatively small amount of its own money and runs to a big bank like Goldman Sachs or Citigroup for the rest of the financing. (Most leveraged buyouts are financed with 60 to 90 percent borrowed cash.) The takeover firm then uses that borrowed money to buy a controlling stake in the target company, either with or without its consent. When an LBO is done without the consent of the target, it’s called a hostile takeover; such thrilling acts of corporate piracy were made legend in the Eighties, most notably the 1988 attack by notorious corporate raiders Kohlberg Kravis Roberts against RJR Nabisco, a deal memorialized in the book Barbarians at the Gate.

Romney and Bain avoided the hostile approach, preferring to secure the cooperation of their takeover targets by buying off a company’s management with lucrative bonuses. Once management is on board, the rest is just math. So if the target company is worth $500 million, Bain might put down $20 million of its own cash, then borrow $350 million from an investment bank to take over a controlling stake.

But here’s the catch. When Bain borrows all of that money from the bank, it’s the target company that ends up on the hook for all of the debt.

Now your troubled firm – let’s say you make tricycles in Alabama – has been taken over by a bunch of slick Wall Street dudes who kicked in as little as five percent as a down payment. So in addition to whatever problems you had before, Tricycle Inc. now owes Goldman or Citigroup $350 million. With all that new debt service to pay, the company’s bottom line is suddenly untenable: You almost have to start firing people immediately just to get your costs down to a manageable level.

“That interest,” says Lynn Turner, former chief accountant of the Securities and Exchange Commission, “just sucks the profit out of the company.”

Linda Beale, for her part, explains how the two key tax dodges work. First, “carried interest”:

The best known way private equity firm partners reduce taxes is by earning their compensation in the form of “carried interest” and claiming that such profits should be treated the same way a real capital investment in a partnership is treated, even though it is awarded as compensation for their purported management expertise and work and not as a return on an actual investment made.   That is, they claim they are profits partners in the firm and that their compensation is a distribution of the partnership’s profits (usually from gains on sales, and hence eligible for preferential capital gains) to them rather than compensation income.  As such they benefit from the extraordinarily preferential rate for capital gains in the current law as enacted under the Bush administration (generally 15%).  Carried interest is the primary reason that candidate Romney has to pay such a very low rate of taxes on his income from his business.

Then, “management fee conversion waivers”:

The conversion of management fees from ordinary income to capital gains is purportedly accomplished by “waiving” the fees (not necessarily across-the-board throughout the life of the firm, but often selectively and on a quarter-by-quarter basis),  Instead of getting fees, the partner claims they are “converted” to a share of related profits –i.e., they become an additional carried interest–and hence eligible for treatment as (deferred) capital gains from the firm.

Put them together and what we have is a brilliant scheme whereby Romney and Bain Capital risk very little of their own money to capture the surplus and then keep most of it for themselves, to continue buying companies and sending the rest to their private accounts offshore.

Taibbi concludes by explaining what this all means for the current election:

Forget about the Southern strategy, blue versus red, swing states and swing voters – all of those political clichés are quaint relics of a less threatening era that is now part of our past, or soon will be. The next conflict defining us all is much more unnerving.

That conflict will be between people who live somewhere, and people who live nowhere. It will be between people who consider themselves citizens of actual countries, to which they have patriotic allegiance, and people to whom nations are meaningless, who live in a stateless global archipelago of privilege – a collection of private schools, tax havens and gated residential communities with little or no connection to the outside world.

Mitt Romney isn’t blue or red. He’s an archipelago man. That’s a big reason that voters have been slow to warm up to him. From LBJ to Bill Clinton to George W. Bush to Sarah Palin, Americans like their politicians to sound like they’re from somewhere, to be human symbols of our love affair with small towns, the girl next door, the little pink houses of Mellencamp myth. Most of those mythical American towns grew up around factories – think chocolate bars from Hershey, baseball bats from Louisville, cereals from Battle Creek. Deep down, what scares voters in both parties the most is the thought that these unique and vital places are vanishing or eroding – overrun by immigrants or the forces of globalism or both, with giant Walmarts descending like spaceships to replace the corner grocer, the family barber and the local hardware store, and 1,000 cable channels replacing the school dance and the gossip at the local diner.

Obama ran on “change” in 2008, but Mitt Romney represents a far more real and seismic shift in the American landscape. Romney is the frontman and apostle of an economic revolution, in which transactions are manufactured instead of products, wealth is generated without accompanying prosperity, and Cayman Islands partnerships are lovingly erected and nurtured while American communities fall apart. The entire purpose of the business model that Romney helped pioneer is to move money into the archipelago from the places outside it, using massive amounts of taxpayer-subsidized debt to enrich a handful of billionaires. It’s a vision of society that’s crazy, vicious and almost unbelievably selfish, yet it’s running for president, and it has a chance of winning. Perhaps that change is coming whether we like it or not. Perhaps Mitt Romney is the best man to manage the transition. But it seems a little early to vote for that kind of wholesale surrender.

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