Leveraged Buy Outs (LBO’s) are a huge part of our financial system and when intentions and good positive practices are followed through, they can not only turn a struggling company into a great one, but also can also fill the pockets of the private equity firm or bank that originally bought out the struggling company. Lets simplify this process…
As a private equity firm, I have set profits aside (collected from management fees and investments from my clients) for the sole purpose of acquiring struggling companies. I need to have researched heavily and decide that I have a good plan to turn this company around once I have purchased it. That being said, it makes no sense to purchase it completely with only my money because one, that cost is much more than I probably have put aside for the purchase and two, it doesn’t allow room for making bigger returns on my purchase.
THE LEVERAGE PART:
So what I can do is put a value on the struggling company’s total asset worth as well as possibly my own private equity firm and use that as collateral to secure a loan from a large bank or financial institution. Otherwise I might issue bonds in the open market to acquire the cash needed. These of course will not be considered “investment grade bonds”, and are thus titled “Junk Bonds”. Using the targets assets as a way of securing loans to buyout the company is considered a hostile takeover.
THE BUY OUT PART:
In a hostile take over situation I could offer what’s called a “tender offer”. This is where I offer (publicly) a premium price that is higher than the current stock price to the target company’s shareholders, in hopes to quickly gain controlling interest in the company. A tender offer usually has a set time limit and may include provisions set by me that the shareholders must abide by. A gradual acquisition (not public) of a company’s controlling interest would be called a “creeping tender offer”, but is more risky on my end if the target company finds out.
From this point on, my LBO can take on either a more honest approach to rebuilding, re-branding, and restructuring of the acquired company in an effort to actually make the company great. In that case you would then take the company public after a set amount of years and expect anywhere from a 15% to 25% return (maybe more) on your original investment even if the debt is still not fully paid off. This will make the clients / shareholders at my firm very happy. If the company we acquire does better than it was originally doing, then my shareholders and I will make out just fine as well as the acquired company. Even in this scenario though it’s most likely that staff will be cut or jobs will be shipped overseas in order to get more for less regarding production.
There is also a dark path that can be taken if the only goal is to maximize my shareholders dividends. Being that I am a private equity firm CEO, my only actual goal is to manage our client’s investments and bring large returns (dividends) to shareholders while charging management fees that allow my company to profit too. It’s a win/win not matter the outcome of any acquired companies we take over.
For example: I buy a modestly successful company at the lowest price I can with a combination of very little of my own equity and anywhere from 60%-95% borrowed completely on their assets to secure the purchase. I then charge them a management fee that directly goes to my firm. Then I slash the company in everyway possible to pay off the debt borrowed on their assets, whether by firing staff, lower wages & benefits, eliminating pensions, and /or shipping jobs overseas. If I don’t bankrupt the company then I can sell it publicly down the road and pocket the revenue, or if it does go bankrupt then I can simply walk away and cut my losses, because the large debt borrowed was based on their assets, which essentially leaves me off the hook. Firms that operated this way throughout the last 30 years were titled “corporate raiders”.
Either way, I win. Bain Capital along with many other firms have been charged with this title over the last 30 years.
There is a misconception, however, that LBO’s are entirely evil and are meant only to turn a profit with no regard to the targeted company’s success. This isn’t completely true and even in Bain’s case they have had some successes in acquisition turnaround. However, there is another myth running around currently that these same successes for Bain Capital are because of a driving concern for job creation and economic growth on Mitt Romney’s part. This is also false.
For any private equity firm, the goal of acquisition of struggling small companies is sometimes to exploit the distribution channels, networking, or production capabilities of that company, sometimes to hope that acquisition can built them into a flourishing company… but always, (never is this untrue) the goal is to turn a profit on the firm’s investment. If the company flourishes that means it will get a higher price when it is eventually made public. And if the firm purchased it with mostly borrowed money on the targeted company’s assets… well then it’s an even greater payout when sold for Bain.
So the point here is that while it is not accurate to slam the LBO process as entirely evil and hurtful to the average middle class worker, it’s even more important to not pretend that it’s main purpose is to benefit them in any way above the simple goal of making a profit that is greater than the initial investment by any private equity firm. Job creation doesn’t factor in whatsoever as told best by a former Romney colleague at Bain, Marc Wolpow. And I quote from the Bloomberg Business Week website from their interview with him over job creation at Bain…
“The main goal at buyout firms, however, is never maximizing employment. It’s maximizing returns for investors. The facts tend to get lost in the political spin.”
So I think its fair to drop the idea of Bain Capital being vehicle for job creation let alone a great model for how Mr. Romney will bring this country back. For a candidate to express such disgust in the idea of our national debt, it seems awkwardly backwards considering how his firm and him made all of their money. Borrowing and leaving the bill for someone else worked in getting him his fortune. It worked well during the Bush administration as well. Why would debt concern him now? Let alone job creation. Seems largely like his message ought to be, “Do as I say, not as I do”. We certainly know where that leads us as a country.