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Is Private Equity Evil?

There is a lot of debate right now concerning whether or not Mitt Romney’s experience working in private equity is good or bad for his campaign,. Romney is anxious to claim the position of “job creator” – stating that his history of providing financing for companies has been a positive for the economy and makes him more qualified to be President.  His opponents would claim that private equity is not a path towards job creation, and in fact just represents another aspect of greedy corporate America stripping profits out of the business landscape, and actually might really cause the loss of jobs.

This week NPR featured a business professor from Kellogg University who had completed a study of the effects of private equity on the job market.  The study concluded that private equity is really fairly neutral in terms of job creation; that is, it neither creates nor destroys employment.

Over the course of my career I have had a fairly significant amount of experience in private equity.  I have invested my own money in private equity funds to be invested in other companies, and I have received significant amounts of capital to invest in my companies from private equity funds.  For me personally, private equity financing has in most cases been extremely lucrative from both perspectives.  I am currently invested in a private equity fund that was an early investor in companies like Facebook and other very hot technology companies, and my investment in this fund, though not fully realized, at this point is very profitable. More importantly for me, I have received significant financing over the years from private equity funds that have allowed me to expand my company and acquire other companies, significantly increasing the value of my ownership.

Here is how private equity financing works.  A private equity firm forms an investment fund.  This fund raises money from institutional and high net worth investors, banks, trusts, and other entities with significant amounts of money to invest.  A single investment fund may range in value from a few million to billions of dollars.  The fund then takes that money and buys ownership, or significant positions, in multiple companies.  The managers of the private equity fund typically take significant or full management positions in the operational management of those companies, and for forming the funds they take a significant share of the profits and money raised; typically 2% of the funds raised and up to 20% or more of the profits if the fund is successful.  Most funds have a set time frame for the investment, typically five to seven years, at which point the private equity firm hopes to exit the investments with large profits for themselves and their investors.

The benefits of private equity.  Romney claims to be a “job creator” because private equity financing can certainly expand companies and potentially create jobs.  Many incredible companies that employ thousands of employees were spurred to growth by private equity, literally growing from basements into major international conglomorates.  PE money can certainly be beneficial to the American economy and industry, providing crucial funding to technology companies and other cutting-edge businesses that can help keep us at the top of the world economy, and I believe that there is a strong case to be made that this kind of financing has been an inportant component of continued American dominance in the world technology market.

But private equity and job creation do not always go together. Lets not misunderstand the purpose and goal of PE investing.  The mandate is not to expand employment or the power and reach of corporate America, or some other kind of patriotic objective.  The goal of private equity investing is to make money for the investors; nothing else.  If a company becomes more valuable by employing more workers, then the PE firm is happy to see more people hired; but if more money can be milked out of the transaction by cutting back and firing people then they will be equally happy to shrink a company.    Similarly, if a firm can be made more profitable by outsourcing jobs oversees or moving manufacturing, the PE firm will almost certainly make those moves.  Often in a PE transaction several companies will be merged together, with layers of employees eliminated in the merger to make the company more profitable.

The other potential downside of PE financing is its typical short-term exit strategy, though this might vary by fund.  Maximizing a company’s profits over five to seven years normally requires a different strategy than managing a company with a longer time horizon.  In essence, a PE firm is always looking for how to sell a company for the maximum amount, as opposed to how to build a great company for the long haul.  And perhaps the biggest problem with many PE transactions is the use of debt.  Though I have participated in PE funding deals that did not incur any debt, most PE firms will layer on as much debt as feasible onto a company they acquire so they can spread out their investment capital to more companies.  This weakens the acquired company, and can often hinder its development.

So the bottom line…. PE investors do not invest to build great companies and make America stronger; they invest to make money, and the only real yardstick for success among PE professional like Romney is how much money they and their investors make. There is nothing illegal or necessarily immoral about that; most corporate executive’s primary mandate is to make money.  But there is a big difference between a PE executive, and the entrepreneur that starts a great company and builds it with pride so it will last for generations.  I would argue that we need more great entrepreneurs with big ideas, and that we also need to maintain a PE structure to finance some of those ideas.  I have also met many great individuals that work in PE that would not be qualified to actually run a company; they are primarily of value for their investment and input as board members.  They understand how business and finance work, but they do not have the operational skill set to visualize and orchestrate the proper path for an organization.

It also makes perfect sense to me that PE financing is job neutral. While I am sure there are many cases where funding has allowed stratospheric growth for firms, there will be as many examples where the PE management mandate was to cut employment.

But the big question is; does Mitts background in private equity make him a more qualified candidate to be President?  There are many skill sets that a successful PE executive must possess that I think translate well to The White House.  A good PE executive is typically very intelligent and well-educated.  They understand finance and the flow of money, they are usually well-organized, they understand business structure, and they are often very skilled at negotiations. They tend to be very good with budgets, which would be a big plus in this economy.  So if the job requirement hinges on a solid background in business, a PE resume would be a plus.

But I think there is much more to being President than an understanding of business.  A great President has vision, compassion, life experience, great communication skills, a knowledge of history and its potential impact on the future, charisma, and the ability to bring people together; all attributes that don’t exist within any set profession.

 

 

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2 Responses to Is Private Equity Evil?

  1. Scott says:

    A great CEO knows how to get key performers working for him to make himself look better, thus more of a Warrior that can find good workers. For many, many years, we have been lacking that leadership in the Whitehouse and I think we have too many weasels in positions that they are unable to perform in. Not a Mitt fan, but we need someone that will take responsibility and get things done.

  2. The following is a ranking of the largest private equity firms published in 2011. The ranking was compiled by Private Equity International , which reveals that the world’s 50 largest private equity direct investment programs have raised in excess of US$325 billion since 2006.

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