How To Succeed in Business Without Adding Value

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http://www.inthesetimes.com/article/13704/how_to_succeed_in_business_without_adding_value

Private equity funds first emerged in the late '70s and '80s as part of an ideological shift toward making the most for shareholders, giving momentum to an early wave of banking deregulation and to changes in the tax code that made financial engineering more profitable. Firms like Bain Capital, spun off in 1984 from the consulting firm Bain & Company, benefited both from the elimination of old controls and from the new rules encouraging globalization and financialization.

Here's how it works: The managers of private equity firms create big investment funds in which they are “general partners.” They pool unregulated private money from a variety of “limited partners,” ranging from public pension funds to rich individuals (including, in the case of Bain, dubious Central American plutocrats operating out of tax havens such as Panama). The general partners then buy a business in what is called a “leveraged buyout,” using more limited-partner capital and a huge loan, but very little of their own money.

The high debt, or “leverage,” greatly multiplies the profit on successes, but also increases financial instability. The loans must be paid off even if business slows–a minor worry for the private equity fund, because it isn't responsible for those payments. Instead, the purchased business owes the debt created to buy it. The interest on this debt is tax-deductible (meaning that these deals are taxpayer-subsidized), but paying down the principal still puts pressure on the acquired businesses. They in turn typically squeeze employees as the easiest, quickest way to meet interest payments and profit targets.

After Bain-style buyouts, employees often face wage and benefit cuts or mass layoffs. Businesses can also use takeovers to renege on implied contracts or to engineer bankruptcies, thus avoiding obligations to workers such as pension payments.

[JDPriestly]

1. K&R because it is important that DUers understand how this works

and what a leveraged buyout means in this campaign year. This is what Romney did for a living. This is where he got his wealth. Does job experience in the sordid world of leveraged buy-outs really qualify someone to be president? That is one of the questions Americans need to ask themselves this election.

A lot of people don't know how leverage buy-outs work.

It's a sad story.

Companies that are bought out in these deals die due to over-leveraging. But they do not go gently. They do not die natural deaths.

Their body parts (their assets) are sold off and they kind of lose their strength and identity limb by limb. It is an awful process. Especially for the employees some of whom may have invested their careers in the company.

Sorry for the graphic image, but I know a woman -- a political refugee -- who lost her job in one of these dismemberments. She was in her 50s and tried and tried to get another job for which she was qualified but found nothing.

In addition to losing her job, she lost her health insurance and when she developed cancer and needed expensive care she had to seek Medicaid. By that time her pension savings were gone.

She is just one story. There are many, many others. Leveraged buy-outs make no sense to the nation's economy. But they are very profitable to the greedy people who gather the cash and buy and destroy people's livelihoods.

The buyers will argue that the companies they buy are already troubled. Sometimes that is true.

But for the most part buyers are not interested in truly bankrupt companies. No. Buyers want companies with assets that can be turned to cash.

Sometimes the targeted companies are having a problem with arranging succession in their leadership. Sometimes the companies need to change their product line a little or bring in fresh ideas at some level.

But the leveraged buy-out wrecking crews are rarely interested in turning their acquisitions around: they either want to buy them to destroy competition or to cash them out.

Gutting out factories and sending the equipment to a third world country, say China, where with cheap labor, the equipment can produce products that sell for a profit in the US and other formerly industrialized nations has enriched many who specialize in leveraged buy-outs.

Of course, the US and formerly industrialized nations, the countries that allow these leveraged buy-outs lose jobs. Pay declines. Tax revenues decline. Business and society begin to disintegrate. And now we have the world-wide recession. Is anyone surprised?

Leveraged buyouts are a mutation, a cancer if you will, on a healthy capitalistic economy. I hope lots of DUers read the OP.

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2. +1

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3. and here's how leverage helps steer money to the gamblers -- with government help:

bankruptcy laws encourage risk-taking. they're designed to encourage people to start businesses without fear of losing their house if the business fails. however, established companies can play this game any time they want to take a risk by creating a new corporation just for that purposes, separating it from all their other assets.


in the case of a leveraged buyout, say you're ceo and own 10% of a company that has no debt and is worth $10,000,000. congratulations, you're a millionaire, on paper, anyway.

you're indifferent to coin-flip types of decisions, because if the company makes $5,000,000 or loses $5,000,000, that means you personally make $500,000 or lose $500,000. if that's a 50-50 proposition, there's nothing encouraging you to take that risk.

now let's say you do a leveraged buyout. in effect, your company borrows $9,000,000 to buy out the others. now you own 100% of a company worth $1,000,000 ($10,000,000 in assets and $9,000,000 in debt).

now you're quite eager to do that coin-flip. if the company makes $5,000,000, then you get $5,000,000 profit! while if the company loses $5,000,000, your company has a net worth of negative $4,000,000, so you just declare bankruptcy and lose your $1,000,000.



in fact, you're happy to do this even if the odds are stacked against you! let's say you're three times as likely to fail as to succeed. the one time you succeed you get your $5,000,000 profit; the three times you fail you lose a combined $3,000,000. so you're ahead $2,000,000 while succeeding only once in four attempts!

this is exactly the sort of thing that a company like bain can do -- take risky propositions, knowing that the magnified gains are theirs but the losses are limited. of course they layer on fees so they win even when they lose, but that's another story....


in any event, you get to roll the dice, knowing that wins are privatized (you own 100% after all) and losses are socialized (you only put in $1,000,000. your creditors and employees share in the loss but not in the gain.



a company like bain can do this confidently, knowing that the statistics assure them a high probability of enough wins to outweigh the losses. they do this because bankruptcy laws permit them to isolate the wins from the losses. creditors of bain portfolio companies a, b, and c are out of luck, even if bain portfolio company d hit the jackpot.

donald trump also knows a thing or three about this kind of strategy.