Mitt Romney, Leveraged Buyouts, and Morality
A leveraged buyout (LBO)
is a controversial method of acquiring a corporation. Suppose you are a savvy
investor who comes across an ailing corporation. You believe that if you could
take over the corporation you could provide sufficient clever leadership so as
to restructure it and make it profitable. You decide to purchase controlling
stock in the corporation, but there’s one difficulty: you’re unwilling to risk
much money. Undaunted, you persuade the current owners of the stock and a local
bank to cooperate in the following suspicious scheme: the bank will loan the corporation
the money to buy the stock from its current owners (but the amount of this loan
will be given to you so you can buy the stock), with the bank taking as
collateral an interest in the assets of the corporation, which the current
owners of the stock will vote to grant to the bank. [The corporation, as the borrower, itself will
have to pay off this debt to the bank.] Why would the current owners go along
with this outrageous plan which loots their own company? Because that
way they can sell their stock before the company goes under, but if they wait
they will get nothing in the
bankruptcy that’s likely to follow. You
sweeten your offer by putting up a small amount of the purchase price yourself.
Thus is the property of
the corporation “leveraged” (read “misappropriated”) to allow the buyout to occur. Such
is a classic LBO. The existing creditors
of the corporation (and its employees too) will usually object vehemently to
this new encumbrance on the corporate assets, and if the corporation itself had
a voice other than the selling stockholders it would surely complain that it
received no value in return for the
transfer of an interest in its property to the bank. When the smoke has cleared you, the savvy
investor, have bought a majority interest in a corporation, but paid little money
for your new asset. It’s a strange “purchase” that costs the buyer almost
nothing to buy something. If your
prediction proves right and you fire employees, cut costs, trim fat, and make
the corporation profitable again, then you gain hugely—you’ll own the
controlling stock in a profitable business.
If not, and the looted corporation fails, you walk away whistling,
having lost nothing, and in fact gained whatever you paid yourself for running
the company before it crashed.
When LBOs fail, and the
corporation collapses because after leveraging it had insufficient assets to
keep going, the courts have often found that the selling stockholders, the
buying new stockholders, and the bank that took a loan using the assets of the
corporation but then paid the loan amount to the new stock purchasers are all
guilty parties to a fraudulent transfer of the corporate assets, and thus required
them to cough up their ill-gotten gains (the remedy is civil, not criminal). For a thorough analysis of all this see the
splendid opinion of Bankruptcy Judge Samuel L. Bufford in Bay Plastics, Inc.
v. BT Commercial Corp., 187 B.R. 315 (Bankr. C.D.Cal. 1995), which I use as a
central case explaining leveraged buyout fraud in my textbook. Judge Bufford explains that a LBO that is
leveraged beyond the
net worth of the business is a gamble. A highly leveraged business is much less
able to weather temporary financial storms, because debt demands are less
flexible than equity interest. The risks of this gamble should rest on the
shoulders of the shareholders (old and new), not those of the creditors: the
shareholders enjoy the benefits if the gamble is successful, and they should
bear the burdens if it is not. This, after all, is the role of equity owners of
a corporation. The application of fraudulent transfer law to LBOs shifts the
risks of an LBO transaction from the creditors, who are not parties to the
transaction, back to the old and new shareholders who bring about such
transactions.
As the new owner, Bain Capital will demand that the company
squeeze costs, close money-losing divisions and shift resources to more
profitable lines of business. Sometimes—more often than its peers—Bain Capital
will buy a company and stay with it for years, improving management and
restoring it to health. Other times it will shutter factories, lay off workers
and leave a company loaded with debts it cannot pay. In either case, Romney's
firm will boost its own profit or cushion its risk by charging the company
special dividends for its services and by structuring the deal to take
advantage of tax and regulatory rules. These transaction features, known as tax
arbitrage, can easily reap enough profit to let Romney come out ahead even if a
company fails. . . .
In his
management-consulting years, Romney and his team used the starkest of images to
persuade corporate executives to cut loose unproductive assets. They compared
the benefits to "a forest fire—it clears out the detritus even if you lose
some animals in the short run," one colleague explained. "We would
say to CEOs that all of their different divisions and businesses are like the
little hatchlings in a nest," says McCurry, another Bain & Co.
colleague. "When the momma bird shows up with a worm, all those little
open beaks are down there sending the signal 'Give the worm to me!'" He
added, "Where the CEO needs help is to know you can't give everybody what
they want." . . .
There
have been times when Romney acknowledged the ruthlessness of the marketplace.
Twelve times in [Romney’s book] No
Apology, he embraces "creative destruction."
The complete article can be found
at http://www.time.com/time/subscriber/article/0,33009,2122770,00.html.
The Bain Boys Celebrate (click to enlarge) |
There’s nothing wrong with taking
over an ailing company and ruthlessly taking steps to restore it to financial
health. That’s good business and
laudable. But what is wrong is to do so
by gutting the company of its unencumbered assets—assets that the other
creditors were counting on to pay debts owed to them, as were the employees for
the stability of their paychecks—setting things up so that by gambling with the
company’s assets and not your own money you are in a win-win situation even
where everyone else suffers (except the selling stockholders, who also escaped
unharmed). Where the buyer of stock
risks little because the sale is financed by looting the company to pay for the
purchase (a practice hurting innocent parties right and left), that’s
despicable.
In a recent article Rolling Stone article called “Greed and
Debt: The True Story of Mitt Romney and Bain Capital,” August 29, 2012, which
calls an LBO “financial piracy” and explains all of this in much more detail [see
http://www.rollingstone.com/politics/news/greed-and-debt-the-true-story-of-mitt-romney-and-bain-capital-20120829#ixzz26HFx2iWn],
we are given many examples like this one:
Take a typical Bain transaction involving an Indiana-based
company called American Pad and Paper. Bain bought Ampad in 1992 for just $5
million, financing the rest of the deal with borrowed cash [$35 million].
Within three years, Ampad was paying $60 million in annual debt payments, plus
an additional $7 million in management fees. A year later, Bain led Ampad to go
public, cashed out about $50 million in stock for itself and its investors,
charged the firm $2 million for arranging the IPO and pocketed another $5
million in "management" fees. Ampad wound up going bankrupt, and
hundreds of workers lost their jobs, but Bain and Romney weren't crying: They'd
made more than $100 million on a $5 million investment. . . .
Romney has always kept his distance from the real-life consequences of his profiteering. At one point during Bain's looting of Ampad, a worker named Randy Johnson sent a handwritten letter to Romney, asking him to intervene to save an Ampad factory in Marion, Indiana. In a sterling demonstration of manliness and willingness to face a difficult conversation, Romney, who had just lost his race for the Senate in Massachusetts, wrote Johnson that he was "sorry," but his lawyers had advised him not to get involved. (So much for the candidate who insists that his way is always to "fight to save every job.")
Romney has always kept his distance from the real-life consequences of his profiteering. At one point during Bain's looting of Ampad, a worker named Randy Johnson sent a handwritten letter to Romney, asking him to intervene to save an Ampad factory in Marion, Indiana. In a sterling demonstration of manliness and willingness to face a difficult conversation, Romney, who had just lost his race for the Senate in Massachusetts, wrote Johnson that he was "sorry," but his lawyers had advised him not to get involved. (So much for the candidate who insists that his way is always to "fight to save every job.")
In his private life Mitt Romney is
a kind, compassionate, and deeply religious man, and all the available evidence
shows this to be true. As a Mormon he’s
devoted much of his time selflessly to the care and comfort of other Mormons in
distress, a fact he has not publicized and for which he deserves much credit
and approbation. I applaud him for it.
But in business he’s made a
fortune out of a slimy practice that, while not criminal, is a moral sewer.
-------------------------------------------------
Related Posts:
“President Mitt Romney?” April 21,
2012
“Ohio To Put Guns in Baby
Strollers,” June 17, 2012
“Obamacare, John Roberts, and the
Supreme Court,” July 3, 2012
“Supreme Court Overturns Roe v.
Wade!” August 27, 2012
“Mitt Romney: A Mormon President?” October 17, 2012
“A Guide to the Best of My Blog,” April 29, 2013
“Mitt Romney: A Mormon President?” October 17, 2012
“A Guide to the Best of My Blog,” April 29, 2013
I found your post while searching for "what is a leveraged buyout?" I must admit you do a great job of painting a bleak picture. Perhaps it's even acurate. With all sincerity I have to ask, if these businesses are "ailing", as you say, what other course of action is available to them? Bain was able to save some businesses and get them back in the black, while other companies, despite Bain's best efforts, still failed. If my business is failing, what alternatives do I have? On the other hand, if I'm a corporation who specializes in providing countless hours of management, advice, counseling (and whatever else is involved) to get a business back on track, what incentive can a failing business provide me for my expertise? The business is ailing! They cannot afford to hire a management firm, let alone a lawyer. The risk is great that despite my best efforts the business will fail and, just like all of those other creditors, I will never see a dime for my work. I'm not for or against LBOs. I'm trying to understand what options might be available to a company. Bankruptcy? Bailout? Aren't those dishonest to creditors?
ReplyDeleteOn the other hand, in an LBO, if the company makes money, does it pay off it's creditors? So everyone wins?
Leveraged Buyout firms like Bain seem no more dishonest than law firms. But despite the awful reputation lawyers get, I see the value a good lawyer can provide if he aims to be honest and provide valuable service to his clients. Sometimes it works out. Sometimes the client still loses lawsuits — either way, the lawyer needs to be paid for his service.
Please engage me in an intelligent discussion. I'm eager to learn and make the right decision in 2012. Right now, I believe Romney is our best choice. He knows how to cut spending (even if I lose my job) and foster growth in new areas (a new job for me, perhaps in a new field).
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DeleteYour argument is exactly what Bain would say to justify what it does, but here is what’s wrong with that, and with the analogy to hiring a lawyer. If a company is ailing and needs help or legal assistance, it can go out into the marketplace and hire such aid. Whoever it hires will be paid a just salary for its assistance or legal advice, and will have to satisfy the client or be fired. With an LBO the “client” has no choice. Its stockholders sell the stock to an entity whose goal is not primarily to help the target company, but to loot it of its remaining available assets, saving the company only if enough is left over to do so. The other creditors and the employees have no voice in the matter. This is ugly stuff, and if you read the cited Rolling Stones article it will show you that Bain did this over and over again.
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