Newark Mayor Cory Booker’s honest screed against the Obama campaign’s assault on private equity was the kind of refreshing moment that makes you go, “Ah…”
Exactly 13.8 seconds after he finished that screed, the Obama campaign kidnapped Booker and drove him blindfolded in a windowless van to a secret location from which they filmed and broadcast on YouTube a hostage video of Booker partially reneging on his earlier comments. Even Newark doesn’t mess with Chicago.
Despite Booker’s outburst, and some criticism from the media, Obama will continue to go after Romney’s past at Bain Capital. Obama will do this because despite a seemingly bipartisan and bimedia agreement that private equity is good, the concept is still fuzzy. Many explanations involve a lot of financial jargon like credit default swaps and leveraged buyouts, which causes a normal person’s eyes to glaze over. Thanks to the ghosts of 2008, there’s a sense of this large, foreboding, and unwieldy thing that takes on a mysterious and frightening aura, seemingly its own parallel universe of mathematics and laws of physics, a universe that when it implodes will take down our own personal universe with it.
In light of this, Old Frick’s going to take a crack at simplifying it. So here’s a rough analogy on the movement and allocation of capital, i.e. Bain Capital 101:
You own an old windowless Ford Econoline van that you use for pizza delivery, despite the fact that it creeps out parents of local schoolchildren. Delivering pizza is decent money, and the economy’s good, so tips are up. But you’re not satisfied. After reading Rich Dad, Poor Dad for the fifth time, you have an idea for a new business model, a mobile pizza van. Cha-ching!
Problem: You have no money to implement any portion of your idea, i.e. you lack the capital to buy the oven to cook the pizza, the refrigerator for the dough, tools and materials to modify the interior of the van, etc. What to do…
Your next-door neighbor, Mitt Bain, is filthy rich. Over a couple of beers at the local watering hole, you tell him about your idea, which he thinks is genius. In fact, he offers to renovate your van, i.e. front the capital, to get you started. In exchange, he wants a percentage of the profits you rake in.
And rake in the profits you do. The mobile pizza van is a hit. Orders overwhelm you. To keep up with demand, you need a second van, and you hire your buddy to drive it. Still not enough. You realize you need another fifteen vans, two storage locations in different towns to keep raw materials to pack into the vans, and even an accounting department. But there’s a problem. You’re a pizza delivery driver and have no idea how to expand and run the business. You need help. A consultant.
You mention this problem to Mitt Bain. Eureka! Mitt will help you out with advice and support on setting up your business plan, strategy, and management structure, because he’s successfully done this multiple times in the past. But his advice is not for free. Separate from Mitt’s ownership stake in your delivery service, you hire Mitt as an adviser, i.e. you pay directly for his services. Mitt the consultant is very interested in making your business succeed, because Mitt the owner has a lot of money invested in you.
Your business is on fire. You need more money to keep up with expansion demands because you need to buy more vans and hire employees to drive them. Overhead costs at the office soar. However, Mitt the owner is feeling a little exposed and is nervous about injecting more of his own money into the business. Mitt the consultant advises you to borrow the money you need from a lender. So you do.
The lender agrees to give you the loan. Business is booming and you have a bunch of assets as collateral in case the worst should happen. You expand the business into four more counties and into a major city. You’re living like Vince Chase from Entourage after Aquaman.
Then the FDA comes out and says fastfood-style pizza is poisonous. Heart attacks, high blood pressure, strokes, Alzheimer’s… everything imaginable that is bad will happen to you. Sales plummet. You can no longer cover your business expenses. Mitt the consultant says you need to cut back operating costs or you will be broke within six months. You’re forced to close the office you just opened in the city and fire all the workers.
Mitt sees this trend line continuing and determines at which point the individual assets may no longer be able to cover the debt; maybe the sale of the assets can even turn a profit. After all, people will still need ovens, refrigerators, and vans. You decide to hang on. This will blow over. People need pizza, right?
The drop is more precipitous than anyone could have imagined. You are dead broke and can’t make the interest payments on your loans. You go bankrupt. You have to sell off everything the business owned. You lose money. Mitt the owner loses, too, because he partially owned all this stuff. Alternatively, Mitt the owner saw the ugliness coming and sold off the company (which meant there was a buyer who thought there was a possible good outcome to the situation) to make what he could and get out before the collapse.
It was a good idea, and it worked for a while, but the company has failed. Many people lost their jobs and a major business has vanished.
Over the years, Mitt the owner made money from the profits of the booming business. Mitt the consultant also made money as long as you were in business, because his advice helped you organize your business and be profitable. In the end, Mitt in total made money off your business, even though it failed.
What is the bad thing that happened here? The FDA decision of course, something that no one could have seen coming. It could as easily have been a hurricane, a shift in the business climate, or any other number of things. If these things don’t happen, your pizza delivery service goes on to keep making money.
Back to the real world: Bain Capital makes money in similar situations as Mitt Bain does. There were investment and consulting opportunities that went well and some that went poorly. If Bain Capital has more situations turn out well than poorly, it’s doing a good job. By extension, Mitt Romney did a good job. The accusations, (shamefully) dating back to Rick Perry and continuing now with Barack Obama, count on the confusing nature of what Bain Capital does to scare potential voters away from Mitt Romney.
Just as Mitt Bain had no way of knowing the FDA would destroy the pizza industry, Mitt Romney (and Bain Capital after he left) had no idea that the U.S. steel industry would collapse or that other market realities like the digital age or more efficient businesses might tank Ampad. The actual methods of investment and securing loans are obviously more complicated than the simplistic pizza van analogy, but it covers the economic reality well enough: Some businesses thrive and some businesses fail. Not every business or every factory can be saved.
So next time you hear an attack on Bain Capital or on private equity firms in general, just remember that success is more complicated than it looks. If success was easy, the stimulus bill would have kept unemployment under 8%, Solyndra solar panels would be powering the country, and we wouldn’t still be borrowing trillions from China. Companies like Bain Capital are the fuel and spark plugs of the economic engine. Rather than idling, let’s crank it up.