As Mitt Romney touts his business experience in the Republican presidential primaries, he has started facing questions about his abiding faith in “creative destruction.” That’s the idea that when new ways of doing business replace the old, closing factories and laying off scores of workers are painful but necessary steps to building a more efficient economy.
Possibly no industry better embodies this worldview than private equity, the controversial and highly lucrative business that Romney helped shape in the 1980s and 1990s and that, in turn, earned him millions of dollars and molded his perspective on how the economy works.
Romney’s rivals sometimes cast him as just another Wall Street banker. But the former Massachusetts governor comes from a highly specialized brand of work that — unlike many jobs on Wall Street — frequently gets into the guts of how a business operates and then obsessively asks a question posed by chief executives everywhere in corporate America: How do we maximize profits?
The results have been good for investors and, some experts argue, good for the broader economy as companies have grown more efficient. But for those who lost their jobs as private equity firms churned out profits, the sting of seeing their companies turned into vehicles for greater efficiency is harder to live with. And as the 2012 campaign continues, Romney’s past could lead voters to wonder not just about private equity but also about the costs of a modern capitalism that embraces creative destruction.
Bain Capital, co-founded by Romney in 1984, uses the same basic business model as other private equity firms: Buy up a company, increase its value and then reap a profit by selling it or taking it public. The funds used for the acquisitions come from investors, such as pension funds and university endowments, plus money borrowed from banks. This debt is what creates enormous pressure on private equity firms — once known as leveraged buyout, or LBO, firms. They have to move quickly to make a company more efficient, or risk defaulting.
The result is that the industry has on the whole been good for American business, said Steve Kaplan, professor of entrepreneurship and finance at the University of Chicago Booth School of Business.
“The basic evidence on private equity is they make the companies more efficient,” Kaplan said.
For decades, private equity deals have been criticized for leading to massive job cuts. A paper this year by economists and U.S. Census Bureau researchers tracked employment at companies bought out by private equity firms from 1980 to 2005. They found that employment at the companies that had been targeted declined 3 percent over two years after a buyout and by 6 percent over five years.
But then the economists looked at whether new offices, factories or retail outlets were opened by the purchased companies. Here they found that those added jobs offset some of the losses. Net relative job losses, they found, were less than 1 percent.
Some employees whose companies were bought, though, say the job cuts were unforgettably brutal.
Howie Klein, former president of Reprise Records, remembers Bain Capital and other firms relentlessly cutting employees when they bought Warner Music Group, including Reprise, in 2004 for $2.4 billion. Romney was not involved, having left Bain in 1999.
“It was obvious that the industry model was not a model that would be profitable and the model had to change,” Klein said. “Rather than work on changing the model into something that was viable, these so-called investors, vulture capitalists, instead saw it as a half-dead carcass and tried to figure out how they could pick through the bones and get whatever was left and what could be gotten from it.”
In May, Bain and other firms exited the deal, selling Warner Music to billionaire Len Blavatnik for about $3.3 billion, nearly $1 billion more than what they had paid.
“In businesses that need to contract, the private equity firms help those businesses contract, but I think in many cases they would’ve contracted anyway,” Kaplan said.
Romney’s candidacy has put a spotlight on the industry, which last withstood heavy scrutiny around 2006 and 2007 when firms began buying out enormous companies with household names, including Hertz, Hilton Hotels and Dunkin’ Donuts.
The Private Equity Growth Capital Council, a trade group for the industry, counts 2,300 firms in 2011 in this country investing in 14,200 U.S. companies. The group says companies backed by U.S. private equity firms employ 8.1 million people.
Josh Kosman, author of the book “The Buyout of America,” said that despite the businesses’ positive track record with investors, it’s hard to find examples of companies that private equity firms have expanded to Fortune 500 size.
Moody’s released a report this month looking at 40 big deals from the buyout boom, which they count as lasting from 2006 to early 2008. A few had performed well, the report said, but overall Moody’s found that the companies have had “weak revenue growth and high default rates” since the deals had been closed.
When Romney was asked this week on “Fox News Sunday” to explain his views on “creative destruction,” he defended it as an “essential part of free enterprise.”
“You have to have a setting that allows people to get trained for the new positions,” he said, “a safety net to make sure people are not on the streets.”