Private equity is not VC, but it’s related

As the Republican party’s presidential sweepstakes proceeds, Mitt Romney’s private-equity experience at Bain Capital has come to the fore. Romney’s competitors for the Republican nomination have highlighted the risk in this risk-asset class.
In response, Romney paints his years of investment experience as creating thousands of net new jobs. His opponents describe the deals that went bad, highlighting Bain’s profits at the cost of lost jobs. This political mini-drama provides a useful teaching moment for the business that even capitalist-friendly Republicans are demeaning as “making money on money.”
First, some definitions. The term private equity contrasts with public equity – stock that a company may issue to raise money through public markets like the New York Stock Exchange or Nasdaq. Private equity, or PE, defined in its broadest sense includes both early-stage variants – venture capital or VC – and later-stage variants – leveraged buyouts, distressed asset purchases and other transactions that involve well-established businesses that may be seeking significant capital to provide liquidity to existing owners or growth capital for the business. Bain’s activities appear to have spanned all of these later-stage transaction types.
In early-stage venture capital, investors back low- or no-revenue startups with hopes that they get big and sell at a much higher price (10 to 20 times higher) than that paid by investors. An early-stage fund manager raises a pool of capital – measured in tens or low hundreds of millions of dollars – to invest in 20 to 30 companies with hopes that one-third will make enough profit to make up for the two-thirds that fail to do so.
There is lots of carnage (loss) in the early stage game, though in the small venture world, the job loss from any given company failure tends to number in the single or double digits. Ownership by the early stage investor most often involves the investor buying a minority position – less than 40 percent. Late-stage PE players deal with companies that have tens or hundreds of millions of revenue with established management teams, business models and customers. The PE player might be providing growth capital which may – like early-stage venture – represent a minority investment.
While early-stage investment typically ranges from hundreds of thousands to low millions of dollars of investment, late-stage growth equity can represent tens or hundreds of millions of dollars of investment. Growth or expansion capital of this form of private equity tends to be more like venture capital in that the investor buys a minority position, joins the board of directors and has substantively aligned interests with the majority owners (presumably the operators).
And then there’s private equity that takes “control” positions in companies – basically, these PE players buy a majority interest (perhaps all of the company’s outstanding shares) and so typically have a perspective on how to grow, turn around or otherwise build value for shareholders in the business.
At one extreme, investors like Bain Capital apply their strategic strengths to reshape a business so that it can compete better after the transaction than was happening before the transaction. High-touch strategic investing of this variety is similar to VC in that both count on growth for returns – one with a minority ownership approach and the other with a control approach.
Turnarounds or distressed asset transactions are a game in which the PE buyer takes control of a poorly performing, or “under-valued,” company with a view that more value can be realized through some shift – often selling assets, shutting down unprofitable or unsustainable businesses with a view to taking more money out than was put in. These two variants – LBOs and distressed situations – create the most potential for “vulture capitalism,” and represent the “making money on money” plans that are the fodder for the attacks that Romney is presently experiencing.
In private equity, losses experienced in growth variations – e.g. not LBOs or distressed situations – contrasts to VC’s 2 for 3 loss ratio with loss ratios that tend to be more like 1 or 2 for 10 – i.e. late-stage companies tend not to go out of business as they are established, growing businesses with customers.
While late-stage growth companies may not realize the growth they had planned, they tend not to go out of business. LBOs and distressed situations are quite different. Failure is – by contrast to growth private equity – more frequent in these ventures and – given the size of these companies – the carnage in terms of jobs loss is more significant as well.
So when you hear Romney talking about Bain’s success in growing jobs at Staples, he’s likely talking about the growth portion of his private-equity portfolio. When you hear his detractors talking about job losses, they are talking more likely about the higher risk distressed asset or LBO portion of the portfolio.
As any PE or VC fund will tell you, the overall portfolio story is what matters most, not the individual successes or failures. Whether PE or VC, we all make money on money. That’s the nature of our jobs.
In the end, Romney’s assertion of net job gains is the correct lens. If he’s made his investors money, and they keep coming back for more, then he’s doing his job. &#8226


Michael Gurau is president of Clear Innovation Partners, a Maine-based, cluster-development organization. He can be reached at
mgurau@clearinnovationpartners.com.

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