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.