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Private Equity: Bain or Boon?

The Bain Capital model of private equity privatizes gains and socializes losses, but there’s another private equity model that scores wins for both investors and society.

Submitted by: Francesca Rheannon

Posted: Jul 26, 2012 – 09:09 AM EST

Tags: jobs, csr, politics, mitt romney, private equity, deutsche bank, environment

 
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By Francesca Rheannon

Update: SJF announced on May 2, 2013 that it had overshot its target for raising investments in its third fund, tripling the size over its previous second fund.

Mitt Romney hopes to become president by running on his business experience, claiming that it demonstrates that he’s a “job creator.” He’s touted his leadership role at Bain Capital as evidence of the claim.

Tax Deductible Debt-loading Produces Profits but Kills Jobs

But, as anybody with a pulse knows by now, it’s come back to bite him with a vengeance, with revelations that Bain destroyed a goodly number of jobs when it pumped companies full of debt and then dumped them when they couldn’t pay it back.

It happened both before Romney says he “retroactively resigned” from Bain (1999) and after (2000-2002) -- a time when he was “sole shareholder, sole director, president and chief executive officer,” according to the firm’s filings with the SEC, and drawing at least $100,000 in executive compensation until 2002, despite claiming he had nothing to do with Bain.

As Bloomberg News reported:

“What’s clear from a review of the public record during his management of the private-equity firm Bain Capital from 1985 to 1999 is that Romney was fabulously successful in generating high returns for its investors. He did so, in large part, through heavy use of tax-deductible debt, usually to finance outsized dividends for the firm’s partners and investors. When some of the investments went bad, workers and creditors felt most of the pain. Romney privatized the gains and socialized the losses.”

And it’s not just Bain -- after being acquired by a private equity firm, a company’s workforce shrinks Mitt Romneyby an average of 6 percent, according to one study reported in the New York Times.

“More Free Stuff”

Romney and his partners enriched themselves through management fees and “carried interest” – compensation received despite not contributing any initial funds themselves. Moreover, “carried interest” is taxed at the lower capital gains rate, not at the regular rates that lesser mortals like you and I pay. Add to that the tax deduction for the debt they loaded companies up with and you have some very tax-privileged people.

All the more ironic, then, is Romney’s thinly veiled racially coded comment the day after addressing the NAACP convention, where he was booed for vowing to repeal “Obamacare.” In front of a largely white crowd at a campaign fundraiser, he said:

“I hope people understand this, your friends who like Obamacare, you remind them of this, if they want more stuff from government tell them to go vote for the other guy-more free stuff. But don't forget nothing is really free.”

When Romney and his private equity cohorts don’t play by the same tax rules ordinary people do, it means, in effect, they are getting “free stuff” from the government – stuff that ordinary people have to make up for in higher taxes and a shredded social safety net. (The social safety net for irresponsible failing banks, however, is fully intact -- a policy applauded by Mitt Romney.) That kills jobs, too.

Balancing Impact and Returns: Private Equity for the Common Good

But there’s a growing movement in the private equity world that seeks to leverage not debt but capital to protect the environment and improve society. (It includes both venture capital and private equity funds.) And the returns, both financial and social, are impressive.

“There is a whole new genre of wealth managers and private equity firms that look at the full integration of sustainability and financial performance,” Anders Ferguson of Veris Wealth Partners told CSRwire. He points to recent research by Deutsche Bank and others showing that companies that are more sustainable are worth more.

Conservation Private Equity Funds

One example is furnished by conservation-oriented private equity funds, like those managed by the Lyme Timber Company, the oldest of such funds (established in 1976).

The Lyme Forest Funds “monetize conservation values through conservation easements,” according to founder Peter Stein CSRwire. Those easements preserve the land for certified sustainable forestry, public recreation, and ecosystems and watershed protection and generate income through mechanisms such as mitigation credits and conservation interests.

One such deal involved the purchase of a large tract of land from International Paper in the Lyme Forest FundsAdirondack Mountains and reselling 275,000 acres to the New York State Department of Environmental Conservation. The land is forever protected from real estate development and will provide sustainably harvested timber and recreation in perpetuity.

Conservation private equity also creates and preserves jobs for foresters, rangers and parks workers, helping to support rural communities that are often hard-pressed to hold onto employment.

Investor Profiles and Returns

The funds attract three types of investors:

  • Tax exempt institutions, such as educational entities and foundations
  • High net worth individuals and families;
  • Platforms like Trillium, Calvert, and Wells Fargo Private Wealth

Surprisingly, of the $160 million The Lyme Timber Company has to invest, 40 percent comes from impact investors, while a whopping 60 percent comes from what Peter Stein calls “agnostic” investors – those who are in it pretty much for the money. That’s because the Funds under its management can boast healthy returns in the “high single digits,” in spite of the fact that the whole area of impact investing is fairly new, and natural resource investing is the newest field within it.

Venture Capital Investing For Impact

Some have referred to the Bain Capital strategy as “vulture capitalism” – substituting “vulture” for “venture.” The kind of venture capitalism practiced by the three funds managed by SJF Ventures couldn’t be farther from the Bain model.

“We invest in minority stakes in growing companies -- it is really additive to the economy, not shifting jobs around or using debt leverage to generate returns,” founder David Kirpatrick told CSRwire. “We are intentional about having a positive impact on environmental and social needs, where ESG investing is fully consistent with generating income growth.”

The SJF funds have found a sweet spot by investing heavily in recycling and energy efficiency – SJF Venturesproven technologies that are the “low hanging fruit” of sustainability – and allocating a lighter portion to the volatile arena of renewable energy. (Kirkpatrick says that SJF has invested less in renewables because the country lacks a consistent national energy policy, making returns riskier.) The portfolios are rounded out with investments in sustainable agriculture, digital media and medical technology – all reliable growth areas.

And like Lyme Timber, SJF Ventures is doing very nicely for its investors. “Our returns are really good,” Kirkpatrick said. He told CSRwire that they are in the top 15 percent of U.S. capital venture funds. “Venture capital funds haven’t been that great in the last five to 10 years, but we are doing well because of the emerging interest in impact investing.”

Impact Investing Gaining Ground, Even With Institutional Investors

It may not be a sea change yet, but “the wind is blowing in right direction,” Kirkpatrick asserts, “and it’s not just us. The Rockefeller Foundation and JPMorgan Chase have done studies on impact investing that have rattled asset managers’ cages a bit, especially among women and younger managers.”

Even institutional investors are sniffing the air currents, seeking to bring their investments more in line with their missions. Anders Ferguson of Veris is seeing the shift too. “Most funds like Bain – their primary investors are institutions, insurance companies, pension funds, big foundations. But this is beginning to change.”

Anders says that, slowly and steadily, the walls are being broken down between the program and investment sides, one board of directors at a time. He says there is
more than $3 trillion out of $30 trillion of private investment capital that is on some point on the spectrum of balancing returns with impact.

“As the world changes, more people will realize that you can’t have democracy and not have communities that build wealth,” Ferguson told CSRwire. Let’s hope that’s something the next U.S. president will realize, as well.

The opinions, beliefs and viewpoints expressed by CSRwire contributors do not necessarily reflect the opinions, beliefs and viewpoints of CSRwire.

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