Venture Capital

[awm]

With Mitt Romney and Bain Capital in the news a lot, I read this article on CNN today. Certainly I owe my job at Google (in part) to venture capitalists, and I have some friends who have done very well for themselves at small computer software startups. But my impression about venture capital / venture capitalists seems very different from what I've heard described at Bain Capital. Perhaps someone more in the know about these things can help. Here are my impressions (mis-impressions?):

 

1. Venture capitalists normally fund entrepreneurs looking to start a company, or moderately successful small businesses looking to expand. In contrast, Bain Capital took over a lot of existing businesses which were not doing very well, some of which were quite large (i.e. Staples).

 

2. Venture capitalists provide funding, in exchange for equity. There are often some strings attached (seats on the board, etc) but normally the venture capitalist is not involved in the daily management decisions of the company they fund. In contrast, Bain Capital seems to have been directly involved in many hiring/firing decisions, whether to close factories, etc.

 

3. Venture capitalists will lose money if the company they fund goes out of business. However, they make a lot of money when the company succeeds (because they got in on the ground floor with cheap equity). It's a high risk - high reward sort of thing. However, Bain Capital seems to have somehow made money even when the companies they took over went bankrupt. While probably technically legal, this always seemed shady to me (and sounds like it took advantage of some weirdness in the way federal taxes work that probably shouldn't exist).

 

4. On the specific case of Solyndra, my impression was that the government program existed to fund companies which were unable to obtain private investment capital, but which potentially serve a compelling national interest (here, clean energy). Even successful venture capital firms have a moderately high failure rate (I've seen reported that 22% of companies that Bain Capital funded went under, and imagine this is not an unusually high rate), and these government investments are inherently more risky (else they could get private capital). So we'd expect some failures in such a program even if it was run as well as the best private investment firm. While it's reasonable to investigate any time an investment goes bad, to make sure proper procedures were followed, I haven't heard of any direct evidence of malfeasance in the Solyndra case.

[barmar]

Yes, there are venture capitalists who mostly fund start-ups, and they're not the kind that are under fire.

 

I think Bain is viewed more like the kind of company in "Wall Street". Rather than investing in startups, they invest in established companies, often struggling ones. They swoop in and take over, perhaps brokering an acquisition. And the cost cutting necessary to save the company often involves many layoffs. Or maybe they acquire the company for pennies on the dollar, then liquidate it -- this picking at the carcass of a dead company is why they're referred to as "vulture capitalists".

[kenberg]

There could be a deep discussion of venture capitalism, for which I plead ignorance. Your post, and the CNN article, seem largely inspired byt he current political scene however.

 

I have been trying to think through where I come down on this. I certainly don't criticize someone for making money, or for making a lot of money. Romney touts his experience at Bain as a reason for people to vote for him, and it seems fair enough to try to think through just what conclusions to draw from this experience.

 

I suppose that, when a company such as Bain comes in to buy up a company, they do not exactly go out of their way to be explicit about their plans for that company. They will say what they need to say, agree in writing to as little as possible, and once they gain control, they will feel free to do as they please. It is fair to ask if this is a correct description of how Bain operated under Romney's direction.

 

It's in our own best interest to be skeptical but fair in evaluating all candidates, but it seems to me that more than the usual caution might be right in assessing Romney's statements. Apparently quite a few Republicans agree with this.

[Finch]

I don't think that VC has to go to start-ups, it's quite commonly used to fund management buy-outs or leveraged take-overs. The UK has a tax-advantaged form of investment called a 'venture capital trust', and the only (relevant) rule is that the companies have to be either unquoted or listed on AIM (designed for small companies); so they can be quite big and/or mature. Also, it doesn't have to be equity, in fact debt is quite common I think, particularly subordinated and hybrid or convertible debt.

 

You might well see VC investors involved when a company is close to going bust, particularly if it is about to default on its debt - the idea is the VCs buy out the bank debt in exchange for equity and - as you say - take a high risk stake in the company. The most famous such takeover in the UK a few years ago was when a VC company called Alchemy tried to buy Rover from BMW for £1.

 

While I agree that typically VC investors don't get involved in day-to-day operations, they may well be heavily involved & on the board for financing and strategic decisions

 

To be honest, 'venture capital' seems to be used to refer to any form of capital or semi-capital investment that isn't a publicly listed company and isn't owned (or originally owned) by its management. I'm not sure I can see much of a distinction between 'venture capital' and 'private equity', except that private equity may also have significant shareholdings in companies that are otherwise listed.

[barmar]

The "venture" in the term "venture capital" refers to the fact that they're making a high risk investment. That's why it generally refers to investing in startups or failing companies.

[awm]

I've got nothing against making money; heck I make pretty good money.

 

But I think there are different ways to make money, and some of them strike me as very unethical. For example, making money by lying to people and convincing them to buy things that you know are crap seems very unethical to me (although depending on exactly how the lying is done, it might be legal). Selling people insurance and then trying to wriggle through legal loopholes to avoid paying legitimate claims seems very unethical to me (even though you might win in court). Basically, I find jobs where you make money primarily by deceiving other people and screwing them over to be unethical, even if technically legal. There are also certain tax-avoidance techniques (accounts in the Caymans, etc) that strike me as almost defrauding the government (even if, again, technically legal). And I do think someone's ethics are a valid concern when deciding who to vote for, especially since politics offers huge opportunities for the unscrupulous to make a buck (or a few million bucks) by selling out a lot of unsuspecting people.

 

For me it basically comes down to people making money by creating wealth (i.e. creating something, or providing a service) vs. making money in a zero- or negative-sum way (by screwing over other people, especially people who arguably need the money more than the person taking it does).

 

In general I do not think of venture capital firms as an "unethical way to make a living"; typically they are betting for businesses to succeed, and a lot of great companies got their start with VC funding. But I'm less sure about what Romney did for a living.

[hrothgar]

My impression about venture capital / venture capitalists seems very different from what I've heard described at Bain Capital. Perhaps someone more in the know about these things can help. Here are my impressions (mis-impressions?):

 

Bain Capitial is a private equity management group.

 

Historically, about 1.5% of the firm's revenue has come from venture capital (investments in start ups and the like)

FWIW, I'd argue that venture capital traditionally is traditionally used to refer to investments in startups...

 

The first sentence of the wikipedia discussion of Venture Capital starts:

 

Venture capital (VC) is financial capital provided to early-stage, high-potential, high risk, growth startup companies.

 

The first sentence of the investopedia definition starts:

 

Money provided by investors to startup firms and small businesses with perceived long-term growth potential.

 

The vast majority of the firms profits have been derived from what is (uncharitably) termed corporate raiding.

 

In general, Bain made its money by

 

1. Buying distressed companies

2. Borrowing massively against that companies assets

3. Recasting the companies revenue from profits to capital gains (there-bye gaining tax advantages for Bain)

4. Stripping the caompany's pension funds

5. Selling off the remains before the almost inevitable bankrupcy

[Winstonm]

Bain Capitial is a private equity management group.

 

Historically, about 1.5% of the firm's revenue has come from venture capital (investments in start ups and the like)

FWIW, I'd argue that venture capital traditionally is traditionally used to refer to investments in startups...

 

The first sentence of the wikipedia discussion of Venture Capital starts:

 

 

 

The first sentence of the investopedia definition starts:

 

 

 

The vast majority of the firms profits have been derived from what is (uncharitably) termed corporate raiding.

 

In general, Bain made its money by

 

1. Buying distressed companies

2. Borrowing massively against that companies assets

3. Recasting the companies revenue from profits to capital gains (there-bye gaining tax advantages for Bain)

4. Stripping the caompany's pension funds

5. Selling off the remains before the almost inevitable bankrupcy

 

Sounds like Boone Pickens, as well.

[y66]

from Krugman's blog today:

 

William Cohan has an interesting take on Mitt Romney, which is completely distinct from the policy and left/right issues. According to Cohan, who did deals with Bain during the Romney years, the company specialized in dirty tricks.

 

Specifically, Bain would make the high bid for a company being offered for sale — then, after the other bidders had been sent away, would start finding things to complain about, and haggle the price down. This was, I gather, a major sin, since believe it or not Wall Street wheeling and dealing requires a high level of trust in one’s personal word.

 

This isn’t a policy issue; it’s the kind of thing I usually try to stay away from, the supposedly character-revealing nature of someone’s personal history. But as these things go, it’s especially interesting. Would you buy a used company — or a used ideology — from this guy?

 

Edit: I see PassedOut already posted Cohan's WaPo piece on the Republican Primary thread. Not surprised to see him beating Krugman to the punch.

[kenberg]

It is perhaps of interest that we had a couple over last night that have probably never voted for a Dem in their lives. The guy told me he plans not to vote this fall. Of course this is January, the election is in November, so we shall see. But I get the idea that a number of Republicans are viewing the situation with more than a bit of dismay. It's not that I think Democrats are such faultless heroes that they should get a free ride, so I am also finding this a bit disturbing.

[mike777]

As I am taking a course in ethics right now, finance and ins I found this:

 

I do strongly agree with awm and his main point about deceiving people is not ethical. I note that in general he thinks BAIN did what everyone who knows BAIN or should have known, expected.

 

Assuming this survey is close to correct:

 

 

8% say quite acceptable to bilk insures

10% say ok to submit claims for items not lost or damaged

40% will not report someone who ripped off an insurer

10% say they would commit insurance fraud if they can get away with it.

 

 

40% in 1997 said ok to exaggerate insurance claims to make up deductible.

 

 

3%-10% of health care expenditures are fraudulent or around 115 billion.

 

 

---

 

 

estimated 80 billion in insurance fraud(life/property) in 2006.

[PassedOut]

I've got nothing against making money; heck I make pretty good money.

 

But I think there are different ways to make money, and some of them strike me as very unethical. For example, making money by lying to people and convincing them to buy things that you know are crap seems very unethical to me (although depending on exactly how the lying is done, it might be legal). Selling people insurance and then trying to wriggle through legal loopholes to avoid paying legitimate claims seems very unethical to me (even though you might win in court).

I agree with this strongly. And in making business deals, trust is crucial: otherwise you'd need to have lawyers involved every step of the way, not just to formalize the eventual agreements. Most business people are honest, in my experience, and I can only think of a couple of serious exceptions after many years in business. In one case I did have to get lawyers involved after the fact and it was resolved satisfactorily. In the other I was warned in advanced, so was prepared.

 

I can say this: If someone lies to me, he's done.

[PassedOut]

Stephen Colbert defends attack ad

 

The PAC, dubbed the “Definitely Not Coordinated With Stephen Colbert Super PAC” is now behind the “serial killer” attack ad, which riffs on South Carolina front-runner Romney's infamous statement that “corporations are people."

 

The reasoning: if corporations are people, and voters care about Romney's record at venture capital Bain Capital, where some companies went belly-up, then he’s a “serial killer.”

 

Narrator John Lithgow creatively dubbed him “Mitt the Ripper.”

Good stuff!

:)

[kenberg]

The older I get, the more I believe that being straight with people is not only the ethical thing to do but also the practical approach. As just said, if someone lies to me they are done. Why would I try to work with a person if I have to run everything they say through a fact checker, get a lawyer to carefully review the wording, and so on.

 

Romney is going to be the nominee, so it seems, and in fairness to him and for our own best interests we should give him a fair examination. He no doubt has some skills. But he does make me, and apparently others, uneasy.

 

I never was on the bandwagon for saying what great speeches Obama gave, they always sounded like mostly crap to me. I have a fair trust in my instincts for this sort of thing, and now Romney makes me a little queasy.

[blackshoe]

There is a passage in one of Isaac Asimov's "Foundation" trilogy where a politician comes to the planet of the Foundation, and tries to talk them into joining his boss' "star kingdom". After a couple of weeks, he leaves. The leader of the Foundation asks one of his advisers for an analysis of what the politician said. That analysis was that "he said a lot of words during his two weeks here. Semantically, though, they mean exactly nothing." IOW he gave speeches for two weeks, but the net content of the speech-making was nil.

 

Ken, I suspect that your problem with Obama's speeches is that you actually tried to figure out what he was saying. B-)

 

As far as I can see, if we're voting on the basis of integrity, the top candidate by far is Ron Paul. Unfortunately, Republicans may have to ignore the integrity of the candidates in order to get someone who can actually defeat Obama.

 

Ron Paul's appeal to the masses is increasing, but I don't think the country is really ready for a libertarian President. Particularly when Congress is full of "business as usual" types from both major parties.

[cherdano]

If you want to try whether the country is ready for a libertarian president, maybe you could come up with a better candidate than one with idiotic views about the economy and the Fed, and who didn't read the newsletter he was publishing/was fine with racist articles in a newsletter under his name as long as it made money?

[barmar]

The paradox (or perhaps Catch-22) is that I think the kind of libertarian we might be ready to have as president is not the kind who could distinguish himself during the nomination process. Ron Paul probably wouldn't have the amount of support he has if he weren't such a firebrand.

[blackshoe]

That's a good point. I do think there's a growing trend in this country towards agreement with and support for at least some of what you might call the libertarian platform. I don't think the trend is yet strong enough to put a libertarian — even a firebrand — into the White House. Which probably explains why Ron Paul is a Republican. B-)

 

I also think that if Paul did get elected, he'd find the realities of the office won't let him do a lot of the things he wants to do. Which, depending on your point of view, may be a good thing or a bad one.

[barmar]

I also think that if Paul did get elected, he'd find the realities of the office won't let him do a lot of the things he wants to do. Which, depending on your point of view, may be a good thing or a bad one.

That's probably true no matter who gets elected.

 

Which basically means that the more a candidate promises to change things, the more disappointed we'll be with them once they actually get into office. Obama ran on a platform that was all about change; add the lack of change to all the other problems the country is having, and you have a recipe for his low approval rating.

[hrothgar]

That's probably true no matter who gets elected.

 

I'm not sure that I agree...

 

Paul's agenda is very much based on stopping the government from doing things that it currently does.

The President has much more power to stop things from happening than they do to drive a "positive" agenda.

 

As a practical example, what if Paul were to refuse to appoint a new Chair for the Fed or chose to appoint Cabinet heads to a number of agencies?

 

I think that a Ron Paul presidency would be catastrophic.

If he truly has "integrity" we'd be looking at a new Great Depression...

[Winstonm]

That's a good point. I do think there's a growing trend in this country towards agreement with and support for at least some of what you might call the libertarian platform

 

History shows that at times of great economic stress many countries have looked for radical solutions - public support does not equate to good policy.

[blackshoe]

It doesn't equate to bad policy either.

[y66]

From Krugman today

 

Since I just gave Larry Summers a bit of a hard time over that distressing Dec. 2008 memo to Obama, this is probably a good time to note that way back when he and Andrei Shleifer wrote an essay on the economics of leveraged buyouts (pdf) that is very worth reading now that Mitt Romney is running on the theme that his Bain experience means that he knows how to create jobs.

 

Summers and Shleifer argued back in 1988 that buyouts are often aimed at “value redistribution” rather than “value creation”; specifically, a lot of the gains to the buyout specialists come from breaking implicit contracts with “workers, suppliers, and other corporate stakeholders.”

 

They make one especially keen point: if it were really about adding efficiency, why do the same people lead takeovers in many industries, instead of people with specific expertise in each industry doing the job? Their answer is that these specialists are specialists in deal-breaking, not value creation.

 

Jim Surowiecki has more about how that game is played nowadays, with an especially fruitful discussion of the Harry and David’s case. (Sorry, couldn’t help myself). He also notes that often the result of these manipulations is to put taxpayers on the hook.

[Phil]

From Krugman today

 

Great..Krugman...

 

a lot of the gains to the buyout specialists come from breaking implicit contracts with “workers, suppliers, and other corporate stakeholders.”

 

Implicit contracts?

 

Employees are stakeholders, but not in the absolute sense.

 

Suppliers are stakeholders?

[kenberg]

I suppose an implicit contract isn't worth the paper it's not written on, but there truly can be issues.

 

I am receiving a pension from the University of Maryland, where I worked for 37 years. They offered several pension plans, I chose one, I paid the premiums. Now I feel entitled to the pension. Is there a contract? I would think so. I don't think I have a sheet of paper somewhere that says "Contract". I have heard speculation that in fact there is no contract. To me this is nuts. I can't take my car into a shop, select the $30 oil change, and then say that since we have no written contract I don't have to pay. They offered a selection of pension plans, I chose one, I paid the premiums, I want the pension.

 

The thought that I, and others, might end up in court trying to enforce an "implicit contract" is not appealing.