Mitt Romney and Bain Capital: Understanding the Reality

In support of his run for the Republican nomination, Mitt Romney has cited his experience at Bain Capital, the private equity firm he founded and led for many years. He has argued that that experience in which he "created 100,000 jobs" demonstrates his capabilities at job creation for the nation and is a qualification for the position of president. Some Romney supporters have gone further. Thus, Utah Governor Gary Herbert, appearing on CNBC's Squawk Box, argued that Romney's experience at Bain in "turning around" companies demonstrates that he can "turn around" the United States. Romney's claims of job creation opened the door to attacks from other Republican candidates. Newt Gingrich and a "super PAC" supporting him, financed by Las Vegas mogul Sheldon Adelson, are claiming in emotion laden ads that Romney's activities at Bain actually reduced jobs and harmed employees. And Texas Governor Rick Perry has characterized private equity companies like Bain as "vultures" that destroy worker's lives.

Now, Republican leaders of all stripes, including former Arkansas Governor Mike Huckabee and New York Mayor Rudy Giuliani are rushing to the defense of Romney, arguing that attacks on his business record are antithetical to the Republican party's support of business and free market capitalism.

The reality is both more simple and more complex than all those allegations would have one believe. It is simple because the function of Bain and other private equity funds has no planned relation to job creation or job losses. It is more complex, because the activities of Bain do tell us something about Mitt Romney -- having nothing to do with jobs. Let's look at how Bain and other private equity companies actually operate.

The business goal of private equity companies is to make profits for investors in the equity funds they manage. The greater the profits for the investors, the larger the take of the fund managers, who typically receive a base management fee of about 2 percent plus a portion of the fund profits, generally around 20 percent. If the fund manager is very successful then the manager's participation in profits may run as high as 30 percent, which investors may be prepared to accept just to be able to invest with that manager. We're told that Bain was very successful in creating very high returns on investment for its investors, said to be an astounding 88 percent per year, to the point where it could get 30 percent participation in profits. One tax advantage of the fund mangers is that although their business is to get paid by creating values, unlike other payment for services, which is taxed as ordinary income, their return for their services is treated as capital gain and taxed at the lower capital gains rate.

What the private equity firms do to earn those returns is to seek out opportunities to acquire companies where by adding their efforts and talents they will be able to increase the value of the company to the point where they can realize the increased value by selling the company or its assets. A sale can be made to another company, frequently a much larger one in a related field, to another private equity fund which believes it can create even more value for its own investors, or in a public offering to a broad group of shareholders. Most often, in order to increase the return on capital invested by the fund, the fund will borrow a significant portion of the purchase price of the business. And sometimes, if it can, the fund will take back as a distribution immediately upon closing the purchase of the business, a portion of its investment in the purchase price, reducing its own investment and enhancing its return on the investment left in the business. This distribution may come from the company's existing cashable assets or from money that the company is caused to borrow. This additional leverage also creates additional risk; if things don't go right the business will not be able to pay the carrying costs of the debt, the lender will take over the business and the fund will lose its investment. Sometimes, that results in the acquired company placed in bankruptcy proceedings either to liquidate its assets to pay off the debt or to restructure, a process Bain also experienced.

It should be evident in understanding the function of Bain and other equity funds that job creation or job loss is ancillary to the investment goals and activities. To increase the profits of the acquired company, the fund may reduce the number of employees, reduce pay levels or curtail work time. In that case the fund could face worker anger and union pressure. If the company happens to become very successful, as Staples did after Bain acquired it, it may expand its business requiring that it increase hiring and work time.

So what does all of that tell us about Mitt Romney? Certainly, his success in founding the Bain equity fund and operating it very successfully for a number of years speaks to his initiative and intelligence, his commitment to hard work, his ability to pull together a team of talented people and work closely with them. It also tells us that he is willing to take risks and to take action required to achieve his goals irrespective of whether that action helps or hurts people affected by it -- in this case employees of the acquired companies. It also tells us that he is flexible -- he could not accomplish what he did without being adaptable, willing to "go with the flow" and accommodate his views to his business interests and those of his investors and lenders. We have already seen much of that flexibility in his willingness as a candidate to change his political positions to accommodate the demands of the constituency whose support he is seeking. It also tells us that what he says now on the stump is not necessarily what he will do if he is elected president to accomplish his goals.

It also should be evident that "turning around" a business has little relationship with trying to change the direction of a country. The objectives of Bain were clear-cut: increase the profits from the business at whatever cost to employees or suppliers. The objectives of a nation are rarely clear-cut and reflect the balancing of interests of different constituencies with different, often conflicting, desires and aims. The ability to change an acquired company's direction lay within the power of Bain management. By contrast, the power of a president is diffuse and depends on political circumstances beyond the president's control, like which party is in power in which branch of government. Leading a nation in a particular direction in those circumstances is very difficult if not impossible, and requires political talents of the highest order to bring the nation with him.

And therein lies the rub. Mitt Romney of Bain Capital was a good businessman. The selection process of choosing the Republican candidate and later the president calls for a different valuation based on other criteria: choosing a political leader whose values conform to those of the voter making the choice. A person whose emotional make-up allows him to handle the crushing burdens of office and gut wrenching decisions such as sending troops off to war. Mitt Romney's business activities at Bain tell us very little about those important values and what he would seek to do as president. And unfortunately, Mitt Romney's career as a politician and now as a candidate tell us little more than that he can be all things to all people. We have to look elsewhere than Bain Capital to make a well-reasoned decision about Romney's qualifications for the job of president.

Mr. Lifton, a businessman and political activist is writing a book entitled "Life's Lessons and Stories From a Member of the "Greatest Generation."

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