Why Bain Capital's Targets Went Bust—David Frum

Stephen Bainbridge, Professor of Law at UCLA, sums up some important research to explain why Mitt Romney's Bain targets went bust so often:

[R]ecent research suggests that business failures are an inherent part of the private equity business model. A study of UK firms that went from being publicly to privately owned in leveraged buyouts by private equity firms like Bain Capital found that "companies going private have a significantly higher default probability. Private equity firms sponsoring P2P deals acquire firms with a higher risk of bankruptcy than non-acquired firms that remain public."

In turn, that finding "suggests that PE firms are not deterred by the risk of financial distress but consider it a value creating opportunity."

Private equity firms thus come to financially distressed corporations and offer to buy out the existing shareholders. Those shareholders get out from a bad situation with a premium over the market price of their shares. The newly private target corporation gets new management to replace the managers who got the company into financial trouble in the first place. The newly private target also gets access to capital from the private equity buyer at cheaper prices than an arms-length banker probably would be willing to charge (if such a banker will willing to lend to the financially distressed target at all).

Ideally, this results in a turn around that creates a stronger, more profitable company.

And sometimes it doesn't. After all, many of these target corporations were financially distressed before they were bought by somebody like Bain Capital. Typically, there are reasons firms are financially distressed. Sometimes those reasons can be addressed and solved. But sometimes they can't.