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Burger King and the Romney Perversion

August 28, 2014

The merger of Miami-based Burger King and Tim Horton's of Canada is adding fuel to the raging debate about the so-called "tax inversion." While Jordan Weissman questions Burger King's denial that the decision to base the new fast food giant in Canada was motivated by a desire to lower its corporate tax bill, Megan McArdle and David Harsanyi argue BK's royal decree is just common sense.
But lost in the debate about the degree to which Burger King will screw American taxpayers is the inescapable fact that it already has. Thanks to another a different gaming of the tax code that can rightly be called the "Romney perversion," Burger King's private equity owners already redirected millions of dollars from the U.S. Treasury to line their own pockets. And among those who padded their own bank accounts at taxpayer expense was Mitt Romney himself.

In 2010, Burger King was purchased by Brazilian private equity giant 3G for $3.3 billion. But as Joe Nocera documented in the New York Times two years ago, BK was only changing hands. Eight years earlier, the struggling company began its first spell as a cash cow for rich investors:

Enter -- ta-da! -- private equity. In 2002, Goldman Sachs, along with two private equity firms, TGP and ... hmmm ... Bain Capital, teamed up to buy Burger King. This is exactly the kind of situation private equity firms like to trumpet: taking over a downtrodden company and nursing it back to health. And to get them their due, Burger King's new owners did some good, stabilizing both the company and the franchisees, many of whom were in worse shape than Burger King itself.
But the private equity investors also cut themselves an incredibly sweet deal. Their $1.5 billion purchase price included only $210 million of their own money; the rest was borrowed. They immediately began taking out tens of millions of dollars in fees. Four years later, they took Burger King public. But, first, they rewarded themselves with a $448 million dividend. In all, according to The Wall Street Journal, "the firms received $511 million in dividend, fees, expense reimbursements and interest" -- while still retaining a 76 percent stake.

Despite having left Bain Capital in 2002, Mitt Romney continued to reap a windfall from the golden parachute he negotiated prior to his departure. But as I documented two years ago ("How We Built Bain Capital"), Romney's stratospheric earnings as a leveraged-buyout pioneer would not have been possible without his uncle. Uncle Sam, that is. Your United States tax code doesn't merely allow the "carried interest exemption" that enables the likes of Mitt Romney to pay a lower rate than many middle class families. Without the public subsidy that is the corporate debt interest deduction, there might not be a Bain Capital--or a private equity industry as we know it--at all.
In 2012, Matt Taibbi explained how federal tax law made it possible for Mitt Romney to become a $250 million man:

Essentially, Romney got rich in a business that couldn't exist without a perverse tax break, and he got to keep double his earnings because of another loophole - a pair of bureaucratic accidents that have not only teamed up to threaten us with a Mitt Romney presidency but that make future Romneys far more likely. "Those two tax rules distort the economics of private equity investments, making them much more lucrative than they should be," says Rebecca Wilkins, senior counsel at the Center for Tax Justice. "So we get more of that activity than the market would support on its own."

And much more debt than many of the takeover targets of the LBO kings could afford. But by insisting these companies immediately begin paying them dividends and management fees, private equity parasites like Mitt Romney realized they could win big even when the firms they acquired failed.
The Economist explained how the perverse incentives work:

From 2004 to 2011 private-equity firms piled more debt onto their companies so they could take out $188 billion in dividends to pay themselves. The deals got bigger and bigger. The largest ever, in 2007, was the $44 billion purchase of TXU, an electricity company. The market worries the company will go under.
But though the private-equity people may have walked off with the loot, America's tax code was partly to blame, because it encourages this behaviour. The tax deductibility of interest payments on debt gives private-equity executives an incentive to pile extra debt onto the companies they buy, thereby risking the health of these firms for the sake of a tax benefit and the prospect of higher returns.

"In the majority of these deals," Lynn Turner, former chief accountant of the Securities and Exchange Commission explained, "the tax deduction has a big enough impact on the bottom line that the takeover wouldn't work without it." And that interest," Turner said, "just sucks the profit out of the company." As Taibbi rightly noted, "You almost have to start firing people immediately just to get your costs down to a manageable level."
"Traditionally," Josh Kosman noted in 2009, "cash-rich public companies have paid dividends to lure and reward investors." But private equity firms, he explained, stand this process on its head. "Fourteen of the largest American private equity firms had more than 40 percent of the North American companies they bought from 2002 until September 2006 pay them dividends," Kosman pointed out, adding, "In thirty-two of the eighty-three case, 38 percent, they took money out in the first year." And the innovator behind the business model?

Mitt Romney was a pioneer of this strategy. His private equity firm, Bain Capital, was the first large PE firm to make a serious portion of its money not from selling its companies or listing them on the stock exchange, but rather by collecting distributions and dividends, which in this context is the exact opposite of reinvesting in a company. Bain Capital is notorious for failing to plow profits back into its businesses.

So much for candidate Mitt Romney's 2007 claim, "Don't forget that when companies earn profit, that money is supposed to be reinvested in growth."
During his tenure as CEO from 1984 to 1999, Bain invested in 40 companies in the U.S. While seven later went bankrupt, in June the New York Times reported that "In some instances, hundreds of employees lost their jobs. In most of those cases, however, records and interviews suggest that Bain and its executives still found a way to make money." That mirrors a January 2012 analysis by the Wall Street Journal, which revealed:

Bain produced stellar returns for its investors--yet the bulk of these came from just a small number of its investments. Ten deals produced more than 70% of the dollar gains.
Some of those companies, too, later ran into trouble. Of the 10 businesses on which Bain investors scored their biggest gains, four later landed in bankruptcy court.

Put another way, Mitt Romney's investing was almost risk-free. He won when his portfolio companies won and often when they lost. Thanks in large part to the dangerous incentives unleashed by the U.S. tax code. With the policy choices of our elected United States government, Mitt Romney simply would not have gotten nearly as rich as he did at Bain Capital. As Matt Taibbi put it, "the way Romney most directly owes his success to the government is through the structure of the tax code."

In other words, the government actually incentivizes the kind of leverage-based takeovers that Romney built his fortune on. Romney the businessman built his career on two things that Romney the candidate decries: massive debt and dumb federal giveaways. "I don't know what Romney would be doing but for debt and its tax-advantaged position in the tax code," says a prominent Wall Street lawyer, "but he wouldn't be fabulously wealthy."

But it wasn't just Mitt Romney who got rich courtesy of the Whopper. So did his Mormon Church. As ABC News detailed during the 2012 campaign, "the private equity giant once run by the GOP presidential frontrunner carved his church a slice of several of its most lucrative business deals, securities records show, providing it with millions of dollars worth of stock in some of Bain Capital's most well-known holdings." Among those well-known holdings that enriched his Church while lowering his tax bill:

Records from the Securities and Exchange Commission show that the Mormon Church has reaped more than $13 million over the last 15 years by selling shares in companies that Bain Capital invested in, including Burger King Holdings and Domino's.

As we fast forward to his week's marriage of Tim Horton and Burger King, many Americans are beginning to tally the loss to Uncle Sam's coffers from this latest tax inversion. But thanks to the Romney perversion, billions of dollars in damage have already been done.


Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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