When a PE Executive Runs for Governor: Bruce Rauner in Illinois
Sometimes managing a portfolio of private equity companies can get ugly. However, unless there’s a lawsuit or bankruptcy, the ugliness seldom becomes public. There’s one other occasion when the unattractive side of private equity surfaces. If one of the partners decides to run for public office, the unpleasant stories begin to surface. Former-Governor Romney’s run for President triggered an examination of some of the deals funded by Bain Capital. In this election cycle, Bruce Rauner, a founder of the private equity firm GTCR, is running for Governor in Illinois.
Much like Governor Romney, Mr. Rauner is touting his business acumen and investment track record. A large part of GTCR’s investment returns are available because the Washington State Investment Board (WSIB) publishes the returns of its private equity managers. Overall the returns have been consistently good, as you can see below. These figures suggest that Mr. Rauner has earned a great deal of carried interest over the years, as well as profits on money he invested in the funds.
GTCR Fund Returns as Reported By the Washington State Investment Board: December 31, 2013
While private equity promotes itself as long-term investment shielded from the quarterly pressures of public ownership, this isn’t true at all. Private equity has a very high cost of capital. After all, they’ve promised investors returns of 15% to 20% per year, which means the investments have to generate something like 20% to 30% before fees and expenses. Moreover, they’ve promised investors that they’ll get their money back within 6 to 8 years. Investor expectations, financial leverage, and PE executives’ insatiable appetite for wealth combine to ensure that private equity is about speed and intense pressure. Even if the PE firm has the best financial engineers and savviest managers, there are bound to be some bad deals and a decent amount of collateral damage.
As the Illinois gubernatorial race heats up, Mr. Rauner is being confronted with a very unfortunate outcome from a nursing home investment, Trans Healthcare. Unfortunately, for Mr. Rauner, there’s a bankruptcy proceeding underway as he campaigns which involves the sale of the company. I’ll leave it to the Chicago Tribune to describe the matter. Apparently, this particular investment was fraught with problems throughout GTCR’s ownership. Predictably, Mr. Rauner is putting as much distance as possible between himself and the management of the investment even though he was on the board of the company. When you start to dig through press clippings you quickly find several other bankruptcies and pieces of litigation. While this stuff is great fodder for Mr. Rauner’s political opponent, it is actually business as usual in private equity.
If you invest in a difficult business like a nursing home chain and then try to wring as much profit as possible out of it, there’s probably a decent likelihood that something bad is going to happen. Obviously, not every deal is going to going to run into huge problems, and I’m sure Mr. Rauner can point to a few deals that were good for his investors and even a particular company’s customers and employees. However, you can’t generate the kind of returns achieved by GTCR without producing some damage, including investments that were successful from a financial perspective but disastrous for employees or other stakeholders.
David Sirota has once again dug through the annual reports of several Illinois pensions and discovered that GTCR is a private equity manager for the Illinois Teachers and Illinois Investment Board. Mr. Sirota correctly points out that Mr. Rauner continues to have an economic interest in various GTCR funds even though he resigned from the firm in 2012. Thus, some small amount of the pensions’ capital continues to flow into accounts owned by Mr. Rauner in the form of fees and carry. As Mr. Sirota asserts, if Mr. Rauner becomes Governor, he will appoint pension trustees who oversee investments that pay Mr. Rauner. It is indeed an odd situation. However, there’s nothing wrong with it. According to old annual reports for the Teachers and Illinois Investment Board, GTCR has been manager for these pensions since at least the early 2000s. Long before Mr. Rauner entered into elective politics, he and his firm won these mandates. While I think the economics are far too favorable to the money manager, Mr. Rauner is no different from any other large private equity executive. He’s gotten rich and will continue to get richer through the fees and incentives granted by the Illinois pension plan and a lot of other investors.
Illinois allows vast sums to be contributed to political campaigns, and money managers are taking the opportunity to write large checks to Mr. Rauner’s campaign. It’s been widely reported that Ken Griffin, founder of Citadel, has contributed $3.6 million to the effort. I downloaded Mr. Rauner’s contribution list from Followthemoney.org and found dozens of large donations (over $50,000 apiece) from money managers. None of these managers has violated the SEC’s pay-to-play rule as they aren’t currently managers for an Illinois public pension. However, the SEC rule does not prohibit them from managing money for a public pension. The rule only says that the manager can’t receive a fee for two years after making the donation. If Mr. Rauner wins election, I’m sure that many of the big financial donors will get an inside track in managing a mandate for one of the Illinois public pensions. Mr. Rauner may be their friend and professional colleague, but I’ll bet that some of these people are looking to make a handsome return on their campaign donation.
Illinois faces some significant fiscal challenges. On the surface, a successful private equity executive might seem to have the skills to address those problems. However, buying and selling companies is a far cry from the complexities of providing government services. If I were a voter in Illinois, I’d be pretty concerned about a money manager who only owns up to the good parts of his investment record and counts financial engineers as his most ardent supporters.