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Private Equity Has a 'Social Responsibility': Carlyle Founder

Outside of becoming more socially responsible by making growth boosting investments and grooming idealistic financiers like Romney with the skills to potentially help the U.S. government balance the budget and cut the national debt, what else can private equity firms do to mend their image?

One possibility would be to market their services as similar to venture capitalists, who are seen in a much more positive light after giving the early stage investment to some of the great U.S. companies like Facebook, Apple (AAPL) and Google (GOOG). The difference is that venture capital firms give early stage cash to companies, while private equity firms oftentimes make takeover investments with debt financing that can give companies little margin for error and can initiate investment and job cuts.

The difference is embodied in the conflicting accounts of Mitt Romney's record at Bain Capital. Romney oftentimes touts his investment in Staples (SPLS), a company that grew many times over and created thousands of jobs after Bain's early equity investment. Competing candidates would rather highlight Romney's buyout of Dade International and the debt subsequently plied on the medical equipment company, in part to enrich partners, which eventually put it into bankruptcy.

Already, the private equity industry is headed in a more venture capital-like direction, albeit it unintentionally. Rubenstein noted that when he founded Carlyle, buyout firms only put up 5% of their cash to make acquisitions. The rest of deals were financed using debt in a process then known as "bootstrapping." That equity component has grown to 40%, estimated Rubenstein. Meanwhile, debt-fueled leveraged buyout deals have dropped off significantly since a pre-crisis boom.

Using more equity instead of debt for investments would also physically cut private equity ties to Wall Street. In the pre-crisis days, debt financing for leveraged takeover acquisitions by private equity firms generated billions in fees for Wall Street investment banks, but those numbers are down significantly. Even after a 33% 2011 gain, buyout loan fees of $5 billion paid to investment banks were roughly half of pre-crisis highs, according to Dealogic.

Private equity firms have been accused of receiving an outsized benefit from that leverage because of it's tax-deductability, profiting from a government subsidy.

Meanwhile, the industry can focus on how its investments provide higher returns than most offered on Wall Street, after all private equity returns have outperformed most other asset classes through the crisis, even as hedge funds and banks and even money market funds went belly up. "It's one of the best things you can do with your [money], legally," said Rubenstein about the top quartile of private equity returns, which he estimates can beat public market returns by as much as nine times.

Pension funds that serve the retirement accounts of millions of U.S. workers, for instance, look to high returning private equity investments as a way to manage those future liabilities.

In 2011 earnings released on Thursday, the Blackstone Group (BX - Get Report) reported continued inflows of private equity fund assets, in large part by investors like state pension funds and endowments seeking outsized returns not available on Wall Street. Private equity "is not only an important contributor to a healthy economy, it is a vital one," said Blackstone President Tony James on a media call after earnings were released.

Blackstone reported a 12% fall in fourth quarter profits on Thursday as fees and income on investments declined in the quarter. Private equity competitors KKR (KKR - Get Report) and Apollo Global Management (APO - Get Report) report earnings next week.

Proving a positive impact on job growth, acknowledging their social responsibility and cutting leverage may be the way for private equity to win over the public.

-- Written by Antoine Gara in New York
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