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Usually this happens because the company has gotten into cash flow trouble. When that happens, the company’s creditors lose faith in its ability to invest capit

Usually this happens because the company has gotten into cash flow trouble. When that happens, the company’s creditors lose faith in its ability to invest capitol in productive ways. But an LBO is usually the option of last resort. If you don’t have cash to make payroll next month and you have 2500 employees, you take the LBO. An LBO allows the company to raise cash to fund a turnaround; but the incentives of PEs are set up such that the PEs don’t need to actually turn it around to make money — aggressively cutting costs is often enough. The creditors don’t care because they get paid back on IPO and get to collect interest in the meantime. The alternative is usually going to be a buyout by a competitor, chapter 7 reorganization or simply ceasing operations like Toys-R-Us is doing once their debt rating is so far past junk they can never qualify for an LBO. Then the company dies. This is the “service” PEs provide to the economy — they help wind down failing businesses in a somewhat orderly way while extracting maximum value into the economy from a company that is headed for the scrap heap. You can argue as to whether or not that’s valuable.

Bartweiss 9y ago
Thanks, this makes sense. I could never understand why a company takes an LBO instead of just taking out a massive loan against their assets directly, but this explains it. A combination of "the existing team isn't trusted to use that money" and "the creditors can collect without a full recovery" explain it nicely; PEs might theoretically be more objective at deciding when to restructure and when to strip assets.
- Blackstone4 9y ago
  I've invested in private equity funds across the entire spectrum. I mainly focused on the small to medium end of the market... The bankruptcies of the large LBO deals skew the public's perception of the industry. Sure it has faults but the reality is much more nuanced than some of the views outlined above. Yes there are large private equity firms that will acquire companies and overload them with debt, cut costs and sell prize assets. Yes there are many other firms who operate very differently. In the smaller end of the market, debt loads are much more conservative and returns are generated through moving into new geographies (i.e. opening a new store in MA), moving into adjacent markets (i.e. we sell tables. Let's move into the chair market), let's hire more sales people, acquire complimentary products to cross-sell etc. The list goes on. There are many positive qualities to private equity but the industry is tarred because of the large amounts of money. People on the whole don't like large amounts of wealth. So why does a company sell to an LBO? Could be any number of reasons. The founder might want to retire. Maybe the kids inherited the business and no longer want to run it. Maybe the business is in dire straits and the current owner lacks the skill or the patience to turn it around. Maybe a company wants to sell a non-core division. Maybe a parent company is financial trouble and will sell assets. Maybe the price is right.

Bartweiss 9y ago

Thanks, this makes sense. I could never understand why a company takes an LBO instead of just taking out a massive loan against their assets directly, but this explains it. A combination of "the existing team isn't trusted to use that money" and "the creditors can collect without a full recovery" explain it nicely; PEs might theoretically be more objective at deciding when to restructure and when to strip assets.

Blackstone4 9y ago
I've invested in private equity funds across the entire spectrum. I mainly focused on the small to medium end of the market... The bankruptcies of the large LBO deals skew the public's perception of the industry. Sure it has faults but the reality is much more nuanced than some of the views outlined above. Yes there are large private equity firms that will acquire companies and overload them with debt, cut costs and sell prize assets. Yes there are many other firms who operate very differently. In the smaller end of the market, debt loads are much more conservative and returns are generated through moving into new geographies (i.e. opening a new store in MA), moving into adjacent markets (i.e. we sell tables. Let's move into the chair market), let's hire more sales people, acquire complimentary products to cross-sell etc. The list goes on. There are many positive qualities to private equity but the industry is tarred because of the large amounts of money. People on the whole don't like large amounts of wealth. So why does a company sell to an LBO? Could be any number of reasons. The founder might want to retire. Maybe the kids inherited the business and no longer want to run it. Maybe the business is in dire straits and the current owner lacks the skill or the patience to turn it around. Maybe a company wants to sell a non-core division. Maybe a parent company is financial trouble and will sell assets. Maybe the price is right.