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Two words: leveraged buyout. I'm not sure what purpose they serve other than to create debt. Working at a company that was acquired by a smaller fish with a $4

Two words: leveraged buyout. I'm not sure what purpose they serve other than to create debt. Working at a company that was acquired by a smaller fish with a $4 billion loan, it made things painful when cuts were constantly made to pay interest on debt. Somehow, the situation benefited the shareholders that signed off on the deal.

jackfraser 9y ago
Well yeah, it's pretty straightforward. Company A borrows $4 billion; it's leveraged against the company they're going to buy; they buy Company B, paying out the shareholders, and B merges into A and keeps the debt. I'm having a struggle with whether this seems moral or not. B is saddled with a big debt, and employees of company B may suffer as a result of this (anything from losing bonuses or profit sharing opportunities, to losing headcount, or having the very future of the company put into question). The new owners also have to live with this situation, while the old owners skip merrily away with their profits gleaned from the future work that will be done to pay down the loan. This seems negative, but has to be balanced with the fact that the shareholders of company B are the owners of the company, and it is their decision to do as they wish; if they're offered a certain sum for their shares, it's their choice to take it. It's unfortunate that this comes with blindness to the future impact of that action, but this may be a necessary or at least presently contingent artifact of capitalism.
- adventured 9y ago
  The morality of it depends on what you believe owners owe employees. There's clearly no objective basis there, it's down to a given person's moral beliefs. In my observation, you'll get a very different response to that from one business owner to the next. Some owners/operators take it as an intense matter of morality to safeguard their employees, others could care less and believe they owe their employees between nothing and very little. If you look at the top dozen economies in terms of prosperity or economic growth, you'll find a lot of different cultural approaches to that owner/operator-worker relationship, and they all have managed to generate rather spectacular results. France, US, Germany, South Korea, Japan, China, Sweden, Switzerland, Australia, Denmark - all have between slightly and very different approaches. It also takes you down a road of other similar questions. Joe loads up on his credit cards and puts his family at risk. Should that be illegal? Is it immoral? (arguably it's immoral) Social contracts are a fascinating thing and they're essentially all-pervasive across everything people do. We go out and drive on the roads with a sort of social contract, that properly we're not going to act like maniacs and endanger each other.
  - beojan 9y ago
    The difference here is that it's the acquired company that owes the debt, as opposed to the acquiring company owing a debt with the acquired company as collateral.
    - asmithmd1 9y ago
      Here is how it worked: Bain Capital decides to acquire Toys-R-Us so they set-up NewToyCo and invest $5B in it. NewToyCo buys Toys-R-Us with that $5B and installs new managers at Toys-R-Us. Since the invested cash was investment and not a loan, NewToyCo owns Toys-R-Us free and clear The new managers of Toys-R-Us get a $5B loan from banks secured by the assets of Toys-R-Us and pay a one time $5B dividend to shareholders of NewToyCo. If everything goes well and Toys-R-Us can service the loan, Bain owns Toys-R-Us for free and sells it or takes it public. If things don't work out, they collected huge management consulting fees for s few years. Bain ran this exact same play on KB Toys with the same (bankruptcy) result.
      - ars 9y ago
        So it's basically the opposite of going public? You use that $5B to pay all the original owners (shareholders), and now have debt instead.
    - kaycebasques 9y ago
      This is bizarre. I did not know that leveraged buyouts could work like this.
      - mseebach 9y ago
        It's just like a mortgage. Even though it's you buying the house, it's in a way the house that ends up owning the mortgage (in many jurisdictions, you can walk away from the house and mortgage, and the bank had no leverage against your person, they can only repossess the house).
        9y ago
santiagogo 9y ago
Well, to be fair, leveraged buyouts can be a useful tool to take over a company when there is a bad management team or an opportunity to generate a synergy when it is bought by another player in the same segment. For example this was recently the case with Dell and Hilton. But generally the high amount of leverage implies aggressive cost cutting, which negatively impacts the employees and in some cases R&D, which in turn means risking the future sustainability of the company for short term profits. If you're interested in the topic, "Barbarians at the Gate" is a great book to understand the in and outs of LBO's. The writing style also makes it fun to read.
mti27 9y ago
Don Draper said it best: "Do you want to build something, or help an accountant turn a dollar into a dollar and 10 cents?" I can say from personal experience if Blackstone buys your company you'll be focusing on the second objective.
walshemj 9y ago
well actually the heavy debt based corporate actions can really hurt share holders if as often happens it goes pear shaped and the share holders get 90% wiped out by the bond holders The ones who win are the corporate finance companies who make $ by arranging these complex financial instruments.
VLM 9y ago
I think you have confused cause with effect. Debt is cheaper than equity. The purchaser isn't diluting their equity returns as much so in theory they're getting a higher return. Interest is usually slightly higher than usual corporate lending so banks win. The profits should be more positive so the purchasee employees should be better off. So a LBO is a generally good idea other than its much more complicated and only scales to large purchases (like a nationwide toy store, perhaps) The effect you're probably confusing with the cause, is a deal thats dead, zero-sum or worse, with a pure equity structure might barely flip slightly positive if you do some financial alchemy and run it as a LBO... however thats exactly the kind of situation thats highly likely to crash and burn, no matter what you do. Essentially you get to try doing nothing and go out of business two years ago, do a pure equity deal and go out of business last year, or do a LBO and go out of business this year, or maybe, possibly, LBO has the best chance of making it. Its a common pattern often seen in military or business argument, a small scale tactic that maximizes success (minimalizes failure, I guess) when in retreat somehow gets blamed as the sole cause of the entire retreat itself. Smoke grenades screen a retreat better than clear air, therefore the war was lost or maybe a bad idea to start because we tossed smoke, well, it doesn't really work that way. In a very wide sense you are sort of correct that a deal or a company thats only microscopically barely alive by using every trick in the book including LBOs is correctly perceived as a dead company walking; just remember that almost all companies that successfully LBO are never talked about, therefore in a weird survivorship bias like scenario the general public will never hear about LBOs except in the case of a dead company. A good analogy would be lots of people who die immediately spent some time in a ICU, therefore there seems no purpose to ICUs other than death. However, many/most people only spend a little while in ICU and then recover but you'll never hear about it, they'll just call it post op recovery or critical care or some similar euphemism. Another weird medical analogy is doctors play an odds game. If the medical advice is the lowest risk treatment X is 90% success and 10% fatal, one patient dying doesn't disprove that advice, especially if 9 or more live, also you're only likely to hear about the fatalities which causes a false belief that docs are always wrong.
- asmithmd1 9y ago
  What does this mean: > Debt is cheaper than equity You have to pay interest on a debt, not so with equity. I am having a hard time relating your military and medical analogies to Bain/Vornado buying Toys-R-Us and then saddling it with $Bs in debt.

jackfraser 9y ago

Well yeah, it's pretty straightforward. Company A borrows $4 billion; it's leveraged against the company they're going to buy; they buy Company B, paying out the shareholders, and B merges into A and keeps the debt. I'm having a struggle with whether this seems moral or not. B is saddled with a big debt, and employees of company B may suffer as a result of this (anything from losing bonuses or profit sharing opportunities, to losing headcount, or having the very future of the company put into question). The new owners also have to live with this situation, while the old owners skip merrily away with their profits gleaned from the future work that will be done to pay down the loan. This seems negative, but has to be balanced with the fact that the shareholders of company B are the owners of the company, and it is their decision to do as they wish; if they're offered a certain sum for their shares, it's their choice to take it. It's unfortunate that this comes with blindness to the future impact of that action, but this may be a necessary or at least presently contingent artifact of capitalism.

adventured 9y ago
The morality of it depends on what you believe owners owe employees. There's clearly no objective basis there, it's down to a given person's moral beliefs. In my observation, you'll get a very different response to that from one business owner to the next. Some owners/operators take it as an intense matter of morality to safeguard their employees, others could care less and believe they owe their employees between nothing and very little. If you look at the top dozen economies in terms of prosperity or economic growth, you'll find a lot of different cultural approaches to that owner/operator-worker relationship, and they all have managed to generate rather spectacular results. France, US, Germany, South Korea, Japan, China, Sweden, Switzerland, Australia, Denmark - all have between slightly and very different approaches. It also takes you down a road of other similar questions. Joe loads up on his credit cards and puts his family at risk. Should that be illegal? Is it immoral? (arguably it's immoral) Social contracts are a fascinating thing and they're essentially all-pervasive across everything people do. We go out and drive on the roads with a sort of social contract, that properly we're not going to act like maniacs and endanger each other.
- beojan 9y ago
  The difference here is that it's the acquired company that owes the debt, as opposed to the acquiring company owing a debt with the acquired company as collateral.
  - asmithmd1 9y ago
    Here is how it worked: Bain Capital decides to acquire Toys-R-Us so they set-up NewToyCo and invest $5B in it. NewToyCo buys Toys-R-Us with that $5B and installs new managers at Toys-R-Us. Since the invested cash was investment and not a loan, NewToyCo owns Toys-R-Us free and clear The new managers of Toys-R-Us get a $5B loan from banks secured by the assets of Toys-R-Us and pay a one time $5B dividend to shareholders of NewToyCo. If everything goes well and Toys-R-Us can service the loan, Bain owns Toys-R-Us for free and sells it or takes it public. If things don't work out, they collected huge management consulting fees for s few years. Bain ran this exact same play on KB Toys with the same (bankruptcy) result.
    - ars 9y ago
      So it's basically the opposite of going public? You use that $5B to pay all the original owners (shareholders), and now have debt instead.
  - kaycebasques 9y ago
    This is bizarre. I did not know that leveraged buyouts could work like this.
    - mseebach 9y ago
      It's just like a mortgage. Even though it's you buying the house, it's in a way the house that ends up owning the mortgage (in many jurisdictions, you can walk away from the house and mortgage, and the bank had no leverage against your person, they can only repossess the house).
      - 9y ago

santiagogo 9y ago

Well, to be fair, leveraged buyouts can be a useful tool to take over a company when there is a bad management team or an opportunity to generate a synergy when it is bought by another player in the same segment. For example this was recently the case with Dell and Hilton. But generally the high amount of leverage implies aggressive cost cutting, which negatively impacts the employees and in some cases R&D, which in turn means risking the future sustainability of the company for short term profits. If you're interested in the topic, "Barbarians at the Gate" is a great book to understand the in and outs of LBO's. The writing style also makes it fun to read.

mti27 9y ago

Don Draper said it best: "Do you want to build something, or help an accountant turn a dollar into a dollar and 10 cents?" I can say from personal experience if Blackstone buys your company you'll be focusing on the second objective.

walshemj 9y ago

well actually the heavy debt based corporate actions can really hurt share holders if as often happens it goes pear shaped and the share holders get 90% wiped out by the bond holders The ones who win are the corporate finance companies who make $ by arranging these complex financial instruments.

VLM 9y ago

I think you have confused cause with effect. Debt is cheaper than equity. The purchaser isn't diluting their equity returns as much so in theory they're getting a higher return. Interest is usually slightly higher than usual corporate lending so banks win. The profits should be more positive so the purchasee employees should be better off. So a LBO is a generally good idea other than its much more complicated and only scales to large purchases (like a nationwide toy store, perhaps) The effect you're probably confusing with the cause, is a deal thats dead, zero-sum or worse, with a pure equity structure might barely flip slightly positive if you do some financial alchemy and run it as a LBO... however thats exactly the kind of situation thats highly likely to crash and burn, no matter what you do. Essentially you get to try doing nothing and go out of business two years ago, do a pure equity deal and go out of business last year, or do a LBO and go out of business this year, or maybe, possibly, LBO has the best chance of making it. Its a common pattern often seen in military or business argument, a small scale tactic that maximizes success (minimalizes failure, I guess) when in retreat somehow gets blamed as the sole cause of the entire retreat itself. Smoke grenades screen a retreat better than clear air, therefore the war was lost or maybe a bad idea to start because we tossed smoke, well, it doesn't really work that way. In a very wide sense you are sort of correct that a deal or a company thats only microscopically barely alive by using every trick in the book including LBOs is correctly perceived as a dead company walking; just remember that almost all companies that successfully LBO are never talked about, therefore in a weird survivorship bias like scenario the general public will never hear about LBOs except in the case of a dead company. A good analogy would be lots of people who die immediately spent some time in a ICU, therefore there seems no purpose to ICUs other than death. However, many/most people only spend a little while in ICU and then recover but you'll never hear about it, they'll just call it post op recovery or critical care or some similar euphemism. Another weird medical analogy is doctors play an odds game. If the medical advice is the lowest risk treatment X is 90% success and 10% fatal, one patient dying doesn't disprove that advice, especially if 9 or more live, also you're only likely to hear about the fatalities which causes a false belief that docs are always wrong.

asmithmd1 9y ago
What does this mean: > Debt is cheaper than equity You have to pay interest on a debt, not so with equity. I am having a hard time relating your military and medical analogies to Bain/Vornado buying Toys-R-Us and then saddling it with $Bs in debt.