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So, some PEs do try to run businesses sustainably. But we mostly hear about the PEs that turn a business that's slowly dying to one that will operate "as normal
by toast0 2y ago
So, some PEs do try to run businesses sustainably. But we mostly hear about the PEs that turn a business that's slowly dying to one that will operate "as normal" until it suddenly dies, usually somewhere around 5-7 years later.
The first thing is that, if at all possible, the PE wants to do a leveraged buyout where the acquired company itself has borrowed most of the funds to buy itself. This cashes out the previous investors, but leaves most of the risk with lenders rather than the PE firm. Sometimes the PE may get a cut of the financing revenue. Most of the loan will be sold on the bond market, typically as junk bonds. Junk bonds have high interest rates, because there's a good chance the loan won't be repaid, but maybe you'll collect enough between interest and the bankruptcy settlement.
While the company operates under the PE's management, it's getting paid management fees.
It's also likely to move valuable assets out of the company; for real estate, sale and leaseback is common; when the company implodes, the PE keeps the land and can sell or lease it to someone else. The sale price was probably under market and the lease over market, so the PE earns money here. Having a high lease payment helps the PE finance the purchase, and may help it finance similar property as well.
- markus_zhang 2y agoQuestion is, why do lenders lend money to them? Maybe they can get the principles back somehow?
- sct202 2y agoThey got 13 years of payments which might have been enough to make it worth it for the lenders depending on the premium they were getting on loaning the money. Sears and Joann's also took about 13 years from buyout to bankruptcy. Party City only took 6 years.
- toast0 2y agoThe interest rates are high, and the lenders likely will sell off the loans in a few years. If the company sticks around for a few years and looks ok, they might even be able to sell the loan for more than they lent out. Especially if the corporate numbers look good because of short-term changes, they may be able to get out. When the company goes bankrupt, the lenders have first priority for remaining assets, sometimes lenders will takeover a business and run it away from the shore and earn a profit that way, too.
- markus_zhang 2y agoThanks, looks like interesting cases to study.
- chgs 2y agoStick the junk bonds in. With solid bonds and hide that they exist. Sell to a greater fool.
- ferguess_k 2y agoThanks, I remember reading about those LBOs many years ago when they were kinda new to the public. Should have thought about that. Guess the key is: 1) Find a suitable monetary situation 2) Find companies that still have long term value but are struggling 3) Find a loan 4) Execute
- snozolli 2y agothe PE wants to do a leveraged buyout where the acquired company itself has borrowed most of the funds to buy itself. Planet Money did an excellent podcast back in 2012 about Bain Capital buying and effectively destroying an iconic American manufacturer of legal pads. It's a great example of exactly this behavior: https://www.npr.org/transcripts/147590440 https://www.npr.org/transcripts/147590440