There's a decently successful chain of restaurants that owns properties across the county for its locations, let's say the priorities alone are worth $500m collectively
Private equity firm does a "leveraged buyout", so they borrow $500m against the value of those properties and put up the rest to cover the additional value of the business themselves and buy out the chain for $800m, assigning the $500m of debt they borrowed to the acquired company.
Then they start up another company that they own separate from the acquired company and start selling off the properties to it and converting the restaurants to leasing them. Now the restaurant chain is paying $20k/mo in rent to their new company instead of just paying property taxes on the land they used to own. Pretty soon the chain locations are all losing money because the PE firm is also cutting corners everywhere and they didn't have this huge rent expense before. Locations start getting closed and people lose jobs and communities lose what was once a totally viable business. Restaurant chain is eventually bankrupt under the massive debt that was assigned to them, PE firm still owns all the land and gets to sell it off on top of all the rent they collected.
This is not how leveraged buyouts work. Why would the lenders, themselves are significant, powerful financial institutions, agree to lend money for LBOs if this was how it worked? Reason it out for a second.
What you've described is fraudulent conveyance (investopedia has a great article on this if you're interested). It does happen (in cases such as Caesar's LBO, which resulted in a large settlement), but it is usually rectified in court. This happens in select cases, and is obviously extremely illegal.
The actual reason why private equity causes bankruptcy is sort of evident in your first part, which is the leveraged part in the leveraged buyouts. PE funds use a lot of debt to buy out companies, making them risky and more likely to default. Lenders know this. In the end, the people who really get screwed are all employees except top management.
There are many reasons to hate private equity, so if you're doing it, do it accurately.
Except that this isn't a hostile takeover, the owners of the original chain have agreed to this route and likely know what it means with a fairly minimal amount of research into how these deals proceed. Might be hard to outlaw the private sale of a moderately sized company with two willing parties
I don't think the sale itself could be made illegal, but every single step of this depends on state-sanctioned fictions that we created to facilitate economic benefit and on the net this behavior is not an economic benefit. It's a scam and we've outlawed plenty of exploitative harmful scams before
Maybe certain classes of financial institutions that receive federal benefits should not be allowed to finance leveraged buyouts. Maybe there can be restrictions on selling assets that are going to continue to be used to a related entity after a financed acquisition. These aren't forces of nature we're dealing with here they're state-facilitated transactions.
Maybe the whole overall maneuver should be made illegal. Pyramid schemes are composed from otherwise legal transactions too but if it can be proven that what you did overall adds up to a pyramid scheme you're going to jail.
You're a cool person and thanks for typing all this for people to read and educate themselves that there are ways worth trying that can improve the current situation immensely.
So it should be illegal for the original founders of the restaurant chain to make $800m on their successful business? Or for the PE firm to move assets or charge fees between two companies they own? Or for PE firms to mismanage their own investments and lose their own money? Or for restaurants to go out of business? Or for new ones to start?
To be clear, moving assets away from companies and/or charging fees between related companies is actually tightly controlled and audited.
If it’s 100% your own companies, that’s fine but as soon as third parties are involved ( banks, minorities shareholders) you need to follow market value.
Moving assets away to another company and declaring bankruptcy is defrauding the banks and very illegal.
Siphoning cash away from another company through inflated fees/ rents is also fraud if the company has other shareholders (it’s their money too)
Yes of course—fraud is illegal and there should be no tolerance for it. I’d argue though that fraud occurs much less often in PE than the vast majority of industries—to your point, their transactions are highly scrutinized and fines / lawsuits are quite simply bad for business.
OP asked how PE firms bankrupt businesses. The best answer is that they generally don’t—the best investment is one that grows and thrives forever. When they do, sometimes it’s simply because they made a bad investment and just cut their losses. Sometimes, yes, they maximize value out of a slowly declining business and eventually sell it off for assets—as is the prerogative—but this isn’t always a bad outcome. When stagnant companies die, newer and better businesses can take their place.
PE has its problems no doubt but it’s really not the bogeyman many want it to be.
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u/themightychris Feb 14 '25
Here's a common scenario:
There's a decently successful chain of restaurants that owns properties across the county for its locations, let's say the priorities alone are worth $500m collectively
Private equity firm does a "leveraged buyout", so they borrow $500m against the value of those properties and put up the rest to cover the additional value of the business themselves and buy out the chain for $800m, assigning the $500m of debt they borrowed to the acquired company.
Then they start up another company that they own separate from the acquired company and start selling off the properties to it and converting the restaurants to leasing them. Now the restaurant chain is paying $20k/mo in rent to their new company instead of just paying property taxes on the land they used to own. Pretty soon the chain locations are all losing money because the PE firm is also cutting corners everywhere and they didn't have this huge rent expense before. Locations start getting closed and people lose jobs and communities lose what was once a totally viable business. Restaurant chain is eventually bankrupt under the massive debt that was assigned to them, PE firm still owns all the land and gets to sell it off on top of all the rent they collected.
Yes, it should be illegal