Imagine you have a lemonade stand, and you’re doing pretty well. A rich person comes along and says, I’ll buy your stand and make it even better!
But instead of using their own money, they borrow a LOT of money in your lemonade stand’s name. Now, your stand has to pay back that big debt.
Then, the rich person takes a bunch of the money your stand makes and gives it to themselves and their friends. But your stand still has to pay the debt, and soon, there’s no money left to buy lemons or cups.
Now your stand is out of business, and the rich person walks away with a big bag of money.
Why are lenders making these kind of loans? It's like giving a mortgage without a lien on the house, then the homeowner sells the house, pockets the cash, and tells the bank tough luck. I'm surprised lenders are dumb enough to fall for it if this is indeed what happens.
The goal isn't to bankrupt the company. The goal is to squeeze the company for as much profit as possible. Sometimes that means the company goes bankrupt, but the end goal is to keep it around on a skeleton crew for as long as possible to make as much profit as possible.
If the company goes under, its assets will be sold off and the bank will still likely get almost all of their money back.
So the best case scenario is some of the businesses pay off their high interest loans to the bank and the bank makes a tidy profit, and some of the businesses go bankrupt but the bank still gets most of the money back in assets.
The business itself is the collateral. It has physical assets that can be liquidated, and has proven the ability to generate cash flow to repay the debt.
Private equity companies look for businesses with high cash flow and low debt to acquire for this reason. All the liability sits within the newly acquired company and all the profits can be safely extracted by the private equity firm.
It's the business equivalent of taking out a bunch of credit cards out of your neighbor's mailbox because they make good money and have good credit. The only reason it's legal is because it benefits the wealthy.
A bunch of misinformation on this thread. Private equity is terrible, but the below and above comments are just not how this works. I encourage you to read or watch something outside of reddit on the matter. These people have no idea what they're talking about.
Everyone is saying the most braindead shit. Like some dude said the lenders will make more if the borrowers fail to pay back because they can write off the lost loans and get a massive tax break to give them more in profits than they lost. The fuck?
Because the post you're responding to fails to mention that the banks have security over all or some of the target entity's assets.
PE forms HoldCo. HoldCo acquires Target. HoldCo pledges as security for the loan its shares in Target. Target grants security over all or some assets (including its subsidiaries), and its subsidiaries grant security over some or all of its assets. Some of this depends on the type of company, how leveraged this acquisition is, the target's cash on hand, the strength of the PE sponsor, the jurisdiction of Parent and its subs.
It gets tricky when the company is massive and has subsidiaries that are not encumbered by any liens. What keeps a lender up at night is the target and it's subsidiaries (that have liens on its assets) being able to transfer an asset that should be subject to security to another subsidiary that has no liens. Now that sub can sell the asset and use that money to service debt, pay dividends, burn it. No good.
I've also asked this question. The answer is surprisingly hard to find.
Private equity often works. They specialize in finding businesses that have a good central business idea that are being run poorly. They buy it, whip it into shape, and sell it. Often, poor leadership means over hiring. Either the business has contracted or the leadership doesn't know how to deal with a high number of employees that don't share the company's vision. I.e. you have to hold some feet to the fire unlike your brother and best friend who share a vision of success - and maybe have equity in the company.
Lenders may give some leeway to a firm as failure means they take a nasty hit - but at some point they aren't going to throw good money after bad.
The stories of PE failure are classic rage bait pieces. Successes are ignored or only focus on layoffs, without highlighting the fact the company was failing and, without a PE firm, going to close and leave no one with a job.
Because the private equity firm has a billion in assets and/or insurance for every hundred million you’re loaning them. If the specific loan you’re giving them falls through, they have more than enough other sources of money to go after. They also have a very solid history of repaying their loans.
Private equity firms are similar to venture capitalists - as a hypothetical, let’s say they find ten companies with potential, and they put a hundred million into each one. If even just one of those companies then makes them over a billion dollars, it doesn’t matter that the other nine lost everything.
Nope. You write off unpaid loans because it's literally money you lost. It decreases profits. You are taxed in profits. Therefore, you will pay less taxes.
Say you someone borrowed $100 from you and you charge $10 interest. He needs to lay back $110. Your tax rate is 10%. You pay that 10% tax on your PROFIT of $10, which is $1. Now the guy can't pay you back, you write off $100 from your profits because you literally lost $100. So you can shave off $10 from your overall taxes for that year but you still fucking lost $100. Your down $90.
If your scenario is correct,then everyone would be giving shitty loans out like candy and praying their borrowers default on all of them. Does that seriously make sense to you?
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u/Borntwopk Feb 14 '25 edited Feb 14 '25
Imagine you have a lemonade stand, and you’re doing pretty well. A rich person comes along and says, I’ll buy your stand and make it even better!
But instead of using their own money, they borrow a LOT of money in your lemonade stand’s name. Now, your stand has to pay back that big debt.
Then, the rich person takes a bunch of the money your stand makes and gives it to themselves and their friends. But your stand still has to pay the debt, and soon, there’s no money left to buy lemons or cups.
Now your stand is out of business, and the rich person walks away with a big bag of money.