Yes some businesses are SaaS but here's the real problem: Many businesses' sole purpose is _leveraged buy-outs_ which really is the devil in disguise.
It goes like this: A VC specialising in veterinary clinics finds a nice, privately owned town clinic with regular customers and "fair" prices, approach the owners saying "we love the clinic you've built! We'll buy your clinic for $2,500,000! You've really earned your exit!".
So now the VC lends the money from the bank, buys the clinic, and here's the important part: _they push the debt onto the clinic's books_. So all of a sudden the nice town clinic has $2,500,000 in debt, raise prices accordingly, ~~burn out personnel~~ slim operations accordingly, and any surplus that doesn't go to interest and amortization goes straight to the VC.
Debt and collateral on the veterinary clinics.
Risk free revenue to the VC.
This mostly correctly describes a leveraged buyout (LBO). LBOs are done by LBO shops, a type of private equity (PE) firm. Not VCs. (VCS do venture capital, a different type of PE.) And LBO debt isn’t “pushed” onto the company’s books, it’s never on the sponsor’s (LBO shop’s) books in the first place to any material extent.
Private credit, on the other hand, involves e.g. Blue Owl borrowing from a bank to lend to software businesses, usually without any taking control or equity. It’s fundamentally different from both LBOs and VC or any private equity inasmuch as it doesn’t have anything to do with the equity, just the debt. (Though some private credit firms will turn around and lend into a merger or LBO. And I’m sure some of them get equity kickers. But in that capacity they’re competing with banks. Not PE. Certainly not VC, though growth capital muddles the line between what is VC and other kinds of PE or even project financing.)
Doesn't the LBO shop still need to pay off the debt, technically speaking? AFAIU the company's assets (hospital in OP's example) are used as collateral in a credit agreement between the LBO shop (as the hospital's new shareholder) and the bank. But unless I'm mistaken, this is not exactly the same as the debt being on the hospital's books and the hospital having a credit agreement with the bank. (For an increase in debt on the liabilities side of the balance sheet there would have to be an equal increase of assets on the other side.)
Leverage. They raise money in their public funds. And then they borrow, typically around 50% of their capital, to amplify returns.
Note: “Private credit lenders won’t lose money before private equity firms do. That’s how the capital stack of companies work: Equity is the first in line for losses. Before lenders like Apollo Global Management, Blue Owl Capital or Ares Management lose a dollar on their loans if a portfolio company fails, the private equity owners will already have been hit” [1]. Leveraging the senior debt is actually less risky than leveraging the underlying equity. (Though obviously they compound when done together.)
[1] https://www.nytimes.com/2026/03/12/business/dealbook/private...
From a financial engineering perspective this is wrong.
Both equity and debt have costs of capital. Debtholders expect interest, capital holders expect RoE. The money going to debt interest is money that would previously have gone to equity, but now does not because the equity is replaced with debt.
Crucially, the costs of debt is lower than the cost of equity because of the interest tax shield. Therefore, the vet clinic now requires less revenue to maintain or even increase its return to equity.
And the LBO model is much less resilient to economic headwind. Let's assume a 25% EBITDA margin business, with most costs fixed (like the clinic example). Unfortunately revenue drops 20% because of external factors. It would maybe have a tiny profit left, tax would also be tiny and there is no interest to pay. The shareholders receive near zero, absorbing most of the problem for a year waiting for times to get better.
Now the same business, same reported EBITDA, but paying a large interest sum every year to the bank. If revenue drops 20% they can't pay their interest, and banks don't just wait for next year. Now the business has the restructure, agree with the banks what that looks like, or face a bankruptcy risk.
While the new PE shareholder has a better RoE due to leverage in the upside scenario, the business (and the PE) could be completely cooked in a downside scenario. For the PE this is a calculated risk, they optimise the overall portfolio. But for the employees and customers this isn't a great scenario.
The small-town vet would have probably accepted a lower RoE. More critically, they’d have been more willing to absorb shocks to said RoE than a lender will to their debt payments.
How is that risk free? If the clinic goes bankrupt the VC will be on the hook for the rest of the loan. It’s not free money.
Ohhhh a live one! Sir do I have a wonderful bridge in Brooklyn to sell you! :)
Fun fact: banks fund this sort of nonsense constantly. I've asked about this before: why they do it. They must be making money I just don't know how. The LBO guys pay themselves massive management fees and dump the debt on the company so they walk away scott free.
My wild guess was the banks offload the eventual IPO onto investors and so make their money on the IPO fees and funneling their own clients the dead-man-walking shares. But I honestly don't know.
The banks get paid back their debt when the next PE fund buys the company or the company pays it off. Unless an IPO is being done to pay off debt, which it never is, the mechanism you describe doesn’t occur.
or some manager at it? it must be easy enough to raise that starting money, if the PE firm could get the loan
"lends" -> "borrows", right?
The VC lends (the money from the bank) which the vc borrowed, to the clinic.
They are a sort of middle man. It the clinic is on the hook to the bank and the Vc takes fist cut before playing the bank.
Eg. The vc only risked the company they were buying, and gets paid first.
(Edit: To be clear, I agree with the other commenters that none of this is what VCs do. I'm just pointing out that the way this is being described doesn't even work on its own terms. Needless to say, LBOs are not "risk free".)
It does not happen overnight. But what happens is after they take control of the clinic or company they change the sales model to boost reoccurring revenue, this then allows the clinic or target company to take loans out. Because they look good on paper. The company then pays VC back when then pays bank back.
This can be done in about 6mo to 1 year process with some companies. The initial out of pocket expense is small and paid back very quickly.
I also forgot. Sometimes they will take the newly owned company and merge it. During that process they extract more money and load more debt onto the remaining entities, again making the VC money.
In some cases they can even get huge tax benefits by loading the company with debt which offsets the tax bill of the final entity.
When these transactions are done, within the span of a day multiple companies are created and merged and absolved.
There is little to no risk for the VC
This is actually a case where using the correct terminology clarifies.
VCs don’t do LBOs. Private equity firms do. When their deals go bust they lose the equity they invested. That equity is the first layer to take a loss. When that happens, the lenders—whether they be banks or private credit firms—take over the company, often converting some of their previous debt into equity.
There is a lot of risk in LBOs. It’s why they have such a mixed record.
This was the missing bit for me. Thanks for taking the time to explain!
First, VC stands for venture capital, which is a subset of private equity that does zero LBOs and doesn't even acquire any businesses. VC funds buy equity in startups, and take on zero debt to do so. You have your boogiemen totally confused.
Second, the entire point of a PE fund that uses a leveraged buyout strategy is that they need to sell the acquired firm at a profit to make any returns to the fund. LBO funds don't 'cashflow' businesses, and saddling a business with a bunch of debt is antithetical to that purpose anyways.
Third, this is not "risk free revenue." It's a high risk strategy to use the debt to increase the value of the business by improving operations enough that you can sell it for a profit to the fund. If you saddle a company with debt and DON'T increase the value of the business beyond the debt you took on, the PE fund will not be in business for fund 2.
The risk-free revenue while the fund is alive comes from the management fees that investors in the fund pay (usually 2%, which is way too high IMO, but has nothing to do with the debt or the acquired businesses).
Please do not write confident sounding comments about things you don't understand, it spread misinformation and makes the internet a worse place.
IF you have problems with the vocab and terms, fine. But I have seen personally this issue in my life, that is affecting my bank account.
And we have seen example after example of these LBO's ruining otherwise functioning businesses. It's happening. All over the place.
Your anecdotes and the anecdotes in media are no statistical evidence for "this is happening all over the place".
Yes, PEs/LBOs deserves criticism, but "PE" and "LBO" isn't a one size fits all situation.
It's just as likely the business that was acquired was already failing or unsustainable to begin with (hence why the owner wanted out at low multiples). LBO funds don't acquire promising businesses at 5-10X revenue like tech companies do, they usually buy businesses at low multiples that are past their prime or failing in an attempt to revitalize them (with debt, since you can't raise capital by selling equity in a failing business).
Obviously this will not always work out great, given the trajectory of target companies was already not great to begin with. Momentum is the strongest factor in all markets.
The problem is, Private Equity has become a conspiratorial catchall boogieman and scapegoat for every problem under the sun, so it's hard for me to assess without further details of the situation.
Nit: beta is the strongest factor in all markets. Which is actually relevant for the success for PE funds in general, as a rising tide lifts all boats and people taking on debt to finance equity generally post outsized returns in bull markets.
Anyway, the rest of the stuff you're saying I agree with.
If you buy a “factor-weighted” etf the idea is it’s tilting you into those “factors” away from pure beta like buying whole market.
PE you could argue is largely just leverage plus an illiquidity factor play, since if PE just returned beta (which these days it might!) you’d be smarter to buy the S&P500 with equivalent leverage and not pay crazy fees.
On your second point: LBOs aren't the only tool in the toolkit, and it's not as popular as it was decades ago, so I would lean towards the parent simply conflating "buying an ownership stake in a business in some capacity using other people's money" with the strict definition. Regardless, yes PE firms need to figure out how to get 20%+ IRR throughout a short timeframe (usually a 5 year holding/funding cycle) -- however this is through any means necessary. Philosophically, it's about increasing efficiency of operations and growing the business. In practice, it's financial engineering because PE firms do not have the operational skills to make any value-added changes to firms besides driving costs down.
Saddling a business with debt is reductionist. I've seen absolutely nonsensical financial structures that make no sense for a layman, but in practice end up "using the business' finances to 'own' (beneficially) the business" (see: at the most vanilla, the strategy of seller financing in SMBs). No this is not technically "putting debt on the books" but it is in all practical respects a novation/loan transfer that can leave the purchased co financially responsible for servicing any debt that was used in its purchase.
On your third point: what I wrote above can be used as context. It's not risk free revenue, frankly it's very risky unless you're in an inflationary environment where your assets will grow regardless of your business operations solely because the overarching economy is growing and you're riding a tailwind. However, it again boils down to financial engineering. It's not as simple as assets - liabilities = equity. The calculations used to determine valuations are so ridiculously convoluted. The amount of work that goes into financially analyzing businesses and finding "loop holes" that can justify higher prices is the core business model. The debt factors into it, but there's ways to maneuver around it through various avenues.
For example:
* debt-to-equity conversions (reclassification of debt as equity)
* refinancing
* sale-leaseback (selling company's assets to a 3rd party and using that money to pay down the debt, then leasing the equipment back)
* creative interpretations of what is actually debt (e.g. reclassifying real debt as a working capital adjustment or a "debt-like")
* dividend recapitalization (a nasty trick of loading the company with debt, paying that out as a dividend to the holdco, then selling the company at lower enterprise value. They still extracted value for their LPs/investors, despite the exit being lower)
* separating the debt from the operating company into a different holding company that services the debt
Our affordable plan came to an end when the rates tripled! Turns out a private equity firm bought the company, jacked the rates on every customer, and sold it off again. This was not a fundamental cost being passed on in slightly increased fees -- it was private equity extracting millions from the people who can afford it the least. Across my financially optimized life, I see this happening repeatedly.
Personally, I can afford a more expensive cell phone bill. But I would imagine that many who have a $10/mo plan do not have many other options. I would like to punish the banks who are funding attacks on consumers. If by no other means, then by letting them fail.
Not quite. Private credit is to debt what private equity is to equity. (Technically, any non-bank originated debt that isn't publicly traded is private credit. Conventionally, it's restricted to corporate borrowers.)
So bank exposure to private credit generally means banks lending to non-banks who then lend to corporate borrowers.
Business development companies [0]. Blue Owl. BlackRock [1].
> are these buy side created SPVs?
Great question! Not always [2].
[0] https://www.reuters.com/business/finance/private-credit-fund...
[1] https://www.blackrock.com/corporate/newsroom/press-releases/...
[2] https://www.datacenterdynamics.com/en/news/meta-secures-30bn...
In this private credit situation the analog for the banks are these private credit funds that have raised the capital they've lent from institutions and high-net-worth individuals (as opposed to banks, which have funds from consumer deposits). The analog to the individual mortgage borrowers from 2008 are actual companies.
To connect the dots, if the private credit funds were like the banks pre-2008, where due diligence was an afterthought, then this could turn out to be similar. So the real question is: are the borrowers (businesses in this case) swimming naked? Or do you believe the private credit funds when they say they actually conducted a good amount of due diligence when extending their loans? Once you know the percent of the companies that are naked you can evaluate whether this could/would end up similar to 2008. Nobody knows that yet, even, I suspect, the private credit funds themselves.
Private-credit lenders are literally shadow banks [1]. But I'd be cautious about linking any shadow banking with crisis. Tons of useful finance occurs outside banks (and governments). One could argue a classic VC buying convertible debt met the definition.
That said, the parallel to 2008 is this sector of shadow banking has a unique set of transmission channels to our banks. The unexpected one being purely psychological–when a bank-affiliated shadow bank gates redemptions, investors are punishing the bank per se.
[1] https://en.wikipedia.org/wiki/Non-bank_financial_institution
Imagine you got a loan to buy a bunch of laundry machines to run a laundromat. But your laundromat earns $8,000 a month, and the loan payment is $10,000.
You can decide to sink $2,000 of your personal money into the laundromat every month, or you can give up.