As a business owner, if you want cash today because you are done with a business. You could go to a bank and get a loan to pay dividends. This is a bad deal for the bank as you have no incentive to operate the business after you cash out the loan. A private equity firm comes in and operates the business on the model that they still keep some of the profits after the loan value.
The crappy side comes in as a customer, the PE firm can do this to an arbitrary number of firms in the area and raise prices on each/cut services. PE firms can trivially build out monopolies. Many of these monopolies will be invisible as they leave the existing branding etc. in place.
> As a business owner, if you want cash today because you are done with a business. You could go to a bank and get a loan to pay dividends.
If you are a business owner you could borrow yourself using the business as security.
One correction is that it’s not like paying for the company with money from the company you’re buying, because that obviously wouldn’t benefit the sellers. The money comes from a lender and they get terms to take the business if the loan terms aren’t meant. The lenders are the effective new largest owners of the company with the PE firm being a smaller owner but the expected primary operator.
Even 3% or 0% down mortgages?
That's why the parent is saying "It is like paying for the company with the money from the company you are buying.".
It's like taking out a mortgage on a house, but letting the house owe the debt.
Isn't that a non-recourse loan, which in some states is the default for the initial loan to acquire the housel
*Coverage of 1:1 is an accident waiting to happen, but otherwise sure.
If PE firm A wants to buy company C using an LBO, it could do so by having C borrow money and then A purchase C, or by creating an entity B that borrows money and then purchases C. Whether B or C owns the debt doesn't change anything meaningful for A, and it's pretty clear that you're allowed to form company B (and really hard to imagine how you'd make that illegal without effects that would be worse than current).
I would prefer that! I'd prefer even more strongly that the debt be owed by someone else entirely, so a default isn't associated with me at all. If you're up for it I'd also prefer to use your credit card number to buy stuff on Amazon. But for whatever reason the law doesn't always seem to follow my preference.
I'm sensitive to your point about restricting formation of new corps. The system can't just be changed randomly without extremely careful thought. And often not even then.
Most small-time single family landlords actually go above and beyond that and "pretend" the rental is a house they're buying to live in (or actually is, for a time) and get a "home owner's mortgage" which is even easier.
Large commercial real estate is sold and loaned based on future rental income, pretty formulaically.
It’s possible to “understand” mortgages by understanding that conditions for stable home markets don’t arise by themselves—we collectively make them possible because the outcome is desired—then wonder WTF because what social function is creating conditions for private equity getting us.
Not only is that politically attractive, I think it’s more good than bad as public policy.
Turning back to PE/LBOs:
Having limited liability entities (companies) also serves good public purposes. Having companies being able to borrow money also does. Having companies being able to own other companies also does. I think that’s the only three ingredients you need for the PE model to operate and I don’t think that the public is helped by barring any of those three things.
If the company wasn’t able to borrow money for itself, a wrapper company could which would still have very closely the same effect as being an asset-poor borrower.
Which would increase the rate of defaults (if they are authorized in the first place) and in turn increase interest even further. I guess the PE is always maxxing out the leverage on every deal at _just_ the projected break-even point for loan repayment? But that leaves no room for error or changing market conditions which also increase the rate of defaults and so on.
That's exactly what happened famously with Red Lobster. PE sold off all the underlying real-estate to get the initial sugar-high and replaced it with a leasebacks. Those leases had escalating costs and fixed terms, which made it difficult to adapt to changing trends, and was a big contributor in what ultimately sunk it all.
And everyone gets their management fees until people start asking their money back...
Great another financial crisis.
Pure parasitism.
Note that from the lender's perspective, the risk is the same and in a perfect-information universe could be mitigated by charging higher interest. The problem for society is the externality that the business's services get worse.
Sounds like a problem for whoever is providing the financing. Not really my concern unless you're saying there's some systemic problem it causes like with mortgage securitization during 2007. The lender will charge a high interest rate if what you're saying is true.
It’s literally a way to extract revenue from our broader social institutions by spreading the pain across so many people that individuals don’t complain (or, in some cases, don’t even understand how it harms them).
Has everyone forgotten the social contract? We do not exist as communities to make a small number of people richer. If the trade doesn't work for all involved, we change the rules.
In fact, they'd much rather single-action foreclose as they'll likely get a house than force you into bankruptcy where they might not even get that.