Just look at Guitar Center. Unfortunately when they explode, they're going to take companies like Gibson and probably also Korg with them. Gibson is already in the process of unraveling right now. Their impending bankruptcy was obvious when they didn't have a booth at NAMM this year.
It's absolutely predatory behavior what they did.
They don't care about long term. You could argue that they're setting up the companies for failure but that's not their intent. They do however have complete disregard for anything but making a profit.
One thing they like to do is sell off holdings and pocket the money. This hurts the company long term as it can't use those assets as collateral. An example of this is selling off store front property and then renting it back from the new owner.
They aren't trying to bankrupt companies, they are aware that what they're doing is harmful, and they don't care if their short term actions do bankrupt the companies in the long run.
It's like a kid throwing rocks at cars. They aren't trying to cause an accident or injury anyone but their actions can only lead to bad things.
That problem is not necessarily what Bain does, it's that they don't care about how it impacts others. That's pretty much the problem with society today. They're like vampires extracting the wealth from these companies and leaving them by the side of the road. At the end of the day the profit at the expense of everyone else.
1. PE company secures a loan in the company’s name (usually contingent on a turnaround plan executed by the PE with a history of turning companies around)
2. Company turns around and loans the money for purchase to PE firm
3. PE firm buys the company
4. PE firm runs the company, normally collecting management fees (paid out of the pool of cash used to buy the company)
5. PE firm cashes out by IPOing the company (usually at the same or higher price paid during LBO process).
6. PE firm uses the proceeds from the IPO (which the PE keeps because they are the sole shareholders; NOT the company itself) to pay back the loan.
The PE usually breaks even on the transaction itself once transaction fees are taken into account; but they make a killing on the management fees (which can be hundreds of millions a year). Normally, the company is left in roughly the same situation as before the buyout, just with a lot more debt on the balance sheet.
It looks like investors and the PE firm have obvious ways to profit here, but I can't work out what the company gets out of this.
An LBO allows the company to raise cash to fund a turnaround; but the incentives of PEs are set up such that the PEs don’t need to actually turn it around to make money — aggressively cutting costs is often enough. The creditors don’t care because they get paid back on IPO and get to collect interest in the meantime.
The alternative is usually going to be a buyout by a competitor, chapter 7 reorganization or simply ceasing operations like Toys-R-Us is doing once their debt rating is so far past junk they can never qualify for an LBO. Then the company dies. This is the “service” PEs provide to the economy — they help wind down failing businesses in a somewhat orderly way while extracting maximum value into the economy from a company that is headed for the scrap heap. You can argue as to whether or not that’s valuable.
I could never understand why a company takes an LBO instead of just taking out a massive loan against their assets directly, but this explains it. A combination of "the existing team isn't trusted to use that money" and "the creditors can collect without a full recovery" explain it nicely; PEs might theoretically be more objective at deciding when to restructure and when to strip assets.
The bankruptcies of the large LBO deals skew the public's perception of the industry. Sure it has faults but the reality is much more nuanced than some of the views outlined above.
Yes there are large private equity firms that will acquire companies and overload them with debt, cut costs and sell prize assets. Yes there are many other firms who operate very differently. In the smaller end of the market, debt loads are much more conservative and returns are generated through moving into new geographies (i.e. opening a new store in MA), moving into adjacent markets (i.e. we sell tables. Let's move into the chair market), let's hire more sales people, acquire complimentary products to cross-sell etc. The list goes on. There are many positive qualities to private equity but the industry is tarred because of the large amounts of money. People on the whole don't like large amounts of wealth.
So why does a company sell to an LBO? Could be any number of reasons. The founder might want to retire. Maybe the kids inherited the business and no longer want to run it. Maybe the business is in dire straits and the current owner lacks the skill or the patience to turn it around. Maybe a company wants to sell a non-core division. Maybe a parent company is financial trouble and will sell assets. Maybe the price is right.
Also, you can imagine that Bain has a few inside managers who do very well personally from this kind of deal.
Yet every time they IPO their debt rating gets worse because they’re carrying more legacy debt, until finally it’s so laden no bank will fund another buyout, so there’s a fire sale on remaining assets and the company closes.
But I can't explain what CEOs and shareholders are up to; surely they know when an LBO is over-leveraged and likely to bankrupt them. Can anyone explain why these offers keep getting accepted?
You only hear about the failures, not the successes. So the likely explanation is somewhere between, "because it works" and "because they don't have much choice."
Also, they often buy and hold. So it's not like they go about gutting every company they acquire.