0

Private Equity buyouts are sometimes described as follows:

PE buys a company using huge loans, secured with the assets of that same company. They then pay themselves (who are now the new owners) giant dividends and management fees. Naturally, the company goes bankrupt, and there is nothing left to pay the loans. The PE people go off and enjoy their enormous gains.

But why do the banks agree to this? Don't they realize that they will lose all the money that they lent out?

3
  • 2
    In the mid 2000's OSI Restaurants went private with a financed leveraged buy out and just about everyone made a bunch of money. – Pete B. Apr 13 '20 at 10:24
  • Thank you. And yet the banks could make no more than their initial loan plus interest. – Joshua Fox Apr 13 '20 at 11:08
  • 2
    That may not be true. There could be many side deals, like what if lending institution was given the right to underwrite the IPO when the company went public again? Just an example, but there are hundreds of other possiblities. – Pete B. Apr 13 '20 at 11:19
4

The company doesn’t in fact generally go bankrupt. Occasionally it does, and the bank loses its money, but if the bank is competent then the interest it earns on all the similar loans that don’t go bad will more than make up for it. Note also the bit about “secured with the assets of that same company”; the assets still exist if the company goes bust, and so some or all of the loan will be repaid anyway by selling the assets.

3
  • 2
    Also, secured creditors get paid off first in bankruptcy proceedings, They're unlikely to be getting 5 cents on the dollar like other creditors may. – richardb Apr 13 '20 at 9:43
  • @Mike Scott, that makes sense. But about the collateral -- for example, real estate owned by a retail chain -- isn't that often sold off long before the bankruptcy, as the company is split up, leaving nothing for the banks? – Joshua Fox Apr 13 '20 at 9:49
  • 4
    @JoshuaFox If an asset is being used to secure a loan, it can’t be sold off, any more than you can just sell your mortgaged house and pocket the entire proceeds. – Mike Scott Apr 13 '20 at 9:51

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.