How private equity firms make billions by driving companies into bankruptcy

Private equity firms use borrowed money to buy undervalued companies, suck the cash out of the companies in the form of special dividends and other fees, and then rake in more fees when they unload the damaged and desperate company to another private equity firm, which squeezes more value out of it, repeating the cycle until the company is bankrupt.

In the short video accompanying a New York Times article about the 133-year-old Simmons Bedding Company's fatal entanglement with the private equity industry, Charles Duhigg, a financial projects reporter, remarked, "When I was in business school, there was nothing sexier in this entire world than private equity. It's exactly where you went if you wanted to one day own an island -- and one of my classmates just bought an island."

These private investors were able to buy companies like Simmons with borrowed money and put down relatively little of their own cash. Then, not long after, they often borrowed even more money, using the company’s assets as collateral – just like home buyers who took out home equity loans on top of their first mortgages. For the financiers, the rewards were enormous.
Twice after buying Simmons, THL [Thomas H. Lee Partners of Boston] borrowed more. It used $375 million of that money to pay itself a dividend, thus recouping all of the cash it put down, and then some.
A result: THL was guaranteed a profit regardless of how Simmons performed. It did not matter that the company was left owing far more than it was worth, just as many people profited from the mortgage business while many homeowners found themselves underwater.

At Simmons, Bought, Drained and Sold, Then Sent to Bankruptcy

Mark Frauenfelder is the founder of Boing Boing and the editor-in-chief of MAKE and Cool Tools. Twitter: @frauenfelder. Come and hear Mark speak at the ALA conference in Chicago on July 1.

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The Snowden Principle

noen

“Is this what political theorists mean by “late stage capitalism”?”

Why, yes it is. Can you guess what comes next? Sadly, the only “new economic model” around is the Chinese model of totalitarianism plus capitalism.
Anonymous

While I can’t condone this activity, the fault lies with whomever is dumb enough to loan money to these people.
ill lich

“Well, I lost my job, but at least somebody got to maximize their profits, so that’s good, right?”
chris

uggh I woke up to the new format, and I hate it!
yer_maw

see:

Manchester united
Liverpool FC

Borrowing money to buy a company then transferring the borrowed money to the company you just bought doesnt seem like a very risky endeavour.
wil9000

Oh for christ’s sake! Nothing about the scumbags at the top surprises me anymore. None of it makes sense, none of it can make sense. If people actually knew what was going on in the “financial services industry”, there would be an awful lot of guys in suits being tarred and feathered and run out of town on a rail. I don’t mean to be alarmist, but these people are getting paid obscene amounts of OUR money for robbing US all blind.
bcsizemo

You know it’s times like these that I wouldn’t mind my government sticking it’s finger into the money pie if you will. As a peon, how am I suppose to challenge such corporate take overs or they subsequent pillaging of them? This is one of the few areas that I could see big government actually helping the economy. It’s this kind of mentality that needs to be contained and destroyed. A company should fail from it’s own doing, not from the greed of the new owners.
noen

Somehow, this seems appropriate:

Corporate Cannibal
phisrow

I eagerly await an otherworldly explanation of how this mechanism actually represents efficient capital allocation, rather than a subtler variation on classic smash_and_grab.
dr.hypercube

Unfortunately, the NYT couldn’t bring itself to use the real name for this behavior: looting.

http://www.nakedcapitalism.com/2009/10/quelle-surprise-new-york-times-reluctant-to-call-private-equity-looting-by-its-proper-name.html

http://www.scribd.com/doc/13579076/Looting-Akerlof-Romer
gollux

An additional thought, Alan Greenspan put it so well:

I made a mistake in presuming that the self-interest of organizations, specifically banks and others, was capable of protecting their own shareholders and the equity in the firms…

Self-interest splays out in so many different ways, in the end, remember that it is the self-interest of those wielding the power, not the shareholder, the customer or the worker that counts…
gollux

Heh, the American people are pretty stupid and put up with this stuff. Had it happen to a local industry that actually was doing quite well, but you don’t want that to happen to your company because it makes for easier takeover. Asset rich, average stock price, low liabilities, all things that a company with a good long-term market for their product might think are good management practice also make them easy to be acquired. Killed off 220+ jobs as the plant was closed, assets and standing stock sold off for maximal short term profit. Hey, hey, it’s the American Way!
avraamov

Frog: ‘Why did you sting me? now we’ll both drown’

Scorpion: ‘Because I’m a scorpion.’
dr.hypercube

@phisrow – I think the proper nomencature is bustout – http://www.youtube.com/watch?v=5ydqjqZ_3oc – there is zero diff between Paulie and the PE criminals, as far as I can see – other than the risk of doing time.
Omir The Storyteller

Wow, I used to do this all the time in Railroad Tycoon. Who knew you could do it in real life? (Well, besides Jay Gould, James J. Hill and THL)
millionpoems

An island. As if that would be enough protection from the zombies!
mmechanic

Things get even worse when you combine private equity with something like affordable housing… here’s a piece Mother Jones ran recently on that very thing:

http://bit.ly/liyI1
DWittSF

I suggest we trade Goldman Sachs to the Chinese to pay down our debt. They know how to deal with business criminals over there.
zikzak

Is this what political theorists mean by “late stage capitalism”? It seems like the free market has gotten to a point where the best opportunities for profit involve destroying value, rather than creating it. Time for a new economic model?
Pooky tha quant

“the fault lies with whomever is dumb enough to loan money to these people.”

Never was a truer word said, one of the myriad of problems was that the people writting loans were paid based on how much they gave away meaning. They had no vested interest in the quality or probabilty of repayment. People respond to incentives.
tp1024

Oh well, nothing that you couldn’t have seen a thousand times over in East Germany, after West German companies took over about 85% of East German companies (and subsequently shut them down, serving the consumers from West Germany instead – job losses were horrific, about ~80% of jobs were lost).

But of course, that was aaallll because Communist companies were all not viable and people in the east too lazy to work …

When will people start to learn that sometimes the obvious is just obvious?
WalterBillington

This happens because of the cash that individual deal-makers can pull from the deals. They work on a “carry” system, which rewards them for the increase in the value of the funds they represent. That’s a purely financial measure, which makes it liable to manipulation.

As indicated, the game is to convert an asset to cash.

Some firms do, some firms don’t. Private Equity is powerful and greedy, but is in second place to the investment bankers in terms of financial societal impact – they’re the bankers’ clients.