The Spark

“The emancipation of the working class will only be achieved by the working class itself.” — Karl Marx

Leveraged Buyouts Ruining Retail Stores

Apr 2, 2018

The retail industry's total leveraged debt skyrocketed to $152 billion in 2017. Not only Toys “R” Us, but other large retailers like Sears and The Bon-Ton may collapse under their heavy leveraged debt.

In leveraging schemes, the private equity firm buys a company by using a significant amount of money (i.e., debt) borrowed from banks, pension funds, and other investment firms.

It is rather common that the private equity pays only 10% of the purchasing price of the company, and the debt used to carry out the purchase can be as high as 90% of the price. Hence, the private equity “leverages” its buyout onto the company it buys, and takes comparatively little or no risk.

The collateral in this debt scheme are the purchased company's assets (e.g., cash in the bank, buildings, machines, land, inventories) and cash flow (e.g., cash generated from sales).

Since the private equity controls this scheme, it recovers part of its investment up-front, at the time of the purchase, by charging high amounts of fees for the "work done" toward the purchase and asking for immediate dividend payments for its investors. The private equity structures the purchasing contract such that it gets the first cut in the case of bankruptcy.

Bloomberg predicts such schemes could cause bankruptcy of many sound and fully functional big companies. There is more money to be made stripping and flipping companies than there is in running them.