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What happens when a private equity deal goes sour?

| Jun 7, 2021 | Corporate Bankruptcy & Restructuring

Private equity firms have taken to a wide market, purchasing everything from doctor’s offices to pet stores. Entrepreneurs who run these firms profit by purchasing a business only to turn around and sell it at a higher rate a few years later. Business leaders who go into these deals may be lured by a high initial return and potential for future growth only to find out that the reality of working with a private equity firm is not what in their business’ best interests.

What could go wrong?

It is important to keep in mind that in most cases the only concern of the PE firm is a focus on profit. This may mean building a better product or service. It could mean making serious cuts or increasing expectations to help lower the bottom line and build a better profit margin. It could also mean the PE firm pulls in other businesses with a similar product or service and combines them into one. In any of these scenarios, the process is not that of a hands-off investor that gives the business funding and lets them thrive. PE firms are very much involved in the business.

In some cases this active level of involvement can help the business thrive. In others, it could cause major problems. In one example gone wrong, executives with Shopko Stores Inc. reported drastic cuts to payroll and retirement plans after PE firm Sun Capital Partners Inc. acquired the business through a leveraged buyout. In an effort to get that profit margin, the PE firm sold Shopko’s best asset: its real estate. The move led to about $800 million in short term gain, but cost Shopko increased rental costs in the long-term. Ultimately, this played a large role in the need for the stores to file for bankruptcy.

Is bankruptcy a bad thing?

A recent analysis in the New York Times explores the role of bankruptcy in these types of situations and notes that it is a healthy part of our economy. Why? Because it helps encourage the evolution of business. If a business fails, it allows the owners to move on to other opportunities.

What is the takeaway lesson?

First, that bankruptcy is not a bad option for business owners who find themselves left struggling after dealing with a bad PE deal. Second, that business leaders, the public as a whole and even lawmakers are starting to question the role of PE firms. There is growing concern that these investors are pushing businesses to failure. This could lead to more push back and potentially even fuel legislative action.