I think they just load up on debt, so they aren't really buying it with their money. But what I don't understand is how they get people to loan them money when they know that they are just going to strip mine the company for all valuable assets and leave a shell of a company for the lenders to fight over.
> how they get people to loan them money when they know that they are just going to strip mine the company
Because on average, target firms of leveraged buyouts become more productive [1]. That lets them pay back shareholders and lenders in most cases.
The reason public perception is off is the size effect and availability heuristic. The first shows that big deals do badly [2]. The second means the last widely-reported deal is likely to stand in for private equity in the public consciousness [3]. Add in inflation, which makes each sticker price seem more historic than it is, and the fact that the last deal in a cycle is doubly cursed by being financed and priced at precisely the wrong time and you have a consistent pattern of the most recently-memorable deal being a clusterfuck.
Public perception is negative because profitability is usually reached by cutting unnecessary jobs and projects in the poorly run firm. People don’t like their jobs being cut
Here's the PDF so you can read more than just the abstract [1].
It's always hard to analyze anything this big, especially with something as vague as "more productive":
> First, employment shrinks more rapidly, on average, at target establishments than at controls after
private equity buyouts. The average cumulative difference in favor of controls is about 3 percent of initial employment over two years and 6 percent over five years. Second, the larger post-buyout employment losses at target establishments entirely reflect higher rates of job destruction at shrinking and exiting establishments. In fact, targets exhibit greater post-buyout creation of new jobs at expanding establishments. Adding controls for pre-buyout growth history shrinks the estimated employment responses to private equity buyouts but does not change the overall pattern. Third, earnings per worker at continuing target establishments fall by an average of 2.4 percent relative to controls over two years post buyout
So if I'm reading this right, huge layoffs followed by lots of churn with an overall decrease in salaries. But I must be missing something because the framing & wording seems to suggest that this is a positive thing. That paper also only looks at 2 years of data following acquisition. But the criticism for leveraged PE takeovers like this is that the PE firm is starting a 5-10 year project to strip mine the company for all it's worth and leaving a husk of a company that's loaded with the debt that was used to acquire it and no real assets. I'm not sure how looking at the first 2 years tells you anything.
The PE firm's switch to cheaper labor and suppliers is also reflected typically in a significant decrease in product quality which isn't analyzed here.
The main argument for leverage PE buyouts are they are performing a valuable service as they're doing a more graceful shutdown of a company vs letting the company fail on the public markets. But that's a harder argument when squarespace doesn't seem to be particularly struggling - they just IPOed during the pandemic bubble when internet stocks were crazy overvalued but they've been working their way back up.
> the PE firm is starting a 5-10 year project to strip mine the company for all it's worth and leaving a husk of a company that's loaded with the debt that was used to acquire it and no real assets
Long-term default rates for private-equity targets are low across markets [1]. Banks and leveraged-loan lenders tend to get paid back.
Also, most targets that later go public have low enough leverage to be able to immediately pay dividends [2]. You just don’t tend to hear about the specialty farm equipment maker IPO in most circles.
> that's a harder argument when squarespace doesn't seem to be particularly struggling
They’re turning hundreds of millions of dollars of revenue into hundreds of thousands of profits by spending hundreds of millions on sales and marketing.
> So if I'm reading this right, huge layoffs followed by lots of churn with an overall decrease in salaries. But I must be missing something because the framing & wording seems to suggest that this is a positive thing.
You read it right. Private Equity firms come in, and then lay off everyone they can and replace them with the cheapest folks possible, to churn down salaries and get rid of long-time staff with higher benefits costs. It's the classic playbook, and it's written here positively because if you're a soulless MBA beancounter, this is a positive thing. If you're a 50 year old engineer who is 12 years from retirement and just got a cancer diagnosis 6 months prior, it's not a good thing though.
For a leveraged buy out, the most important thing are the cash flows. So if a business has enough $ to service the loan there should be no problem.
Also good to remember that the business model of PE firms is to buy a leveraged asset, hold for 5 ish years, resale asset at a higher price than it was bought from. Ofc easier said than done, but these investors don’t get involved to lose money purpose
ALL LBO models are about selling the asset for a higher multiple than it was bought for. Not just tech.
Also, CFs are the most important thing for an LBO. The point of this investment model is for an asset to pay for itself, so if it has no cash flows how can it possibly do that. Also cash flows =/= profit here. You can be cash flow positive and not be profitable.
And you are right about LBOs not being done on rev multiples
I misspoke. Generally speaking, when modeling an LBO you assume entry = exit multiple to be conservative. What I meant to say is that in Tech, if you sell at the same, call it, 10x multiple on Revenue but your annual revenue grew some X% over the period, you can still get to a very compelling IRR even if the actual CF profile of the business hasn't improved at all. Obviously if you sell at a higher multiple that is doubly true.
The point is Tech companies don't strictly need profitability to be considered good LBO candidates, because everything is done at the top line level for the "sexier" very high growth companies.
The asset still "pays for itself" on exit, just not so much during the investment period. In other words, the value to equity holders is not from debt paydown with the assets' cash flows, but with the exit proceeds.
