LBOs Make (More) Companies Go Bankrupt, Research Shows

Leveraged buyouts increase the probability of bankruptcy at portfolio companies tenfold, a new study finds.

Illustration by II

Illustration by II

Healthy companies acquired by private equity firms through leveraged buyouts see their probability of defaulting on loans increase ten-fold, new research shows.

According to researchers at California Polytechnic State University, roughly 20 percent of large companies acquired through leveraged buyouts go bankrupt within ten years, as compared to a control group’s bankruptcy rate of 2 percent during the same time period.

The research comes amid increasing public scrutiny of leveraged buyouts — the process of acquiring a company using debt, rather than cash and stock, then designating the company’s assets as collateral for the loan. This month, Democratic presidential candidate Sen. Elizabeth Warren released a plan to put “private equity firms on the hook for the debts of companies they buy” by making firms responsible for their portfolio companies’ debt and modifying bankruptcy rules.

Similarly, research published by worker groups including the Private Equity Stakeholder Project and the Center for Popular Democracy claimed that, over the past ten years, private equity firms were directly and indirectly responsible for 1.3 million lost jobs.

Authors of the California Polytechnic State University paper wrote, “Given the large number of recent high profile private equity-backed LBO bankruptcies, it is difficult for policymakers to ignore the impact of these controversial transactions on their constituents and society as a whole.”

Researchers Brian Ayash and Mahdi Rastad studied $50 million-plus deals in which U.S.-based publicly traded companies were acquired by private equity firms in leveraged buyouts between January 1, 1980, and December 31, 2006. In total, the sample comprised 467 leveraged buyout transactions, as well as a control group of companies that remained publicly traded during that time period.

“Our results show a sharp contrast between the bankruptcy rate of the LBO target firms and the control firms: approximately 20 percent of large LBOs go bankrupt within 10 years, while the matched control firms experience a bankruptcy rate of two percent,” the research said.

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According to the paper, there were three “waves” of bankruptcy exits. The first was between 1990 and 1992 when 42 percent of exits were bankruptcies. The second was between 2001 through 2003 — the three years following the burst of the dot-com bubble. During that time period, bankruptcies amounted to 38 percent of exits. Finally, the third came during and after the financial crisis – 2008 through 2010, when 35 percent of exits were bankruptcies.

These bankruptcies tend to take place in specific industries. According to Ayash and Rastad’s research, retail companies got hit the hardest – with 41 percent of leveraged buyouts leading to bankruptcy between 1980 and 1995, and 23 percent between 1996 and 2007.

“Our results suggest that the leveraged capital structure common in these transactions is speculative, disproving the stylized fact that private equity funds target struggling firms and make them more efficient,” the paper said.