◼ FINANCE Bloomberg Businessweek October 7, 201932 Privateequitycouldn’texistwithoutdebt.It’sthe
jetfuelthatmakesa corporateacquisitionsolucra-
tivefora turnaroundinvestor.Themoredebtyou
canraiseagainsta targetcompany,thelesscash
youneedtopayforit,andthehigheryourreturn
onthatcashonceyousell.
Ultralowinterestrateshavemadethisfuelespe-
ciallypotentandeasytoobtain.Themarketforlev-
eragedloans—industryjargonforloansmadeto
companieswithless-than-stellarcredit—hasdou-
bledinthepastdecade.Almost40%ofallsuch
loansoutstandingaretocompaniescontrolledby
privateequity,accordingtodatafromDealogic.
Some leveraged loans are arranged by banks.
But there’s also been a boom in private lenders,
who may be willing to provide financing when
banks or public debt markets won’t. All the while,
bond and loan investors desperate for yield have
accepted higher risks. As buyout titans have chased
bigger and riskier deals, their target companies
have been left with more fragile balance sheets,
which gives management less room for error. This
could set the stage for a rude awakening during
the next recession.
“We’re seeing scary levels of leverage,” says
Dan Zwirn, chief investment officer of alternative
asset manager Arena Investors. “Private equity
sponsors are all slamming against each other to
get deals done.” Loans to companies with espe-
cially high debt loads now exceed peaks in 2007
●PrivateEquityIsGetting
CompaniesHookedonDebtand2014,accordingtotheU.S.FederalReserve.
Andcompaniesownedbyprivateequitytypically
carrya higherdebtloadrelativetotheirearnings
andofferlesstransparencyontheirfinancialposi-
tionthanothercorporateborrowers.
Debtusuallycomeswithrules,embeddeddeep
inloanandbonddocuments,thathelplenders
protecttheirinvestment.Forexample,theymight
restrictdividenddistributionsorassetsales.The
strictnessofsuchprotectionshasbeenona steady
declineoverthepastfewyears,withPE-backed
companiestypicallyofferingweakersafeguards
comparedwithborrowersthataren’tbackedby
privateequity,accordingtoscoresdevelopedby
CovenantReview,a researchfirmthatanalyzes
debtdocuments.“Investorprotectionsusedto
bewrittenoncocktailnapkinsa yearago,”says
JohnMcClain,a portfoliomanageratDiamondHill
CapitalManagementwhoinvestsinjunkbonds.
“Nowthey’rescribbledincrayonontoiletpaper.”
Buyoutfirmshavealsocomeunderfireformas-
sagingfinancialprojectionspresentedtoinvestors
whennewdebtissoldtomakeearningslookbig-
geranda company’sdebtloadmoremanageable.
PEfirmscanusesomeofthecompaniesthey
ownasvirtualATMs—havingthecompanybor-
rowmoneytopayitsownerspecialdividends.
Thatallowsthefundstorecovertheirinvestment
soonerthantheytypicallywouldthrougha saleor
aninitialpublicoffering.SycamorePartnersLLC,
known for its aggressive bets in the retail indus-
try and related run-ins with creditors, has already
recovered about 80% of the money it put down
to acquire Staples Inc. in 2017 through dividends
mostly funded by debt. Carlyle Group, Hellman &
Friedman, and Silver Lake have also saddled theirthan1%of total positions, because layoffs are
largely balanced by new hires, with the effects
concentrated in retail and service sectors, accord-
ing to the paper, co-authored by the University of
Chicago’s Steven Davis. He and others argue that
private equity owners can turn underperforming
companies into thriving businesses that attract
jobs, return more money to shareholders, and
bolster new technology.
Critics and advocates of PE generally agree on
at least one thing: When people are hurt by deals
that turn companies upside down, there should
be systems in place to assist them. “You don’t
want to stand in the way of economic innovation,”
says Gregory Brown, a finance professor at UNC
Kenan-FlaglerBusiness School. “But you would
hopethatpeoplewho get run over are helped.”
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