Can someone explain to me how hedge funds bankrupt companies?
In: Economics
To keep it super high level, the most common method (there are PLENTY) is what is called a leveraged buyout. It’s when the buyer of a company uses the companies assets to get a loan to buy the company.
Dumb example: You want to buy a lemonade stand. It is worth $10. The owner want’s $30 to sell it to you. So you go to a bank and the ask to borrow $30 to buy the stand. The bank asks what collateral you have for a $30 loan. You say “If you lend me the money, I will own a lemonade stand, so that will be my collateral”. The bank agrees, gives you the $30, you pay the former owner, and take over the lemonade stand. You now own a lemonade stand worth $10, with $30 of debt attached to it, so now it’s worth -$20 dollars.
Since you leveraged the value of the lemonade stand to secure a loan to purchase the lemonade stand, the lemonade stand now has to carrier that debt, so a business that used to be worth $10 is now worth -$20. If the buyer can’t grow that business and pay off that debt, the stand goes bankrupt.
Now you may ask, why would anyone do this? Want to buy a lemonade stand that will be worth -$20? Well, your boss told you if you buy a lemonade stand, you get a bonus of $5. So you go through the leveraged buyout, you didn’t spend any of your money, you collect your $5 bonus, and let the stand fail. You don’t care because you keep your $5.
That’s basically it except replace “lemonade stand” with “Toys R Us” and replace $10 with “$1.86 billion” and replace $30 with “$5 billion” and replace $5 with “$15 million” and replace “boss” with “KKR Investments”
Latest Answers