What’s the advantage of lending money that will get loaded onto a company that is already struggling and may go bankrupt?
In: Economics
Well the banks generally tend to get their money back + make money off of it. The companys generally tend to pay the bank back, simple as that really. The Banks wouldn’t do it if they on average weren’t making money from it
Depending on the risk, the rate of interest can be quite high.
If I am charging 25% interest and the company goes bankrupt after 5 years….I’ve still made some money.
The company *as it currently exists* might be struggling, but it might not be struggling once another company buys it out. It could be operated differently, and take advantage of being inside a larger company.
But the important thing is that banks (at this scale) only lend money when they have a security, being the ability to seize some kind of assets if the loan isn’t paid back. If a bank is lending money to fund the buyout of a company, the security is generally the company. And if a company has $10M of assets but $8M of debt, then yes, that company is in trouble, but if I’m the bank and the $8M of debt is owed to me, and they default on the loan and now I own the company, then now I own a $10M company and I owe $8M to myself, so whatever.
Lenders will only lend money for business ventures that are relatively safe and that they can show it will be paid back. This is also the case for the company that is doing the buying too – they are putting in some of their own (and investor) money. They would have to show a detailed and believable plan of why it would work.
So why would a company be able pay that money back?
– Many owners selling just want to cash out or retire or use the money for something else. So existing sales could pay back the loan over time.
– If it’s a large company selling a part of it, they may feel that the asset doesn’t fit in with what they’re trying to do overall and that it may be expensive to run because of it. In this case, existing sales may be able to pay back the loan.
– Sometimes a private equity company may have an investment hypothesis that involves buying up a bunch of related companies and putting them together in a larger one because they may be able to leverage certain things to save money or sell more stuff. For example, maybe they are buying a struggling company and putting it together with an established one so they can take advantage of a larger, existing salesforce that has a large existing customer base that they can sell to. This not only reduces the cost for the distressed company, because they can get rid of their salesforce, but they may also be able to reach more customers with this new existing salesforce.
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