Working at a company that was acquired by a smaller fish with a $4 billion loan, it made things painful when cuts were constantly made to pay interest on debt. Somehow, the situation benefited the shareholders that signed off on the deal.
I'm having a struggle with whether this seems moral or not. B is saddled with a big debt, and employees of company B may suffer as a result of this (anything from losing bonuses or profit sharing opportunities, to losing headcount, or having the very future of the company put into question). The new owners also have to live with this situation, while the old owners skip merrily away with their profits gleaned from the future work that will be done to pay down the loan.
This seems negative, but has to be balanced with the fact that the shareholders of company B are the owners of the company, and it is their decision to do as they wish; if they're offered a certain sum for their shares, it's their choice to take it. It's unfortunate that this comes with blindness to the future impact of that action, but this may be a necessary or at least presently contingent artifact of capitalism.
If you look at the top dozen economies in terms of prosperity or economic growth, you'll find a lot of different cultural approaches to that owner/operator-worker relationship, and they all have managed to generate rather spectacular results. France, US, Germany, South Korea, Japan, China, Sweden, Switzerland, Australia, Denmark - all have between slightly and very different approaches.
It also takes you down a road of other similar questions.
Joe loads up on his credit cards and puts his family at risk. Should that be illegal? Is it immoral? (arguably it's immoral)
Social contracts are a fascinating thing and they're essentially all-pervasive across everything people do. We go out and drive on the roads with a sort of social contract, that properly we're not going to act like maniacs and endanger each other.
In this case, instead of the lender simply taking over the acquired company, the acquired company declares bankruptcy and is liquidated.
*Obvious simplification is obvious. The risk is they can't keep acquirred company alive long enough to extract a profit before the husk of a company finally implodes.
Or put another way, if the acquiring company has no risk, then the bank putting up the leverage has it. The risk doesn't just disappear.
Similarly, Toys-r-Us was part of the US culture and has been destroyed for a few million in profit because it made economic sense. Hardware stores and book stores will also disappear from our culture, is this the society we want? People band together to support opera and symphonies, I would rather save drive-ins and hardware stores since they are more important in almost everyone's lives.
https://edition.cnn.com/travel/article/abandoned-drive-in-mo...
Many analogous things are true for toy stores and hardware stores etc. And people are banding together to support things that aren't commercially viable, the closest thing to hardware stores in this regard is probably hacker spaces.
And to answer your question directly, yes, I strongly prefer to live in a society where businesses are allowed to fail when they've run their course rather than being kept on life-support for vague past-romantic reasons.
I completely agree non-viable businesses should fail just like we let insolvent banks and automakers...well those were an exception.
It comes down to what our core beliefs are as a society. If we want to maximize private profit, why aren't there slot machines and cigarette vending machines at every bus stop? Toys-R-Us was a viable business that was destroyed for a relatively small profit - should that behavior be: illegal, discouraged by taxes, or encouraged with government backed loans? Those are the kinds of questions we could be asking. Our current regulatory environment is not the same as what it was in the past or what it will be in the future.
Veering a bit off topic, but they're coming back in some locales. Multiple have opened in my area.
Bain Capital decides to acquire Toys-R-Us so they set-up NewToyCo and invest $5B in it.
NewToyCo buys Toys-R-Us with that $5B and installs new managers at Toys-R-Us. Since the invested cash was investment and not a loan, NewToyCo owns Toys-R-Us free and clear
The new managers of Toys-R-Us get a $5B loan from banks secured by the assets of Toys-R-Us and pay a one time $5B dividend to shareholders of NewToyCo.
If everything goes well and Toys-R-Us can service the loan, Bain owns Toys-R-Us for free and sells it or takes it public. If things don't work out, they collected huge management consulting fees for s few years. Bain ran this exact same play on KB Toys with the same (bankruptcy) result.
You use that $5B to pay all the original owners (shareholders), and now have debt instead.
But generally the high amount of leverage implies aggressive cost cutting, which negatively impacts the employees and in some cases R&D, which in turn means risking the future sustainability of the company for short term profits.
If you're interested in the topic, "Barbarians at the Gate" is a great book to understand the in and outs of LBO's. The writing style also makes it fun to read.
I can say from personal experience if Blackstone buys your company you'll be focusing on the second objective.
The ones who win are the corporate finance companies who make $ by arranging these complex financial instruments.
Debt is cheaper than equity. The purchaser isn't diluting their equity returns as much so in theory they're getting a higher return. Interest is usually slightly higher than usual corporate lending so banks win. The profits should be more positive so the purchasee employees should be better off.
So a LBO is a generally good idea other than its much more complicated and only scales to large purchases (like a nationwide toy store, perhaps)
The effect you're probably confusing with the cause, is a deal thats dead, zero-sum or worse, with a pure equity structure might barely flip slightly positive if you do some financial alchemy and run it as a LBO... however thats exactly the kind of situation thats highly likely to crash and burn, no matter what you do. Essentially you get to try doing nothing and go out of business two years ago, do a pure equity deal and go out of business last year, or do a LBO and go out of business this year, or maybe, possibly, LBO has the best chance of making it.
Its a common pattern often seen in military or business argument, a small scale tactic that maximizes success (minimalizes failure, I guess) when in retreat somehow gets blamed as the sole cause of the entire retreat itself. Smoke grenades screen a retreat better than clear air, therefore the war was lost or maybe a bad idea to start because we tossed smoke, well, it doesn't really work that way.
In a very wide sense you are sort of correct that a deal or a company thats only microscopically barely alive by using every trick in the book including LBOs is correctly perceived as a dead company walking; just remember that almost all companies that successfully LBO are never talked about, therefore in a weird survivorship bias like scenario the general public will never hear about LBOs except in the case of a dead company. A good analogy would be lots of people who die immediately spent some time in a ICU, therefore there seems no purpose to ICUs other than death. However, many/most people only spend a little while in ICU and then recover but you'll never hear about it, they'll just call it post op recovery or critical care or some similar euphemism.
Another weird medical analogy is doctors play an odds game. If the medical advice is the lowest risk treatment X is 90% success and 10% fatal, one patient dying doesn't disprove that advice, especially if 9 or more live, also you're only likely to hear about the fatalities which causes a false belief that docs are always wrong.
> Debt is cheaper than equity
You have to pay interest on a debt, not so with equity. I am having a hard time relating your military and medical analogies to Bain/Vornado buying Toys-R-Us and then saddling it with $Bs in debt.
It has some weird results.