High interest rates and low consumer spending are putting pressure on debt-ridden companies backed by private equity groups, forcing them to restructure through bankruptcy or buy time to recover through out-of-court settlements with creditors.
The pressure on private equity-backed companies reflects the most important of the a recent study by S&P Global Market Intelligence, which indicates that a record number of 110 private and equity-backed companies will file for bankruptcy by 2024.
These failures, concentrated in the consumer and health sectors, show that even as the US unemployment rate remains low and the S & P 500 plows high, certain corners of the American corporate are suffering, and many companies are trying to survive under the pressure of high interest rates. , low consumer spending and crippling debt.
“I think the main reason companies file for bankruptcy when they're the subject of private equity acquisitions, there's a lot of debt,” said Lawrence Kotler, a bankruptcy law partner at Duane Morris. “Everything depends on success.”
High interest rates hit all areas of the US economy last year, with bankruptcy to hit their highest level since the financial crisis. But PE and VC-backed companies have had a tougher time, with portfolio companies comprising a rising — and record — share of corporate bankruptcies, according to S&P data.
The data, which dates back to 2010, includes private companies with majority private equity ownership and includes some publicly traded companies with less strategic investment by private equity firms.
A smaller analysis by FTI Consulting focused on large private equity filings does not show a similar increase, but it does note out-of-court tactics that have suppressed the number of private equity-related bankruptcies in recent years.
Senior debt was bolstered by the Federal Reserve's rate hikes, which directly affected the cost of repaying floating-rate loans taken out by private equity-backed portfolio companies. Those high interest rates have now remained elevated for nearly three years, and the likelihood of relief in the form of aggressive cuts has receded.
Software company ConvergeOne, taken private by CVC Capital Partners in 2019, illustrates the problem facing private portfolio companies.
The software group, known for its cloud and cyber security products and now called C1, continued to buy in the following years after its last takeover, taking debt to collect seven companies just before interest rates started to rise.
In the end, the case proved too much to handle. Last spring, ConvergeOne filed for bankruptcy with $21 million in bankruptcy, and $1.8 billion in debt. CVC declined to comment, and ConvergeOne did not respond to a request for comment.
“Consumers are looking for ways to get value when inflation bites,” said Mike Best, high yield portfolio manager at Barings. “The market is full of bankruptcy in the consumer products and retail sectors,” he added.
While most private equity-backed companies fail from a combination of high debt and operational problems, some cases inspire acerbic accusations. One key case: Instant Brands, which makes the popular Instant Pot cookers, has emerged as one of those corporate failures.
In 2019, Cornell Capital bought Instant Brands for just over $600mn. By 2023, the kitchen appliance maker had already filed for bankruptcy. Shortly after the company sought court protection, creditors accused Cornell of siphoning more money from the company's coffers.
Creditors sued Cornell Capital and certain executives in November for “robbery of a portfolio company” by taking a $345 million dividend from its investors, the complaint alleges, leaving Instant Brands insolvent.
A trial on the charges is expected to begin later this year. A Cornell Capital spokesperson in a statement called the accusations a “baseless attack” and denied that the stock recapitalization led to Instant Brands' bankruptcy, instead citing “uncontrollable economic events.”
Meanwhile, out-of-court ways to avoid bankruptcy, called liquidation management undertakings or LMEs, have exploded as companies try to avoid Chapter 11.
“Private investors have a high interest in LMEs,” David Meyer, head of law firm Vinson and Elkins' restructuring and restructuring group, said in an interview. “The main focus is: how can we resolve the situation outside of court?”
While popular, the solution rarely lasts. Just under half of respondents in AlixPartners Research since October it has described the debt management activities as successful. Only 3 percent turned into permanent fixes.
Despite efforts to avoid bankruptcy, some companies have achieved the dubious distinction of entering “Chapter 22” or “Chapter 33” proceedings, a sobriquet that indicates a second or third consecutive bankruptcy.
One of the most recent cases is Joann's, an Ohio-based textile and apparel retailer with hundreds of locations, thousands of employees and two separate bankruptcy filings last year.
Joann was taken private for $1.6bn in 2011 by private equity firm Leonard Green and Partners. The firm then took Joann public in 2021 while retaining its majority stake.
The industry has grown in 2020 due to the popularity of crocheting and other crafts during the Covid-19 lockdown. But sales have slowed as the pandemic worsens, higher prices more than doubled the company's interest payments and supply chain issues — even though 96 percent of its stores are doing well, according to the filing.
The company filed for bankruptcy in March. It emerged a month later after a $1 billion bankruptcy filing, but eventually returned to Chapter 11 earlier this month, this time blaming difficulties in keeping retailers moving products. Joann and Leonard Green did not respond to requests for comment.
“The tide is out, and a lot of boats are rocking,” said Jerrold Bregman, a partner at BG Law. Independent private companies prefer to sell or float their assets at a profit, he added. Usually, all they're looking to do is go to an event with no money and make money.