PE-backed firms hit by wave of bankruptcies

High interest rates and low consumer spending are straining debt-laden companies backed by private equity groups, forcing them to either restructure through bankruptcy or buy time to recover through out-of-court settlements with creditors.

The pressure on private equity-backed companies is most pronounced a Recent research by S&P Global Market Intelligence, which shows a record number of 110 private equity and venture capital-backed companies filing for bankruptcy in 2024.

These failures, concentrated in the consumer and health care sectors, show how as the US unemployment rate remains low and the S&P 500 plows higher, certain corners of corporate America are suffering, with many companies struggling to survive under pressure from higher interest rates. , low consumer spending and crippling piles of debt.

“I think the primary reason why companies file for bankruptcy when they’re the subject of an acquisition by private equity is because there’s too much debt,” said Lawrence Kotler, a law partner at Duane Morris who focuses on bankruptcy. “Everything is leveraged at the hilt.”

High interest rates took a toll across the US corporate landscape last year, along with bankruptcies Hit their highest level Since the financial crisis. But PE and VC-backed companies have been particularly hard hit, with portfolio companies having a growing — and record — share of corporate bankruptcies, according to S&P data.

The data, which is dated 2010, includes private companies with majority private equity ownership and some publicly traded companies with minority strategic investments by private equity shops.

A narrower analysis by FTI Consulting, focusing on larger private equity filings, does not show a similar increase, but notes out-of-court tactics that have suppressed the number of private equity-related bankruptcies in recent years.

The burden of unsustainable debt was made more difficult to shoulder by the Federal Reserve’s rate hike, which directly affected the cost of servicing floating rate debt taken by private equity-sponsored portfolio companies. Those high interest rates have remained elevated for nearly three years now, and the prospect of relief in the form of aggressive cuts has waned.

Software company ConvergeOne, taken private by CVC Capital Partners in 2019, exemplifies the problems facing private equity portfolio companies.

The software group, known for its cloud and cybersecurity products and now known as C1, went on a shopping spree in the years after its last takeover, borrowing to snap up seven companies just before interest rates began to rise.

In the end, the debt proved too much to sustain. Last spring, ConvergeOne filed for bankruptcy with just $21 million in bank debt and $1.8 billion in debt. CVC declined to comment, and ConvergeOne did not respond to requests for comment.

“Consumers look for ways to find value when inflation bites,” said Mike Best, high yield portfolio manager at Barings. “The market is bankrupt in the consumer goods and retail sectors,” he added.

While most private equity-backed firms fail from a combination of excessive debt and operational troubles, some cases stir acerbic complaints. A case in point: The Instant brand, which makes the popular Instant Pot pressure cooker, has emerged as one of those hotly contested corporate failures.

In 2019, Cornell Capital bought Instant Brands for just over $600 million. By 2023, the kitchen appliance maker had filed for bankruptcy. Shortly after the company sought court protection, creditors accused Cornell of stealing large amounts of cash from the company’s coffers.

Creditors sued Cornell Capital and some executives in November for “looting portfolio companies” with $345mn in dividends to its investors, which the complaint alleges left Instant Brands insolvent.

A trial on the charges is expected to begin later this year. A Cornell Capital spokesman called the lawsuit’s allegations a “baseless attack” in a statement and disputed that the dividend recapitalization led to the instant brand bankruptcy, citing instead “uncontrollable macroeconomic events.”

Meanwhile, out-of-court strategies to stave off bankruptcy, commonly called liability management exercises or LMEs, have grown as companies seek to avoid Chapter 11.

“Private equity sponsors have a heightened interest in the LME,” David Meyer, head of the restructuring and reorganization group at law firm Vinson & Elkins, said in an interview. “The primary focus is: How do we deal with a situation outside of court?”

While popular, the solution is rarely permanent. Just under half of the respondents have one AlixPartners survey Since October the liability management exercise has been described as successful. Only 3 percent said they had a permanent fix.

Despite efforts to stave off bankruptcy, some companies have achieved the dubious distinction of entering “Chapter 22” or “Chapter 33” proceedings, indicating their second or third consecutive bankruptcy.

One of the most recent cases is Joanne, an Ohio-based clothing and apparel retailer with hundreds of locations, thousands of employees and two separate bankruptcy filings in the past year.

In 2011, Joanne was taken private by private equity firm Leonard Green & Partners for $1.6 billion. The firm took Joanne public in 2021 while remaining its largest shareholder.

Business boomed in 2020 thanks to the popularity of crocheting and other crafts during the Covid-19 lockdown. But as the pandemic waned, sales slowed, high rates more than doubled the company’s interest payments and supply chain issues ripped through its inventory — even as 96 percent of its stores were cash flow positive, according to filings.

The company filed for bankruptcy in March. It emerged a month later after halving its $1 billion debt, but eventually returned to Chapter 11 earlier this month, this time blaming difficulties in transporting goods to sellers. Joan and Leonard Green did not respond to requests for comment.

“The tide has gone out, and a lot of boats are rocking,” says Jerrold Bregman, a partner at BG Law. Private equity firms prefer to sell their holdings or float at a profit, he added. “Usually, what they’re looking to do is go to a liquidity event and make some money.”