Most anti-private equity activists will cite a famous 2019 study by California State Polytechnic University researchers Rastad and Ayash that finds that private equity-owned companies are 10x more likely than their non-private equity-owned counterparts to go bankrupt.

The study uses data from LBOs that occurred between 1980 and 2006, pre-Global Financial Crisis. These were the days of private equity deals like Nabisco and Toys R Us – deals that quite publicly played out in a bad light. And their findings were accurate for deals of that era.

Post-GFC, however, bankruptcy has been used by private equity owners in a much different way. 

“Since the financial crisis, leverage has been limited due to cost, and many PE firms have adopted a mindset that it’s better to grow or negotiate out of debt issues when possible rather than to rely on bankruptcy. Bankruptcy can be time-consuming and expensive, making it more of a last resort,” explained Bryan Graiff, a partner at consultancy Armanino. “Bankruptcy can be disruptive, expensive, and often lead to no recovery for the investors unless they want to deploy new capital.”

This held true in the post-GFC, pre-Covid economy. For example, in 2021, private equity firms managed about 20% of total US corporate equity. However, it only made up around 10% of US bankruptcy filings that year. 

Things changed, though, once the Fed raised interest rates. Suddenly, private equity-backed companies accounted for 19.3% of bankruptcies in 2023 and 19.2% of bankruptcies in Q1 2024 – record highs, though still proportionally lower than PE’s share of total US corporate equity. 

“The explosion of private equity over the last five to seven years has been pretty pronounced,” said Brian Lohan, the head of law firm Clifford Chance’s US restructuring and insolvency practice. “There were a lot of operational issues and a lot of companies that maybe should not have been surviving got a second wind when everyone was dumping in money.”

“In 2021 you had companies in private equity portfolios that were benefiting from higher multiples being attributed to deals. And it made it easier for private equity portfolio companies to raise capital during those times when maybe those companies weren't as strong and they otherwise would have benefited from restructuring,” he continued. “Private equity companies raised capital and increased debt to try to institute either a turnaround or wait for a better deal after Covid. Covid passed and now a lot of the debt is due for repayment.”

Lohan sees struggles to repay Covid-era debt impacting private equity portfolio companies across the board: small-cap firms, large-cap firms, established firms, and new upstarts. 

“They have a bad investment in their portfolio and they have to deal with it. And sometimes Chapter 11 bankruptcy makes sense,” he explained.

Sector-specific

The largest jumps in bankruptcies for private equity-owned portfolio companies can be seen in two sectors: retail and healthcare.

In healthcare, private equity-owned companies comprise only 4% of the US market but represented over 20% of total bankruptcies in the sector last year. 

“Healthcare is just always very tough. While it's a very attractive asset to own because there's always customers, you are subject to reimbursement rate risk. And cutting healthcare costs for the individual patient is always a political win for a politician,” explained Lohan.

When it comes to retail, the Private Equity Stakeholder Project reports that 10 of the 14 largest retail bankruptcies between 2012 and 2019 were PE-backed. Additionally, two-thirds of the Chapter 11 bankruptcies filed for in 2016 and 2017 by retail stores had private equity ownership. 

“On the retail side, historically what we've seen is private shops don't buy a single brand. They try to buy multiple brands, essentially roll-ups, and sometimes they overpay and sometimes consumer trends get way out of whack compared to the PE firm’s expectations at the time of the initial investment,” Lohan added.

As such, PE-backed consumer buyouts are set to decline, as we outlined in our May 2024 Consumer Sector Private Equity Report. 

Are we going back?

Lohan doesn’t see heightened levels of bankruptcies for PE portcos stopping any time soon.

“I don't think the uptick in bankruptcies for PE portcos is going to go away. While I don't think it's going to subside, I don't know whether it's going to grow either. But it is possible that we are on a plateau. I think we're going to continue to see bankruptcies for right now primarily because of all the prior debt financing transactions that have upcoming maturities,” he explained.

He added: “You need a way to refinance all the debt that was incurred in the Covid era. A lot will depend on the September interest rate cut, the election, and how much liquidity is available.”