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by cj 22 days ago
LBO's are like buying a rental property where the mortgage is approved based on expected future rental income from the property.

That's why the parent is saying "It is like paying for the company with the money from the company you are buying.".
3 comments
nyeah 22 days ago
LBOs are much worse than that. It's like buying a rental property where the mortgage is owed by the a shell corporation that owns the property. The shell corporation, not the purchaser, owes the debt.

It's like taking out a mortgage on a house, but letting the house owe the debt.

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PopAlongKid 22 days ago
>It's like taking out a mortgage on a house, but letting the house owe the debt.

Isn't that a non-recourse loan, which in some states is the default for the initial loan to acquire the housel

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randallsquared 22 days ago
When you put it like that, you make it sound reasonable! The house being collateral for the debt seems in a blurry way to be "the house owes the debt".
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nyeah 22 days ago
That's pretty blurry, though. Blurry enough that we don't distinguish between the collateral and the borrower.
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sokoloff 22 days ago
Exactly. That is largely how commercial lending is underwritten: by ensuring the DSCR (debt service coverage ratio) is over 1.0.
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nyeah 22 days ago
Sure that is commercial lending.* And the acquirer owes the debt. But that's not how LBOs work. In an LBO the target owes the debt.

*Coverage of 1:1 is an accident waiting to happen, but otherwise sure.

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sokoloff 22 days ago
That's not especially different from the typical LLC/SPE holding structure where individual properties in a large real estate portfolio are not held directly, but rather by a single-purpose entity that holds each property and then is owned by a larger but distinct entity. You don't want an issue in a single company/property to be able to take down your entire holding company. If someone will lend you money without cross-collateralization, why wouldn't you prefer that?

If PE firm A wants to buy company C using an LBO, it could do so by having C borrow money and then A purchase C, or by creating an entity B that borrows money and then purchases C. Whether B or C owns the debt doesn't change anything meaningful for A, and it's pretty clear that you're allowed to form company B (and really hard to imagine how you'd make that illegal without effects that would be worse than current).

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nyeah 22 days ago
>If someone will lend you money without cross-collateralization, why wouldn't you prefer that?

I would prefer that! I'd prefer even more strongly that the debt be owed by someone else entirely, so a default isn't associated with me at all. If you're up for it I'd also prefer to use your credit card number to buy stuff on Amazon. But for whatever reason the law doesn't always seem to follow my preference.

I'm sensitive to your point about restricting formation of new corps. The system can't just be changed randomly without extremely careful thought. And often not even then.

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bombcar 22 days ago
That's exactly HOW rental properties are (supposed to) be bought!

Most small-time single family landlords actually go above and beyond that and "pretend" the rental is a house they're buying to live in (or actually is, for a time) and get a "home owner's mortgage" which is even easier.

Large commercial real estate is sold and loaned based on future rental income, pretty formulaically.

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