How are assets stripped before bankruptcy?

Question

This New Yorker article says

...hedge funds and private equity have used leveraged buyouts to purchase chains like Sears and Toys R Us, and then stripped their assets, including real estate, en route to bankruptcies. ...encouraging investors to destroy hospitals that occupy valuable land.

How does a firm acquire an entity and transfer out real estate assets without the value of the real estate coming back to the original owner? For example, how could they buy hospital X, sell or transfer the real estate the hospital sits on, without the value of that real estate ending up on the hospital's books, then declare the hospital bankrupt yet not account for the real estate?

Answer 1

You aquire the equity by buying it using borrowed money. You can use the equity you're buying as collateral against the loan.

Once you own the business, you can start declaring dividends to yourself. Any income the company makes is turned into dividends. Over time, those dividends pay off your loan, but leave the company with no money to re-invest.

One way to get more money to keep the business going is a sell and lease-back arrangement on any real estate the business owns. Sell the land to a property investment company, and then lease it back from them. The money raised can be used to keep the business afloat, or to pay more dividends.

Eventually, the company has no assets left, and is running entirely off borrowed money. It only takes a small drop in sales to drive the company into bankruptcy. But the venture capitalists don't really care by that point - they have taken out more money from the business than they ever spent buying it.

Answer 2

Imagine a hospital in the middle of a city that sits on a valuable piece of land, like ocean-front in San Francisco or something.

Maybe the hospital earns net revenue of... $10M a year. Maybe the land is worth $100M. The hospital owners would need to operate for 10 years before they 'earn back' the value of the land that they could otherwise sell immediately. Now, historical owners might choose to continue operating a business rather than 'strip it for parts', because of some sort of emotional connection to the business [or perhaps because they never considered such a severe action, or don't foresee the same problems in the business model that downgrade the potential of future revenue]. But a hedge fund that just bought the hospital for $90M might have done so because they know the land is worth $100M. They don't care about the business [in this case a hospital] in particular, they just want to sell the land, liquidate the business, and walk away.

For something like Toys R Us, that can lead to significant long-term problems for laid-off employees, or local economies, or other various impacts. For something like a hospital, that can lead to even more severe outcomes [ultimately this is the simple conclusion of a for-profit healthcare system, that shareholder profit is not the same as 'best-healthcare'].