2023 Set to See Worst Year for Bankruptcies Since the Great Recession

The year 2023 is on pace to finish as the worst year for corporate bankruptcies since the end of the global financial crisis. This year has already seen the two largest bankruptcies in American history outside of the Great Recession. If these numbers have you feeling uneasy about the economy, prepare yourself – 2024 is forecasted to be even worse.

A Rough Week for the Banking Industry

The past week saw the collapse of Silicon Valley Bank, the second largest bank failure in American history, as well as the biggest bank failure ever in the form of Capital One Mutual. No amount of money could salvage these institutions’ faulty business models.

Famous Blue Coupon Retailer Shutting its Doors

Home goods retailer Tuesday Morning, known for its ubiquitous 20% off coupons, is abruptly shuttering all of its stores. The closures come on the heels of three bank failures in the span of days, sparking concerns of a wider economic downturn.

Another Beloved Retailer Calls it Quits

Add Bed Bath & Beyond to the list of popular retailers closing up shop for good. According to data from S&P, corporate bankruptcies among major companies they track skyrocketed over 200% in the first half of 2023 alone. High-profile names like WeWork, Vice Media, and Bed Bath have collapsed recently due to poor leadership, shifting consumer preferences, spiking interest rates, and overall weak market conditions.

What Do All These Bankruptcies Mean?

Although these big names have filed for bankruptcy, many are still operating. Vice continues churning out videos. WeWork offices remain open for rental. And Bed Bath & Beyond maintains stores stocked with overpriced laundry baskets. Modern corporate bankruptcies are more strategic business moves rather than a corporate death sentence.

In fact, there are four key reasons bankruptcies have become so commonplace nowadays:

Bankruptcies Reward High-Risk Investing Strategies

A new style of high-risk, high-reward investing championed by private equity firms motivates saddling vulnerable companies with extreme debt. Even if the company fails under the burden, the private equity fund loses little while retaining chance of a massive payout if their scheme pays off.

Private equity refers to investments in non-publicly traded companies. Early stage venture capitalists and angel Shark Tank deals are examples of private equity. Lately however, private equity has been dominated by leveraged buyout firms.

These Wall Street giants raise billions of dollars from university endowments, retirement funds, and wealthy individuals. They use this cash to purchase full companies. The idea is the finance hotshots can overhaul operations and management to boost sales and slash costs.

But the real strategy is taking on boatloads of risky debt that they face no accountability for. Here’s their playbook:

Imagine you’re a private equity partner who just secured $1 billion to spend. You identify a promising but poorly managed target company, say “Toys R Us.” You use the $1 billion to purchase Toys R Us outright and install a new CEO to follow your turnaround plan.

The first order of business is taking out massive loans on behalf of Toys R Us. If the company is profitable at a $1 billion valuation, it can likely borrow around $700 million.

You now have two options with this $700 million. Option one is reinvest it into the business through advertising, new locations, improving online capabilities. Option two is instruct management to funnel it directly to you as the new owner. With the cash in hand, you’re free to buy another distressed company and repeat the process.

This loop of buying companies, piling on debt, collecting payouts, and moving to the next target is known as a leveraged buyout. By exploiting debt they never have to repay, private equity financiers can rapidly multiply returns while offloading risk.

If Toys R Us implodes under its loans, the private equity firm loses little of its own money. And if the company succeeds, they reap jackpot profits. Heads they win, tails they don’t lose much.

With interest rates low in recent decades, this approach has led private equity to swallow up household name brands across all industries. But now with rates spiking, these debt-laden companies can’t afford interest payments on what they borrowed.

Even when everything falls apart, private equity still profits thanks to savvy utilization of bankruptcy proceedings. More on that shortly.

Surge of Bankruptcies Represents Overdue Market Correction

In 2021 and 2022, corporate bankruptcy figures hit record lows despite a challenging economic climate. This is because struggling business leaned heavily on government bailout programs and cheap debt to stay afloat. These lifelines hid the weakness that is now surfacing.

Companies that should have failed long ago survived artificially as so-called “zombie companies.” With bailouts expired and rates rising, they now buckle under their own previously concealed deficiencies.

Bankruptcy Seen as Strategic Move Rather Than End of Road

Another driver of the bankruptcy boom is that it’s no longer viewed as an irreversible kiss of death. Chapter 11 bankruptcy allows courts to protect and restructure failing companies so they can regain solid financial footing. The prevalence of this option reduces corporate stigma against tapping bankruptcy procedures.

Media company Vice continuing to publish content despite declaring chapter 11 demonstrates this dynamic. Viewed through the lens of business strategy, bankruptcy has become more tool than tombstone.

Company Structures Allow Leaders to Avoid Accountability

The final factor perpetuating the bankruptcy bonanza is that crafty corporate structuring enables leadership to escape consequences. Business empires built atop complex webs of shells, trusts, and holdings allow owners and executives to remain financially insulated if part of their enterprise goes under.