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We’ve all heard the statistics about investments that fail to achieve their deal thesis; buyers seem to have accepted as a given that most acquisitions will not meet their synergy targets. However, not reaching targets is quite different from an investment that goes into distress. Investors expect some risk when making acquisitions, but unless they are specifically investing in distressed assets, a significant loss of value is unimaginable.
Why, then, do good deals go bad? Why do seemingly excellent investments end up falling apart?
We wanted to understand if there are underlying trends that may explain why companies that received significant equity and/or debt investment could end up in a challenging situation where they must launch an out-of-court restructuring effort or, more seriously, file Chapter 11 within a matter of years of the investment. We also wanted to understand what these trends can teach us about future acquisitions.
Data review and findings
To explore these questions further, we reviewed publicly available transaction and bankruptcy data from 2018 to 2025 to identify situations where companies ended up in a distressed scenario within a one to four-year time frame after receiving significant outside investment or making their own acquisitions. We did not include any companies that filed for Chapter 11 during 2020-2021, specifically to filter out companies whose distress was most likely linked to the Pandemic.
Using this information, we developed a shortlist of approximately 40 companies, ranging from the middle market to multi-billion-dollar capital structures, across multiple industries, for further research on performance history and potential drivers of distress.
Here’s what we found.
As expected, an unsustainable capital structure was at the heart of distress across most of the companies reviewed.
While capital structures are ideally sized to realistic financial projections, defining “realistic” is often more art than science.
Seldom, however, was the capital structure itself the issue.
Rather, it was the capital structure combined with a number of additional variables that caused ‘good deals to go bad’. Some of these factors were more in the hands of the business. Others, however, would have been much more difficult for investors to predict or for executive teams to manage through. We’ve grouped these into four factor areas:
- Operating performance and management’s inability to course-correct when things weren’t working
- Failure of the fundamental operating model
- Interest rates
- “Surprise events”
Operating performance
Challenges in operating performance were a key catalyst when combined with the capital structure, which caused distress. Drivers of this underperformance include the economic (such as inflation) and operational (such as a failure to reach profitability and loss of key customers).
A turbulent environment, such as the high inflationary economy the country experienced in 2022-2023, will challenge the most competent management teams. Higher prices in some cases eroded consumer spending, pressuring toplines, while increased costs from vendors squeezed margins. Inflation was cited in ~20% of the companies reviewed as having either caused a decline in customer demand and/or an increase in prices that compressed margins.
One casualty of this environment was a promising family-owned restaurant chain that added an additional vertical to its footprint through acquisition. Performance declined, with same-store sales dropping in the two years after the deal, causing its auditors to issue a going-concern warning a few months thereafter. Four months after its going concern, the company filed for Chapter 11, noting in its First Day Declaration that rising menu prices led to reduced customer dining, while food costs for restaurants remained high.
However, these issues were fundamental challenges most comparable restaurant businesses had to face, suggesting deeper issues in the business and/or a capital structure that could not weather a downturn. Notably, the business's operating cash flow was negative in 2021, suggesting the company may have overly focused on growth instead of shoring up its cash flow.
Overall, it's probably not surprising that core operating issues were cited in more than three-quarters of the companies reviewed.
One illustrative example was a mental wellness center operator that, over a decade, was never able to achieve profitability. This business pursued growth through acquisition, acquiring multiple clinics in the late 2010s/early 2020s; “opportunistic” growth was a key message from its CEO with a goal of breaking even and reaching profitability by 2023.
Unfortunately, the business’s focus on growth and increasing revenues significantly was fueled by debt that the company’s operations could not support, resulting in a going-concern opinion in 2024. It was acquired later that year, with the acquirer converting the debt facilities into common shares.
Another instance was the restructuring of a business services company. In this case, the company saw two of its largest long-term customers drastically reduce their business with the company within a year of its acquisition by an investor. At face value, this seemed like an arbitrary and impossible event to predict. However, both customers were slow-moving, and the shifts in their behavior likely took months to implement, suggesting that management may have had more opportunity to maintain the customer relationships.
We observed the distressed exchanges of two private equity-backed alcoholic beverage companies. In both cases, ongoing declines in demand for beer, wine, and other alcoholic beverages placed downward financial pressure on the business, requiring both to modify their existing debt structures to continue operations.
Management often takes the brunt of the blame for not improving operating performance. Our research suggests that it is less about management competence and more about a mismatch between what management is great at and the evolving nature of the operating environment. Put more simply, an executive team with a track record of growth may not be the right people to lead a company through stagnation or distress.
Failure of the operating model
Business plans are founded on a core operating model. In some cases, the core operating model may be unproven but promising enough to attract sufficient attention and investment. In other cases, business dynamics evolve, and the operating model is unable to adjust.
Approximately one-third of the ‘good deals gone bad’ had operating model failures; either a promising premise that was not able to catch on, or a model that had worked but fell victim to significant shifts in how the market operated.
An example of the former is WeWork, one of the early innovators in shared office space. Fueled by over $6 billion in investments from 2017 to 2019, the company attracted significant market attention. However, its 2019 pre-pandemic IPO was unsuccessful, leading its principal investor to pump an additional $5 billion into the business to fund its capital needs.
Unfortunately, by the time the company did go public, it did so with significant negative EBITDA and into a world that had been radically impacted by “work from home." Its rating downgrade to CCC in December 2022 on sustained negative free cash flow and EBITDA was a harbinger of the restructuring talks first reported in March 2023 and its eventual Chapter 11 filing in November 2024. This was where the fundamental operating model shifted radically in ways that would have been extremely difficult for anyone to foresee or present as a downside in 2019.
An example of the latter was a real estate investment trust that attempted to address the changing retail environment with a 2020 restructuring even before the pandemic really took hold.
Unfortunately, despite management being ahead of the curve and pursuing sales of key properties in 2022 and 2023, a lack of market interest constrained the company’s ability to deleverage. Ultimately, as noted in its Chapter 11 filing, it fell victim to the changing consumer expectations, the convenience of e-commerce shopping, the expansion of outlet centers, and declining mall traffic that had been going on for several years.
Interest rates
The high-interest rate environment following the COVID-19 pandemic was the third most-referred-to driver of capital distress. A review of First Day Declarations of companies that sought Chapter 11 highlighted just how vulnerable many businesses were (the below have been paraphrased):
- The significant interest expense on the company’s funded debt, which increased significantly on an annual basis from 2022 to 2023, combined with increased working capital needs over the same time period, depleted the company’s liquidity and impaired its ability to operate in the ordinary course.
- The ongoing increase in interest rates and the debtors’ increased leverage profile undertaken in connection with the Take-Private Transaction, combined with the macroeconomic headwinds impacting their businesses, detrimentally impacted the debtors’ cash flow and related ability to service their debt obligations.
- Rapidly rising interest rates made servicing the company’s funded debt obligations significantly more challenging. Indeed, the company’s total interest expense for 2022 was significantly higher than projected.
Simply put, it appears that what may have been otherwise stable companies saw their liquidity squeezed by the increased rates, reducing their ability to meet debt obligations and make required payments to vendors.
While the change in rates may have been unexpected, in many of the cases we reviewed, the debt structure that was in place was subject to risk, given either its potential for fluctuation, given its peg to LIBOR, or risk due to the total value of debt relative to the size of the company:
For example, an IT service management business received a second lien loan in with a cash interest of 8.5% plus LIBOR. The spike in global interest rates that occurred during the COVID period had a direct impact on the amount of interest due on this loan, particularly as the company was unsuccessful in securing an amendment to transition the loan’s benchmark to SOFR. This created a scenario of increasing interest expense, which illustrates the potential risk in investing with, or in the case of the company, accepting a loan with a floating interest rate.
In the case of a retail franchise operator, the total debt level at the time of filing was significantly higher than the loss recorded to net income in the company’s 2022 10K filed before its take-private transaction in 2023. This debt, combined with interest tagged to fluctuating rates, proved unworkable for the continuation of business as usual.
These debt scenarios, coupled with a difficult operating environment, left the companies no other option than to try and ‘ride out’ the high interest rates, which ultimately proved too challenging.
Unexpected events
A few companies fell victim to much harder-to-foresee events that ultimately cascaded into significant distress, which is less common (less than twenty percent of companies reviewed) but no less impactful than performance, operating model changes, or interest rates.
Our sample included a company that had to re-report financial earnings, which resulted in a crash in share price, funds being mismanaged by an outside advisor, significant SEC investigations, and a company whose tech failed to perform, thereby limiting future growth. While different in nature, these events were the ‘final straw’ that pushed the companies into bankruptcy.
Loss of foundational customers in newer industries also proved to be difficult to build contingency plans around. For example, we identified a few cases in the crypto industry, where the collapse of industry players like Celsius Networks and FTX resulted in a major loss of revenue, which coupled with the downturn in the price of bitcoin, led to significant challenges for an industry that just a few years earlier had received significant investment.
Key takeaways for due diligence and deal structuring
The drivers of distress above show a combination of factors that many businesses face when entering bankruptcy or an out-of-court restructuring.
What then can investors do to help avoid a scenario where a seemingly good deal goes bad?
Based on the observations above, we have a few key takeaways for due diligence and deal structuring. While many are items that are always done, or at least should be, we include them here as a reminder.
Understand the top line: Understanding the revenue and profitability distribution amongst customers provides a key part of the story on where risk may be in the customer base. To further the understanding, investors and their advisors should be willing to ask the ‘tough questions’ to commercial teams about the ‘stickiness’ of customers, even those customers that are seen as the ‘best’ and ‘untouchable’. Doing so can allow a risk-adjusted view of revenue, showing where and how a change in customer impacts future projections and valuations.
If the revenues are high-risk, there is usually only so much cost that can be cut in a downturn.
Run “what if” scenarios: As our 6th annual AlixPartners Disruption Index shows, macroeconomic, technological, and geopolitical risks continue to arise. To account for these items, scenario analyses should extend beyond looking at the variability of top-line figures and instead account for potential external events, such as an increase in interest rates or inflation. While it is not practical to run scenarios for every ‘what if’, creating a set of projections based on a short-list of disruptors may offer a view of what could happen in ‘unexpected’ scenarios.
What are the disruptors most common to the industry, even if the company being invested in hasn’t directly experienced them?
Be cautious about growing into capital structures: If investment in a healthy, growing business is predicated on its ability to do everything right to support the capital structure, there is a reasonable chance that the balance sheet may become unsustainable. This is not the same as investments in start-up concepts, which is how we would categorize companies like WeWork, where investment follows a more venture capital moonshot model.
Businesses whose business plan demands acquisition without a clear path to profitability may not be sustainable.
Scrutinize the debt structure: Beyond a simple look at the balance sheet, investors in the capital structure should review and document the terms and clauses of all significant loans, highlighting those that may be most at risk from a change in rates or another unexpected event. Doing so allows for a more realistic view of where potential risks of default may occur.
While using these approaches to diligence is not foolproof, we believe, based on our research and experience, that they can offer earlier clues as to why a “good deal” may ultimately be at risk of turning bad in the years that follow.
