Big Deals, Big Consequences: How some deals went very wrong

In November 2018, a conglomerate of car dealerships went out of business in California. Within three weeks, a merchant cash advance company, 1 Global Capital, was discovered to have filed bankruptcy as a result. They had lost more than $40 million in that dealership deal alone. Over the ensuing weeks, additional funding companies revealed that they had also been in it and gotten burned, some so badly that they also closed their doors. It was a moment of reckoning for the industry as deals got bigger and the stakes got higher. At the time, it was considered the largest deal (and then the largest default) in history.

Less than two years later, an even bigger deal was revealed, a $91M MCA made by Par Funding. Par also became a rather infamous failed business.

And some time in between the two, a $1B hedge fund that provided credit facilities to small business lenders, also failed and took some lenders down with it.

In each case there was a lesson learned.

1 Global Capital

In 1 Global Capital, internal emails revealed that the company knew the dealerships were on the brink of collapse, but were compelled to keep funding them to avoid taking the loss.

“…if they were to become insolvent, everyone loses,” said 1 Global’s Director of Accounting. The result was they dug a deeper and deeper hole until they were on the hook for tens of millions and their exposure became existential.

1 Global was not forthcoming about the performance of its portfolio to its investors and by the time the dealerships went bust, regulators and prosecutors moved in to deal with the fallout.

Par Funding

In the Par Funding case, foul play appears to have been the defining issue. The large funding amounts and low defaults looked good to the investing public because the books were not being accurately reported. Par was adamant that the power of “compounding” could make up for any losses they incurred, but regulators said they had not even properly disclosed their losses to begin with and investors were not aware of them. The $91M deal was just the tip of the iceberg. Another customer purportedly owed $35M, for example. And then those combined with the next eight largest deals on their books added up to $228M, which made up 54% of their entire portfolio. Par had very severe concentration risk and compounding probably could not save it on other deals if these went bust.

Direct Lending Investments

In the Direct Lending Investments hedge fund case, the CEO had famously proclaimed that small businesses were overpaying for credit and that was how their investors stood to profit. But over time, it became evident that some of the small business lenders they backed actually had customers underpaying for credit and the losses overwhelmed the hedge fund. Unfortunately, the CEO was unwilling to concede the losses and told investors they were actually profitable instead. To try and cover it up and make it back, the hedge fund loaned nearly $200M to telecom companies at high interest rates. And because they made these loans during a state of distress and probably were not underwriting them carefully, the borrowers scammed them and disappeared with the funds. There was no longer a way out and the CEO resigned. The receiver in the case initially estimated that portfolio was then worth $500M less than what they had last reported to investors.

Ironically, the CEOs of all three companies were convicted of crimes for their roles in the lies and the losses.

Concentration risk, misleading investors, and falling victim to the sunk cost fallacy ultimately were their undoing. For some, the deals got larger to try and keep a dead deal from failing. For others, it was a Hail Mary play to try and generate a return to make up for losses elsewhere.