PE & LBO's: Longevity and Exit Flashcards
Explain the pros and cons of the LBO governance structure
Pros [Jensen 1989]:
- Solves the FCF problem in Mature PLC’s and reduces agency costs
- Superiority of LBO Governance over PLC for firm performance means it will persist in the future.
Cons [Rapport 1990]:
- LBO’s are transitory and only effective for short period of time.
- High leverage means less buffer against negative shocks.
- Investors expect to be repaid after 5/10 years hence its short-term
What is the Jensen 1989 v Rapport 1990 debate on longevity of LBO’s?
Jensens 1989 argues LBO Governance will persist because of LBO performance over PLC but Rapport 1990 argues it won’t as its built into structure to be finite and the high leverage means LBO firms have inability to compete over long-term than other firms.
Why do PE Firms exit from LBO’s
The exit is how PE Firms make their money as they need to return LP Capital + interest and then get their own profit share.
To explain how returns to GPs and LPs are split
GP’s get management fee per annum of around 1-2%
GP’s get carried interest of approx 20% of the remaining profit, typically after hurdle rate met
LP’s get their capita back + 80% share of profit
State Evidence of Returns to PE Fund investors
- Kaplan and Scholar 2005 - Net of Management fees, LP’s earn 93% of what could’ve been earned in the S&P 500.
- Harris, Jenkinson and Kaplan 2014 - Outperforms S&P 500 by more than 3% annually gross.
Whats a secondary buyout?
& how does governance structure change?
When a PE Firm sells a portfolio firm to another PE Firm.
Continue with the LBO Governance structure, with different investors.
Why do SBO’s occur (sellers, buyers) and when are they most likely to occur?
Sellers perspective:
- Liquidating their investment to pay LP’s.
- LBO did not achieve initial gains expected.
Buyers perspective:
- PE firms successful in raising capital through PE funds, but relatively few good ‘primary deals’
Occur: Debt conditions favourable, PE firms want to liquidate, Equity/Stock market is cold hence alternative strategy needed.
What are the performance effects of SBO’s?
Use coupe of studies
Generally No additional performance gains from SBO’s as agency costs already low from existing LBO Governance Structure
Wang 2012: Inferior post-SBO Performance, SBO serve no other need than alleviating financial needs of PE Firms
Degeorge et al. 2016: SBOs outperform other buyouts if PE Firms skills are complementary.
Explain an Initial Public Offering (IPO) & when will it most likely occur
When a private company becomes a public company through issuing shares on stock exchange, the Initial offering of shares.
Occur: When stock market is hot, Firm performance has peaked aka Performance timing hypothesis, Jenkinson and Sousa, 2015 state when stock is hot and debt is falling
Examine the performance effects of PE-backed IPOs
If LBO governance structure motivates performance improvements, an IPO will lead to a decline in performance as it leads to more agency costs.
Cao and Lerner (2009) - High leverage has no significant effect on performance and Stock performance of Reverse LBO is as good or better than other LBO’s
Outline issues relating to debt finance
Increasing leverage increases financial risk as the firm needs to continue servicing the debt or it will go bankrupt.
Outline evidence concerning bankruptcy and financial risk
Tykvova and Borell 20212 - i) Portfolio firms do not suffer higher bankruptcy rates, ii) experienced PE Firms lower bankruptcy rates
