MASTER’S THESIS
Private Equity´s
Leveraged Buy-out Exit Mode Selection
Empirical Evidence from the United Kingdom
August 2009
Sander Sebastiaan Gras
Langestraat 59-E
1211 GW Hilversum
The Netherlands
(s.s.gras@student.rug.nl)
PRIVATE EQUITY´S LEVERAGED BUY-OUT EXIT
MODE SELECTION
EMPIRICAL EVIDENCE FROM THE UNITED KINGDOM
SANDER SEBASTIAAN GRAS
ABSTRACT
This research provides empirical evidence for determinants of the exit mode selection (focusing on: secondary buy-outs and trade sales) and exit returns per exit mode. In this study, a sample of 297 leveraged buy-outs in the United Kingdom during the time frame January 1998 – June 2009 is examined. Seven possible determinants are selected: operating performance, portfolio company size, industry affiliation, financial leverage, portfolio company size, investment period and management replacement. The results of this research showed that the determinants portfolio company quality, financial leverage and investment period are statistically significant in the selection of an exit mode. The quality of the portfolio company showed higher means for companies exited via TS. This result contradicts the expectation of a higher outcome for portfolio companies exited via SBO. The expectation that portfolio companies with a higher leverage tend to exit more often via TS was confirmed. For determinant investment duration was found that investment period has a positive influence on exits via SBO, this is in accordance with the expectation. The results regarding the exit returns of exit modes in this research do not show overall higher exit returns for one particular exit mode. However it can be concluded that exit mode SBO can throw off the image of second best alternative.
JEL classification: G11; G24; G34
Keywords:
Leveraged buy-out, LBO, Private Equity, exit, exit mode selection, exit mode determinants, exit return, United Kingdom, trade sale, secondary buy-out.
Supervisors University of Groningen
Supervisor: prof. dr. L.J.R. Scholtens
ACKNOWLEDGEMENTS
First of all, I would like to thank my supervisor prof. dr. L.J.R. Scholtens for his feedback and guidance in this research project.
I would like to thank Boer & Croon Corporate Finance for providing me the opportunity to do an internship at their company. The internship in the corporate finance sector provided me an insight in the corporate finance world behind the literature, which led to an even more increased interest in the sector. I would like to thank my colleagues at Boer & Croon for their ideas and help during the initial phase of writing this thesis.
Also thanks to my close friends, for being motivators, proofreaders and for the necessary diversion.
Special thanks go to my girlfriend Lisette, who has always supported me and put many hours in proofreading this master‟s thesis. Her recent experience with the graduation phase and writing a thesis ensured a sharp private co-reader; her critics were of invaluable use.
Finally, I would like to thank my parents for their continued advice, pride and belief during my years as a student.
I hope you will enjoy reading this thesis.
TABLE OF CONTENTS
1
INTRODUCTION ...1
1.1
INTRODUCTION TO THE RESEARCH TOPIC...1
1.2
PROBLEM DEFINITION ...4
1.3
RESEARCH OBJECTIVE ...5
1.4
RELEVANCE ...6
1.5
STRUCTURE ...6
2
THEORETICAL FRAMEWORK AND LITERATURE REVIEW ...7
2.1
THEORETICAL FRAMEWORK ...7
2.1.1
VALUE CREATION IN LBOS ...7
2.2
LITERATURE REVIEW ... 10
2.2.1
PORTFOLIO COMPANY CHARACTERISTICS ... 12
2.2.2
INVESTMENT CHARACTERISTICS ... 15
2.3
CONCEPTUAL MODEL ... 17
2.4
HYPOTHESES ... 17
3
METHODOLOGY AND DATA ... 20
3.1
DATA COLLECTION ... 20
3.2
SAMPLE DESCRIPTION ... 21
3.3
METHODOLOGY ... 22
3.3.1
FIRST STAGE ... 23
3.3.1.1
DESCRIPTIVE STATISTICS QUANTITATIVE VARIABLES ... 23
3.3.1.2
DESCRIPTIVE STATISTICS QUALITATIVE VARIABLES ... 24
3.3.2
SECOND STAGE ... 24
3.3.3
THIRD STAGE... 25
3.4
VARIABLE CONSTRUCTION ... 26
3.5
EXIT RETURNS ... 28
3.5.1
TOTAL DATA SET ... 29
3.5.2
INDUSTRY GROUP MULTIPLES ... 30
3.5.3
FINANCIAL CLUSTERED MULTIPLES ... 32
4
RESULTS ... 37
4.1.1
COMPARISON OF MEANS AND MEDIANS ... 37
4.1.2
CHI-SQUARE TEST ... 38
4.1.3
LOGISTIC REGRESSION... 39
4.2
EXIT RETURNS ... 41
4.2.1
TOTAL DATA SET ... 41
4.2.2
INDUSTRY GROUP MULTIPLES ... 42
4.2.3
FINANCIAL CLUSTERED MULTIPLES ... 44
4.3
OVERVIEW OF CLUSTER RESULTS ... 50
5
CONCLUSION AND DISCUSSION ... 51
5.1
PORTFOLIO COMPANY CHARACTERISTICS ... 51
5.2
INVESTMENT CHARACTERISTICS... 52
5.3
EXIT RETURNS ... 52
5.4
MAIN FINDINGS ... 53
5.5
LIMITATIONS ... 54
5.6
SUGGESTIONS FOR FURTHER RESEARCH ... 55
REFERENCES ... 56
LIST OF FIGURES AND GRAPHS
List with figures
Table 2-1: Literature overview ...11
Table 2-2: Conceptual model ...17
Table 3-1: Roadmap to sample ...20
Table 3-2: Descriptive statistics total sample ...23
Table 3-3: Descriptive statistics per exit mode ...23
Table 3-4: Frequency table high-technology industry and management replacement ...24
Table 3-5: Correlation table of independent variables ...28
Table 3-6: Descriptive statistics multiples of the total sample before removal of outliers ...29
Table 3-7: Descriptive statistics multiples of the total sample after removal of outliers ...30
Table 3-8: Descriptive statistics multiples of the total sample distribution per exit mode ...30
Table 3-9: Descriptive statistics cluster: technology...31
Table 3-10: Descriptive statistics cluster: sector ...31
Table 3-11: Descriptive statistics cluster: revenue ...33
Table 3-12: Descriptive statistics cluster: EBITDA ...34
Table 3-13: Descriptive statistics cluster: EBIT ...35
Table 3-14: Descriptive statistics cluster: earnings ...36
Table 4-1: Comparison of means of quantitative variables ...37
Table 4-2: Chi-Square Tests of qualitative variables ...38
Table 4-3: Summary logistic regressions models ...39
Table 4-4: Independent Sample T-test, total data set ...41
Table 4-5: Independent Sample T-test, cluster: technology ...42
Table 4-6: Independent Sample T-test, cluster: sector ...43
Table 4-7: Independent Sample T-test, cluster: revenue ...45
Table 4-8: Independent Sample T-test, cluster: EBITDA ...46
Table 4-9: Independent Sample T-test, cluster: EBIT ...47
Table 4-10: Independent Sample T-test, cluster: earnings ...49
Table 4-11: Descriptive statistics cluster: earnings ...50
Table A-1: History of the LBO market ...61
Table A-2: Sample distribution per sector...64
Table A-3: Reference value quartiles ...67
Table A-4: Logistic regression estimates model 1 ...68
Table A-5: Logistic regression estimates model 2 ...69
Table A-6: Logistic regression estimates model 3 ...70
List with graphs
Graph 1-1: Overview of UK buy-outs ...1
Graph 3-1: Exit mode split of the sample ... 21
Graph 4-2: Exits per year per exit mode ... 22
Graph A-1: European buy-outs by country – Value of deals (€ million) ... 61
Graph A-2: European buy-outs by country – Number of deals ... 62
Graph A-3: Overview of exit trends in UK buy-outs ... 62
Graph A-4: PE subset distribution of European Investments by amount invested (in 2007) ... 63
ABBREVIATIONS
Abbreviation Meaning
EBIT Earnings before interest and taxes
EBITDA Earnings before interest, taxes, depreciation and amortization GBP(m) Great Britain pound (million)
IBO Institutional buy-out IPO Initial public offering
LBO Leveraged buy-out
MBO Management buy-out
PE Private equity
SBO Secondary buy-out
1
INTRODUCTION
1.1 INTRODUCTION TO THE RESEARCH TOPIC
A leveraged buy-out (LBO) is: ‘a transaction in which a group of private investors, typically including management,
purchases a significant and controlling equity stake in a public or non-public corporation or a corporate division, using significant debt financing, which it raises by borrowing against the assets and/or the cash flows of the target firm taken private’ (Loos, 2005). Worldwide LBOs became prominent during the 1980s. Graph 1-1 clearly shows
the rapid growth of the number of buy-outs in the UK during the 1980s. From 1997 onwards the number of transactions floated around the 650 per year. In 2008 an enormous decline in the number of transactions is visible, which probably can be explained by the financial crisis. The transaction value shows a growth from the middle of the 1980s with a peak in 1989 (this peak can be explained by the RJR Nabisco LBO1 conducted by KKR). After the peak, the total transaction value declines and stays relatively stable until the middle of the 1990s. From that moment on, the value of the LBOs conducted in the UK shows a gradual growth until a new peak in 2000 arises. During the dot com bubble the value of the transactions declined, but the number of transactions stayed relatively equal. This implies that the value of the average buy-out conducted in the UK during those years declined substantially. In 2003 the value started to grow again until 2006. The year 2007 shows an explosive growth of the transaction value, followed by an implosive decline of the value in 2008. For the year 2009 only the first quarter is taken into account, which explains the extreme low transaction value and number of transactions for this year.
Graph 1-1: Overview of UK buy-outs
Source: CMBOR (2009)
The goal of a private equity (PE) company is to acquire a company that can grow or can be improved. The acquired company is called the portfolio company. Sudarsanam (2003) describes that the structure of an LBO transaction is often the following. A special purpose company, called Newco, is created to carry out the transaction (legal structure). The transaction vehicle‟s financial structure typically consists of substantial debt (sliced into different types of debt), equity and a form with characteristics of both debt and equity (mezzanine). The equity component is provided by external investors who invest in a fund raised by a specialist company that looks for suitable investment opportunities to invest the capital in (Sudarsanam, 2003). Since the equity capital that is invested in the funds of the financial sponsors is raised outside the public stock markets, it is called private equity (PE). A specialist company behind the funds is therefore called a PE company (Sudarsanam, 2003). A brief history of PE in the form of a timeline can be found in table A-1 in the appendix.
1
A LBO can be described as a success for the PE company if the PE company is capable of exiting the portfolio company (divesting their investment) with an exit return which is larger than the transaction value of the initial purchase of the company plus the costs during the holding period. Cumming and MacIntosh (2001) hypothesize that a financial sponsor will exit the portfolio company when the projected added value of the work of the PE company is smaller than the projected cost for this work. The term “exit” can be used interchangeably with the terms “divestment” or “disinvestment” and means that the PE investor sells a partial or complete stake of the portfolio company (Povaly, 2006).
Perhaps the most important critical success factors for PE companies (also known as financial sponsors) are their ability to raise funds, their capacity to add value, the ability to successfully exit an investment and meet the obligation to return funds to their investors at the right time, while delivering a respectable return on their investment (Sudarsanam and Nwaghodoh, 2005). While in the early years LBOs created their value through leverage, tax savings arising in part from the corporation tax deductibility of interest, and clever use of various financial instruments and financial market opportunities to lower the cost of capital, mere financial engineering of this kind is no longer sufficient anymore (Sudarsanam, 2003).
One of the characteristics of investments made by PE companies is that these investments are done for a limited period of time, and that they are illiquid. Butler (2001) found that the average holding period of a LBO in the timeframe 1980-2000 was 53 months. In line with this research is the finding of Sudarsanam and Nwaghodoh (2005) whom found that the average holding period of their sample was 41 months. Another study with a comparable outcome was done by Xu (2004), who found that the horizon for PE or a buy-out fund was around 60 months (Povaly, 2005).
The short holding period implies that the exit of the portfolio company is the primary way to realize a positive return on the investment made by the PE company, which makes it the last and most critical step in the entire investment process from the PE company‟s point of view. Through the exit, the financial investor is able to convert the invested funds back into liquidity, thereby realizing a profit or loss on the investment, although also other aspects (like dividends etc.) have to be taken into account while evaluating the return on the investment. (Voigthaus et al., 2004).
Driven by the aspects described above it becomes clear that the exit mode is one of the most crucial aspects for a successful LBO (Cumming and MacIntosh, 2003; Neus and Walz, 2005; Povaly, 2006). An overview of exit trends in UK buy-outs over the years 1989-2008 is visualized in graph A-3 in the appendix. Although buy-outs represent an important proportion of the PE volume (see graph A-4), only little research has been done related to the exit modes of LBO investments (Schmidt et al., 2009).
Secondary buy-out
An SBO is a transaction in which the PE company is selling an investment (a portfolio company) to another PE company. These types of buy-outs are also known as sponsor-to-sponsor transactions. The SBO will only be realized if the purchaser of the minority equity share, the management or the entrepreneur, is determined to also be able to realize a positive return on his investment (Voigthaus et al., 2004). There are a couple of reasons why financial sponsors could decide to start selling their investments to other financial sponsors. The most important reasons are: difficulties in exiting LBOs through other exit modes; reduced interest of strategic corporations to acquire portfolio companies (especially the smaller transactions); pressure on the financial sponsor to exit their investments when their funds are starting to draw near their contractual lives (Wright et al., 2006).
The most important prerequisite for a successful SBO for the second financial sponsor is that the retiring financial sponsor must not have been able to fully fulfill all the growth potential of the portfolio company into financial gain or the new financial sponsor must have specific supplementary know-how (Voigthaus et al., 2004).
From the historical perspective SBOs are wearing a stigma of failure. The stigma can be explained by the fact that there was the understanding that the rationale for doing an SBO was that the financial sponsor was not able to sell the company to a strategic buyer or bring it public (Anson, 2004). More recently literature (e.g. Voigthaus et al., 2004) is questioning if SBOs in general can create wealth and if they can, what is creating the value-creating potentials. Another question that arises is whether the rise of the SBO is attributable to the fact that they are merely used as a second best exit alternative in order to recycle capital when alternative exit modes are unavailable, due to external factors2 (Voigthaus et al., 2004).
One of the consequences of the growth of the PE market is that the PE companies are having a growing volume of capital available. This is expected to be one of the important aspects that have led to the growth in the number of SBOs (Sudarsanam and Nwaghodoh, 2005). Anson (2004) puts his finger on the spot when he wrote that the PE companies are focusing on already existing deals instead of looking for new potential deals. This can be caused by the fact that the PE market has too much capital available. Along with the rise of the SBOs, there also started a new wave of criticism and doubtful questions about SBOs. These included the following: since the goal of PE companies is to trim costs from their companies as rigorous as possible before selling them, the question is how much (financial) slack can a second private equity owner cut? SBOs feed the criticism that PE companies are mainly focused on fees and financial engineering, instead of focusing on operational improvements (e.g. Flaherty and Davies, 2007).
An explanation for the attractiveness of SBOs besides the financial engineering and the limited lifetime of the funds of the PE companies, is the fact that most of the PE companies are active in a specific stage of the development of (portfolio) companies. There are companies that are specialized in the different segments of PE, for instance seed capital, venture capital, etc. A venture capitalist can choose to sell its investment through an SBO to a financial sponsor who is active in more mature companies, they can add value by for example making use of their experience in the specific stage of PE.
Trade sale
target‟s products and/or technology with its own (either horizontally or vertically) (Cumming and MacIntosh, 2003-I).
One of the main issues in using the TS as an exit method is control in the company after the transaction. Strategic investors are in general only interested in the acquisition of majority stakes (Lange and Ellis, 2004). This makes it an interesting exit mode for financial sponsors, since they can immediately exit their complete investment at once, where some other exit methods cannot be used to exit at once immediately (e.g.: IPO).
An important factor that can lead to a higher return for the financial sponsor (in comparison with an exit via SBO) is the payment of an acquisition premium based upon possible future savings due to the strategic fit and potential savings (Loos, 2005). If a strategic buyer sees potential to achieve synergy advantages it can calculate this into their valuation of the portfolio company. In some situations strategic buyers can achieve larger synergy advantages than financial sponsors, due to overlap in the business models, which will give the strategic buyer the possibility to make a larger (profitable) bid than the financial sponsor.
A factor that can complicate a TS acquired from a PE fund is the fact that after the transaction is completed, the PE fund will distribute the amount received to its own investors (in the fund). This characteristic will lead to severe restriction of the PE fund‟s ability to satisfy any (un)expected claims made by the acquiring company. In general this will lead to a purchaser who will insist that a portion of the transaction sum will be held back by him, until a certain period has elapsed in which the buyer can determine if he will file any claims, or it will be held in an escrow account and will be released after a pre-determined period (Lange and Ellis, 2004). Summarizing, during the exit process of a portfolio company by the PE company a large amount of time can be spend on negotiating the possible future claims and the holdback of a portion of the transaction sum.
For the sake of completeness and because IPO, buy-backs and write-offs will occasionally appear in this paper a short explanation will be given below.
Initial public offerings
In an IPO exit, the portfolio company gets listed. The PE company sells (often only a portion of its) shares to members of the public for the first time. The PE company retains its shares at the date of the public offering, only to sell shares into the market in the months (or years) following the IPO. Usually, the PE company will sell a minimal part of its shares at the time of the IPO. Exits effected by sales after an IPO are called IPO exits.
Buy-backs
In a buy-back exit, the PE company sells its shares back to the company (or entrepreneur) that sold the shares originally.
Write-offs
In an exit via write-off, the PE company comes to the conclusion that there is little or no prospect of ever enhancing its initial investment and therefore decides to no longer spend time or effort in bringing the investment to a success. This walking away from the project often results in bankruptcy and a disappearance of the company.
1.2 PROBLEM DEFINITION
venture capital (VC)), and not on the determinants of the process that lead to and influence the choice of an exit method of the PE company.
1.3 RESEARCH OBJECTIVE
The main goal of this paper is to add empirical evidence regarding the determinants of the selection of exit modes for an LBO. Another goal is to examine if the exit returns differ per exit mode. In relation to the already existing literature, this paper will be an addition to the studies of Sudarsanam and Nwaghodoh (2005), Nahata (2004) and Voigthaus et al. (2004). It adds new empirical evidence for a different time frame and uses a large sample of exits of portfolio companies. The data are obtained from other sources than most of the other researches, which may lead to different data and thereby possible different results. The outcomes can be used to test findings in earlier presented literature. An additional goal is to provide information on country-level, this research focuses on largest LBO market in Europe, namely the UK (see graph A-1 and A-2). This is an addition to the existing literature since most of the studies are focusing on the US.
This research objective will be achieved by answering two research questions. The first research question will focus on the determinants of the LBO exit mode selection:
The second research question will focus on the exit returns of the LBO exit modes SBO and TS.
Methodology and data
This paper examines a sample of 297 portfolio companies in the UK during the period January 1, 1998 till June 1, 2009. The portfolio companies are gathered from the electronic database Mergermarket.
The first part of this research focuses on the determinants of the exit mode selection of a former PE LBO portfolio company, which is reflected by the first research question. The explanatory value of the determinants is examined by a three stage methodology. The first stage focuses on the sample‟s descriptive statistics. Followed by the second stage in which univariate methods are used to analyse the determinants. Tests that are used in this stage are the Independent Sample T-test and Mann-Whitney U test for the quantitative variables and a Chi-Square test for the qualitative variables. The last stage makes use of a multivariate technique; the logistic regression model. In this stage three different models are tested to test the influences of the different determinants.
The second part of this research focuses on finding answers for the second research question, which focuses on the differences between the exit returns of the selected exit modes. In this research exit multiples are used as a proxy for the exit returns. Four different exit multiples are used to analyze whether there are differences between the exit modes. To improve the quality of the analysis several clusters are identified. Clustering portfolio companies with similar companies gives a better foundation for the comparison of the exit returns. The different clusters are build upon characteristics of the industry the portfolio companies are active in, the sector in which they operate and their financials that serve as reference value.
RQII : Is there a difference in exit returns for the PE company between the LBO exit modes SBO and TS?
1.4 RELEVANCE
The purpose of this research is to make a contribution to the field of financial management and performance of LBOs. The lack of studies in this research area can be explained by the difficulty of obtaining data. Loos (2005) puts it strikingly into words: the main difference between the public domain and the PE-industry is the easy accessibility of the stock performance data and accounting information in the public domain, whereas the PE-industry has sealed disclosure of both fund and deal performance. This is caused by the lack of regulation concerning the transparency of PE funds and transactions. The most influential literature on the topic is conducted during the late 1980s and early 1990s, triggered by the public and academic interest (Loos, 2005). The growing number of LBOs in this decade seems to have initiated a renewed interest in this research area.
The majority of the existing literature is focusing on the exit modes of VC-investments. VC is just one subset of PE, which is focusing on start-ups and early expansion and therefore does not include LBOs. Research of Povaly (2006) shows that empirically tested concepts and theories, which were confirmed, do not necessarily have to be valid for buy-out exit modes. Even if some of the determinants were applicable to the complete PE-segment, the question would be whether the importance would be equal within each sub segment. Povaly (2006) suggests that VC-investments need to be separated from buy-outs, in order to examine the results for solely buy-outs. Most literature is focusing solely on VC (e.g. Cumming and MacIntosh, 2003-II; Nahata, 2004 and Schwienbacher, 2002) This paper will follow Povaly‟s (2006) and Sudarsanam and Nwaghodoh‟s (2005) reasoning and will solely focus on buy-outs.
Managerial implications
This paper will not only be interesting for academics, but the results can also be interesting for both managers in PE-companies and managers in (potential) portfolio companies. This can be explained by the fact that it gives an insight in the determinants that are influencing the selection of the exit mode. In addition, this research also examines if there is a difference in the exit returns per exit mode. Managers can use the outcome to adapt their strategy to fit their (exit mode-related) goals.
1.5 STRUCTURE
2
THEORETICAL FRAMEWORK AND LITERATURE REVIEW
This chapter focuses on the theoretical framework and the literature review. In the first section the theoretical framework is presented, followed by an overview of the already existing literature on the topic discussed in this paper in the second section. After this, the conceptual model is introduced, followed by the hypotheses answered in this research.
2.1 THEORETICAL FRAMEWORK
This section discusses relevant studies that are used for building up the framework of this paper. There is one basic principle that needs to be kept in mind when examining the selection of an exit mode, namely that all principles will be traceable to the unifying common idea that the financial sponsor tends to select the exit mode with the highest return (Nahata, 2004).
PE companies are not only pure financial sponsors in the sense of the word. Except for bringing capital to the portfolio company, they also bring their knowledge, network and skills to the table. They can be characterized as value-adding investors. Cumming and MacIntosh (2001) hypothesize that a financial sponsor will exit the portfolio company when the projected added value due to the work of the financial sponsor is smaller than the projected cost for his work. In their research they admitted that some of their assumptions are unrealistic. It is for instance assumed that an investment can be sold at the true value at any given point in time. Still, their study is a solid starting point when examining the reasoning behind exit mode selection.
2.1.1 VALUE CREATION IN LBOS
Loos (2005) describes that the value creation in LBOs is the result of the influence of various sources which can be described on various layers. In his research Loos (2005) makes a distinction between drivers that have a direct effect on the operating efficiency and drivers that do not have a direct effect. Berg and Gottschalg (2005) present a model existing of three primary levers of value creation. Below the value creation in LBOs is briefly discussed on the basis of the categorization of Loos (2005). For a more detailed and in-depth overview of value creation in LBOs see for instance Loos (2005) and Berg and Gottschalg (2005).
Value creation: direct drivers
The direct drivers of value creation are drivers that can be characterized as direct, intrinsic, operational or „value-creating‟, which have in common that they lead to an improvement of the free cash flows of the portfolio company (Loos, 2005).
Cost reductions in LBOs
During the late 1980s the research of Kaplan (1989-II) shows evidence of strong improvements in the operational performance after a management buy-out (MBO). According to Jensen (1989-I) organizational changes are the primary source of value creation. The organizational changes lead to better operating and investment decisions of the company. The operating performance is improved by cost reductions which are initiated by the portfolio companies management, due to the increased level of management ownership. The increased level of management ownership is developed after the LBO by improving incentives for the management of the portfolio companies (Palepu, 1990, Loos, 2005).
Improvement of asset utilization in LBOs
An important direct driver of value creation is the improvement of asset utilization. In the literature can be found that after the LBO often the level of corporate spending will be tightened (e.g. Anders, 1992; Loos, 2005). The goal is to make more efficient use of the corporate assets which leads to an increased cash flow (Bull, 1989). Wright and Robbie (1996) found that the generally increased focus on tighter cost control and efficiency in many companies during the 1990s led to a lower attractiveness for the execution of a LBO which is driven by cost reductions. (Loos, 2005). This finding shows that the drivers cost reductions and asset utilization affect the value creation in LBOs.
Generating growth in LBOs
PE companies do not only aim for operational performance improvements to enlarge the value of the portfolio company, they also actively seek to boost the revenues (Loos, 2005). As mentioned in the introduction, PE companies are not longer only focusing on improving corporate inefficiencies, but actively try to add value by for instance generating growth of revenues after the LBO transaction.
A PE company can generate a growth of revenues by refocusing the strategic focus of the portfolio company (Loos, 2005). Refocusing leads to a renewed analysis of the key products, markets, customers etc. After the analysis non-core or inefficient business units can be divested (Anders, 1992). By refocusing the PE company increases the strategic distinctiveness and eventually the competitive positioning of the portfolio company (Berg and Gottschalg, 2005; Loos, 2005).
Another way PE companies can generate growth of the portfolio company is to make use of an add-on acquisition strategy (Loos, 2005). Using an add-on acquisition strategy means that the PE company acquires other portfolio companies that have a fit with the „main‟ portfolio company. The add-on portfolio companies can be active in exactly the same industry or in an industry which offers the main portfolio company a new market. The goal of the PE company is to integrate the portfolio companies and achieve economies of scale and scope, which will lead to revenue growth.
Financial engineering in LBOs
The financial engineering after the LBO is conducted, is characterized by the inference of the PE company. The financial sponsor uses their financial engineering skills to reform the portfolio company in a way that it makes optimal use of the capital markets (Anders, 1992).
Value creation: indirect drivers
The indirect drivers of value creation are drivers that can be characterized as indirect, extrinsic, non-operational or „value capturing‟ drivers. The indirect drivers are related to organizational changes, changes in corporate governance and ownership structure. These drivers do not have a direct influence on the performance, but they amplify the positive effects that are attributed to the direct drivers of value creation (Loos, 2005).
Leverage
The indirect driver leverage is strongly related to the direct driver financial engineering. However, it is also related to the reduction of agency costs. A high level of leverage will lead to a large debt burden which forces the portfolio company‟s management to run the company as efficiently as possible in order to avoid bankruptcy (Lowenstein, 1985; Cotter and Peck, 2001; Loos, 2005). This reduction of free available cash flows leads to declined expenditures due to the obligation to fulfil the debt payments, rather than spending the funds inefficiently (Jensen 1986; Loos, 2005). Another positive aspect of having a high financial leverage is the additional external governance. The lenders of the funds have a strong incentive to carefully monitor the portfolio company (Berg and Gottschalg, 2003).
There are critics who state that disproportionate leverage in LBOs increases the exposure to external shocks and financial distress (Loos, 2005). Singh (1990,1993) and Rappaport (1990) wrote that these external shocks can even lead to bankruptcy. Another problem which can arise is that managers can become more risk-averse and change their behaviour in a way that leads to reduced risk, in order to avoid bankruptcy (Loos, 2005). This risk-averse behaviour is not expected to be in the best interest of the company. However, Jensen (1989) suggests that the risk of insolvency for PE companies and the subsequent costs of financial distress are much lower than proclaimed (Loos, 2005). This is explained by the fact that it is in the best interest of all related parties to have a successful LBO, which reduces the bankruptcy risk considerably. The research of Kaplan (1989-II) and Kaplan and Stein (1993) showed that the level of systematic risk in LBOs is much smaller than what would normally be predicted for a transaction with this amount of financial leverage (Loos, 2005).
Information asymmetry
An assumption stated in the theory of Cumming and MacIntosh (2001) is that a portfolio company can be sold at any given point in time at the price which represents the best estimate of the true value of the company. This would imply that there is no information asymmetry. However, this is unrealistic since the seller of the portfolio company has greater access to the information than the buyer. Besides this the seller also benefits from their longer relation with the portfolio company, which normally leads to superior understanding of the company and the market it operates in. Information asymmetry has the potential to lead to a reduced price (in comparison with a situation without information asymmetry) when the company is sold (Cumming and MacIntosh, 2003-II).
information asymmetry to larger extent. Cumming and MacIntosh (2001) therefore assume that the financial sponsor will generally select the exit mode which resolves the information asymmetry to the buyer best, in order to maximize their exit return.
The buyer in an SBO is another financial sponsor, which usually distinguishes itself in comparison to the original financial sponsor by having a strong presence in the industry or related industry of the portfolio company. The strong presence in the industry gives the buyer the advantage of an extended market knowledge, which they can use to add value, to an extent the first financial sponsor was not capable of. According to Voigthaus et al. (2004) the strongly developed industry knowledge makes secondary financial sponsors better capable to resolve the information asymmetry than most stockowners in a public company.
In a TS the portfolio company is acquired by a strategic buyer. A strategic buyer is normally active in the same or a related industry as the portfolio company is active in. This leads to large knowledge of the portfolio company‟s sector, which means that the information asymmetry is relatively small. Cumming and MacIntosh (2003-II) argue that the strategic buyer has large bargaining power due to their sector knowledge, which gives them the ability to resolve the information asymmetry and value the true value of the portfolio company better than IPO or SBO buyers.
Agency costs
Another aspect that influences the value creation in portfolio companies are the agency costs. The agency costs are costs related to monitoring and disciplining of the managers of the purchased company. This is closely related to the information asymmetry. Cumming and MacIntosh (2003-II) state that just like with the information asymmetry some buyers can handle the agency costs better than other. Again, the ability to manage the agency problem related costs is priced in the valuation of the portfolio company. Cumming and MacIntosh (2003-II) therefore hypothesize that companies who are better able to handle the agency problem, will value the portfolio company higher.
For an exit via SBO it can be assumed that the monitoring of the management will be more effective than for an IPO exit. The buyer, the new financial sponsor, has a strong incentive to monitor the management, since its goal is to maximize the value of the portfolio company and its own exit return. The experience of the PE company in monitoring portfolio company‟s management can been seen as an additional advantage. When the portfolio company is sold via a TS, the structure will be different from SBO exit and will depend on the strategy of the acquiring company. The acquiring company can choose to integrate the companies or to leave the acquired former portfolio company as a separate business unit. However, the main goal of the acquiring company will be to produce the synergies that are incorporated in the enterprise value of the portfolio company. In comparison with the other two exit modes the TS has the advantage that it fully controls the board, which gives the acquirer the possibility to reduce the agency costs.
2.2 LITERATURE REVIEW
Table 2-1: Literature overview
Author(s) Examined
time-frame Sample
Dependent variable
Key independent
variables Aim Key findings
Sudarsanam and Nwaghodoh (2005) January 1998 – June 2004 UK 104 transactions (only LBOs) Exit mode (IPO, SBO, TS) LBO sponsor reputation, holding period, financial leverage, IPO volume, industry affiliation, company size, exit return, operating performance
Examining the determinants and exit returns of LBO exits
The holding period for companies exited via SBO is significantly longer than for companies exited via TS or IPO
Companies with a high financial leverage, exit more often via IPO compared with SBO
Portfolio companies exited via SBO have the highest EBITDA/TA ratio, TS has the second highest ratio, the smallest ratio is found for portfolio companies exited via IPO
Companies with a high EBITDA / TA ratio exit more often via SBO. Same finding for a high level of TA
High-technology companies exit more often via IPO compared to an exit via SBO
Nahata (2004) 1991 - 2001 US 2868 transactions (only VC) Exit mode (IPO, acquisition, write-off) Financial variables (financing rounds, number of investors, etc.), VC reputation variables, industry variables, other variables
Document factors that are significantly influencing the selection of a VC exit mode
Portfolio company‟s financial performance has a positive relationship with the likelihood of an exit via IPO
The total investments in the portfolio company by the venture capitalist are larger for an exit via IPO and acquisition compared to an exit via write-off
The number of professional buy-outs investors in the portfolio company by the venture capitalist are larger for an exit via IPO and acquisition compared to an exit via write-off
Voigthaus et al. (2004) 1999 – 2004 Germany 195 transactions (LBOs and VC) Exit mode (SBO, MBO, TS) Turnover multiple, EBITDA multiple, EBIT multiple, Earnings multiple Examining if exits SBOs are creating value or if it is a case of capital recycling
An exit via SBO should not be seen as a second best alternative to recycle the PE company‟s capital
SBOs show the highest multiples in most cases. Significant findings are however only found in the leisure sector and the turnover multiple cluster
Cumming and MacIntosh (2003-II) 1992-1995 US and Canada 246 transactions (only VC) Exit mode (IPO, acquisition, SBO, buy-back, write-off, other) Portfolio company quality, VC investment duration, industry affiliation Identify the determinants of the exit mode selection
The likelihood of an IPO is increased with a higher market to book ratio (company quality)
Differences on country level: more buy-backs in Canada, more write-offs and acquisition exits in the US
Povaly (2006) 2006 Europe (Survey at PE companies and 12 interviews) 56 respondents Exit mode (IPO, TS, SBO, recapitalization) Indirect directors, management replacement, PE company size, company type, fund type
Examining the exit mode process management of buy-out investors (exploratory study)
PE companies that frequently replace the original (senior) management after an investment tend to select the exit mode TS less often than PE companies that do not frequently replace the original (senior) management
PE companies that frequently replace the original (senior) management tend to exit the portfolio company more often via SBO than PE companies that do not frequently replace the original (senior) management Schmidt et al. (2009) 1990 – 2005 US and European 672 transactions (LBOs and VC) Exit mode (IPO, sale, write-off)
LBO sponsor age, LBO sponsor experience, holding period, IRR, committed capital, industry affiliation Examining the determinants of exit mode selection
PE companies write-off non-performing investments early, this shows their ability to filter good from bad investments
Evidence was found that the selection of an exit mode is driven by the sentiment of the market
The most profitable ventures are exited via IPO
Schwienbacher (2002) No specific time frame (survey conducted in 2001) US and Europe 171 transactions (only VC) Exit mode (IPO, TS and liquidation)
Holding period, LBO sponsor age, - size, number of investors, industry affiliation, buy-out stage, region, convertibles, financing rounds
Analyzing the impact of VC company characteristics on the exit mode selection and examining differences between the US and Europe
An exit via TS is the preferred exit mode for the VC in the research
Young venture capitalists monitor less, but invest more in early-stage compared to more established venture capitalists
Most of the difference between the US and Europe can be explained by the fact that the capital markets in Europe are less liquid
Research question one focuses on the determinants for the selection of an exit mode of a LBO portfolio company for a PE company. After examining the existing literature seven possible determinants are selected. The portfolio company‟s specific variables are: operating performance, portfolio company size, portfolio company quality, industry affiliation and financial leverage. The investment variables are: investment duration and management replacement. The portfolio company‟s specific characteristics are discussed in detail in section 2.2.1 and the investment characteristics are described in detail in section 2.2.2.
2.2.1 PORTFOLIO COMPANY CHARACTERISTICS
Operational performance
therefore crucial in the selection of an exit mode. Bienz (2004) argues that companies which are highly profitable tend to go public, whereas less profitable companies are exited via a TS. This in accordance with the findings of Degeorge and Zeckauser (1993), who found that companies that went back public after an LBO showed a peak in their operating performance in the year before exiting.
In the research of Sudarsanam and Nwaghodoh (2005) the operational performance is measured by taking the EBITDA and divide it by the number of total assets. The authors have found that the differences in the relationship between operational performance and the selection of an SBO or a TS as an exit mode is statistically significant. This would imply that portfolio companies that are exited via an SBO are in better operating performance. A logistic regression shows that a high EBITDA divided by total assets ratio leads to an increase of the relative probability to exit via an SBO (this is valid in the choice between IPO and SBO). When looking at the choice between SBO and TS, again it becomes clear that a high EBITDA divided by total assets ratio makes the choice for an SBO more likely. They attribute this finding partially to the need for an exit of the financial sponsor, which offers a second financial sponsor an attractive opportunity to enter. It is also expected that the experience of the financial sponsors in due diligence research would give them the systematic advantage to select the best companies from other financial sponsors.
The importance of operational performance for the selection of an exit mode is also confirmed by the research of Povaly (2006). He found that 98% of the respondents of his survey saw portfolio company performance as at least relevant, whereas 68% acknowledges portfolio company performance as at least an important determinant for the selection of an exit mode.
Portfolio company size
In the study of Povaly (2006) it becomes clear that the portfolio company size is an important determinant for the mode of exit from the perspective of the PE companies. The survey conducted in this study shows that 83% of the responding PE companies sees size as an relevant determinant in the exit mode selection process. Even 65% thinks size is an important or even highly important factor in the exit mode selection process. Also in the research of Sudarsanam and Nwaghodoh (2005), the size of the portfolio company is expected to be a determinant in the selection of an exit mode. In their research the use the number of total assets as a proxy for the variable portfolio company size. The authors expect that smaller companies would be more likely to select the exit mode SBO than via an IPO. This is confirmed by their results. They found that the relative probability of an exit via SBO was increased with a high TA value. That would imply that smaller companies would be more likely to exit via an SBO. As another explanation for the lower propensity for an IPO exit, they came up with the argument that due to the bearish capital market in the period 2000-2004, it was easier for smaller companies to raise funds. This is reflected in the decrease of the average transaction size. Wright et al. (2000) argue that a small transaction could not be profitable due to transaction and integration costs. In addition the contribution to the return of the parent strategic company would be marginal. For financial sponsors on the other hand, buying several small companies can be part of add-on acquisitions in which they combine these companies to add value by a buy-and-build strategy.
Portfolio company quality
via IPO. In addition it was also found that high quality portfolio companies tend to exit more often via SBO compared to an exit via TS.
Nahata (2004) also expects the company quality to be an important determinant in the selection of an exit mode. He expects that the quality of the companies held by the portfolio company that would enter the IPO market would be relatively large, whereas companies that would undergo a write-off would have a relatively low quality. He expects the quality of the companies who exited via TS to be between the quality of exits via IPO and write-offs. To measure the quality of the company Nahata (2004) made use of several different proxies (the number of financing rounds, the level of financing in the last financing round before the exit, the total of the investments of all financing rounds and the number of venture capitalists (number of investors) who invested in the company). Nahata‟s (2004) results showed that the number of professional investors was larger for exits via IPO than via TS.
Industry affiliation
Cummings and MacIntosh (2003-II) examine whether there is a relationship between the selection of an exit mode and the industry the company is active in. They split their sample in high-technology and low-technology companies. This is done because there are several differences between these companies. First of all, information asymmetry is playing an important role. It is expected that in high-technology companies there is more information asymmetry, due to the nature of a sector (mainly intangible and transaction-specific assets). Valuation of this type of companies is also difficult since a great proportion of the value is based upon human capital (which is relatively mobile, since employees can resign and work for another company). Secondly, the capacity of achieving transaction synergies are probably better in high-technology companies. This would imply that a TS would be the suited exit mode. Cummings and MacIntosh (2003-II) therefore stated a hypothesis in which they assume that there is an equal probability for a high-technology company to exit via an IPO or TS. They assume that the exit mode pecking order in decreasing order of likelihood would be: IPO and TS, SBO, buy-backs, and write-offs. The results confirm that portfolio companies which were active in high-technology industries are more likely to be exited via TS and SBO than via a buy-back. However, other results did not support the hypothesized exit mode pecking order. It was found that high-technology companies tend to exit via SBO rather than via the expected TS.
Brau et al. (2003) found that high-technology industry affiliation is positively related to the exit mode selection for an IPO. Sudarsanam and Nwaghodoh (2005) also expect that the industry a company is active in, would relate to the selected exit mode. They did not find significant evidence for the selection between a TS or an SBO and industry affiliation. However, they did find significant evidence that a portfolio company active in a high-technology industry is exited more often via IPO compared an exit to via SBO.
Financial leverage
According to Sudarsanam and Nwaghodoh (2005) companies with high debt and related interest costs can consider an IPO to change their capital structure, which allows them to get access to cheaper funding. Close monitoring of the lenders could mitigate the problem of adverse selection, making an exit via IPO attractive for highly leveraged companies. However, the high debt level can also lead to a perception of high risk for the investor, which would lead to a discount in the company price. From this perspective it can be argued that highly leveraged companies select an exit via TS, since this is the more conservative restructuring path (Sudarsanam and Nwaghodoh, 2005).
Sudarsanam and Nwaghodoh (2005), put forward that highly geared small companies with high growth potentials and a large future capital investment plan, have little choice than financing their investment via stock market generated funds. Empirical evidence in the study of Sudarsanam and Nwaghodoh (2005) showed that the highest leverage could be found in the group that exited via an IPO, although this finding was not significant. However, they found that a high total debt / total assets ratio leads to a significant increase of the probability of the exit mode selection of an IPO compared to an SBO. This finding was not applicable to the choice between an SBO or a TS.
2.2.2 INVESTMENT CHARACTERISTICS
Investment duration
The research of Cumming and MacIntosh (2001) focuses on the investment duration and its relationship with information asymmetry. The authors hypothesize that the larger the level of information asymmetry, the longer the investment period (investment period is also referred to as holding period). Since the level of information asymmetry is expected to be higher in high-technology companies, this would lead to a longer holding period for these companies. The results however showed that the investment period is not affected by the sector a portfolio company is active in.
Cumming and MacIntosh (2003-II) hypothesize that the holding period has an effect on the selection of an exit mode. It is expected that the longer the investment period, the more likely the following exit ranking would occur: IPO, SBO, TS, buy-back and write-off. The results did not support the exit ranking. However, significant results were found that the longer the investment duration, the more likely the portfolio companies will be exited via acquisition and buy-back in comparison with an exit via write-off.
Sudarsanam and Nwaghodoh (2005) took a different look on the holding period of a portfolio company. According to them, companies who are funded with VC are first showing an increased likelihood of an exit via an IPO. After that they reach a plateau from which the likelihood of an exit via an IPO decreases as time goes by. The findings indicated that the duration of the investment period has a predictive effect on the exit mode. This fits the thoughts of Wright et al. (2000), who argue that the longer the holding period will be, the more likely the portfolio company will be divested via SBO than via an IPO or TS. The preceding can be explained as follows: the longer the holding period, the more likely it is that the financial sponsor is getting more eager to find an exit method to realize their returns. The results of Sudarsanam and Nwaghodoh (2005) showed that the holding period is significantly higher for portfolio companies which are exited via SBO in comparison with portfolio companies which are exited via TS.
Management replacement
more than the TS. He found that PE companies that replaced the original management often, were less likely to exit the portfolio company via a TS in comparison with an SBO.
Exit returns
When reviewing the literature, it becomes clear that there is no unambiguous result found for the relationship between the selected exit mode and the exit return. The literature can be divided into two categories. The first category are the authors that do not expect differences between the exit returns of different exit modes. Within this category Cumming and MacIntosh (2003-II) argue that it is unlikely that the exit returns are dependent on the selected exit mode. Sudarsanam and Nwaghodoh (2005) also do not assume a specific outcome, but eventually did find evidence that an exit via IPO would lead to the largest exit return, followed by SBO and TS.
2.3 CONCEPTUAL MODEL
The conceptual model (table 2-2) for this research is based on the theoretical framework, the literature review and expectations based on both. In the upper part of the model, the determinants which are based on the portfolio company characteristics are visualized. The lower part shows the determinants which are based on the investment characteristics. Combining the determinants should help answering the first research question. The second research question will be answered by analyzing the exit returns for both TS and SBOs.
Table 2-2: Conceptual model
2.4 HYPOTHESES
The hypotheses are developed based upon the existing literature and the conceptual model visualized in table 2-2 above. The first five hypotheses focus on the portfolio company characteristics. Followed by two hypotheses which discuss the investment characteristics. Testing these seven hypotheses should answer the first research question. The last hypothesis focuses on the exit returns and thereby should answer the second research question.
Portfolio company hypotheses
The existing literature shows mixed evidence regarding the influence of operational performance on the selection of an exit mode. However, most literature suggest that operational performance has a positive influence on the probability of an exit via SBO. Therefore in this research it is expected that the higher the operational performance, the higher the relative probability of an SBO exit compared to a TS exit will be.
HI : High operational performance leads to an exit via SBO.
Preffered exit mode
Investment characteristics Portfolio company characteristics Portfolio company specific characteristics
Portfolio company specific characteristics
According to Wright et al. (2000), Sudarsanam and Nwaghodoh (2005) and Povaly (2006) the attractiveness of a portfolio company may be a function of portfolio company size. Based on their research, it is expected that the larger the portfolio company, the more likely the company would exit via a TS instead of an SBO.
For the variable industry affiliation Cumming and MacIntosh (2003-II) hypothesized that the information asymmetry theory leads to a preference for an exit via TS before an exit via SBO. Although their results showed the contrary, this expectation is confirmed by several other studies (e.g. Brau et al., 2003; Sudarsanam and Nwaghodoh, 2005). Therefore in this research it is expected that companies who are active in a high-technology sector are more likely to exit via a TS than via an SBO.
The research of Cumming and MacIntosh (2003-II) and Nahata (2004) hypothesize that the quality of the portfolio company has an influence on the selection of an exit mode. However, their results were mixed. Nahata‟s (2004) research confirmed the hypothesis, while the research of Cumming and MacIntosh (2003-II) showed opposite results. The hypothesis for this variable is therefore constructed to test the result of Cumming and MacIntosh (2003-II). It is expected that the higher the quality of the company, the more likely the portfolio company will be exited via an SBO in comparison with an exit via a TS.
The research of Sudarsanam and Nwaghodoh (2005) found significant evidence for the exit mode selection between IPO and SBO (highly leveraged companies tend to exit via IPO). However, no significant findings were found for the selection between an SBO and a TS. In this research it is expected that a highly leveraged company is less attractive for a second financial sponsor, which implies that the higher the leverage of a portfolio company, the more likely the portfolio company will be exited via an SBO in comparison with an exit via a TS.
Investment characteristics hypotheses
For the investment characteristic variable investment duration, the existing literature (e.g. Wright et al. 2000; Cumming and MacIntosh, 2001, 2003-II; Sudarsanam and Nwaghodoh, 2005) shows that when the holding period of the portfolio company grows, the need to exit for the PE company starts to grow. Therefore it is expected that the longer the holding period, the more likely the company is to exit via an SBO in comparison with a TS.
The last investment characteristic variable that is tested is management replacement. Schwienbacher (2002) suggests that if the original management of the portfolio company was to be replaced, the management would be replaced by more competent management. The preceding is in accordance with the findings of Povaly (2006). In his study he found that companies who replaced their management before the exit, did use the exit mode SBO
HVI : A long investment duration in the portfolio company leads to an exit via SBO.
HV : A highly financial leveraged portfolio company exits via TS.
HIV : High portfolio company quality leads to an exit via SBO.
HIII : Companies active in high-technological industries exit via TS.
more than the TS. For this variable it is expected that if the management at the original buy-out is replaced, the company tends to exit via an SBO instead of via a TS.
Exit returns hypothesis
This hypothesis is focused on answering the second research question. The literature focusing on the exit returns for the exit modes SBO and TS do not show unambiguous results. Cumming and MacIntosh (2003-II) argue that it is unlikely that the exit returns are dependent on the selected exit mode. However, other research showed some statistically significant results that the exit returns are dependent on the selected exit mode. Voigthaus et al. (2004) found that SBOs can be assumed a superior exit mode (in certain clusters) compared to a TS. In this research is expected that the exit returns are larger for portfolio companies which are exited via an SBO.
HVIII : The exit returns of LBOs exited via SBO are larger than the exit returns for exits via TS.
3
METHODOLOGY AND DATA
The focus of this chapter will be on the data collection and the methodology of this paper. The first section will discuss the data collection methods and their implications. The second part will elaborate on the applied methodology.
3.1 DATA COLLECTION
The sample is gathered by using the electronic database Mergermarket3. In Mergermarket a search is started within the time-frame January 1, 1998 – June 1, 2009. The explanation for this time frame is two folded. On the one hand, there is no recent study which is covering the (PE) LBO exit modes for a period this extensive, and there are no recent studies (which include both SBOs and TSs) that are focusing on the time period 2004-2009 at all. On the other hand, this time frame is also induced by the information source used for the data gathering. The Mergermarket database has data available about the PE LBO exits starting January 1, 1998.
As mentioned in the introduction the portfolio companies of the transactions were based in the UK. For this paper only transactions with a transaction value of at least 25 million GBP are included in the sample. This lower limit is set since in a test sample it was not possible to obtain the necessary financials in more than 90% of the cases of transaction with a transaction value below the 25 million GBP. Also transactions with an undisclosed transaction value were excluded (summarized in Figure 4.1; step 1, next page).
Based on the criteria above the Mergermarket database identifies a number of 967 transactions. The 967 transactions are checked upon the availability of the necessary financials. When these financials were not available, Amadeus4 is used to find the necessary financials. After checking and searching the last financial statements before the buy-out for these 967 transactions, 609 portfolio companies were removed due to the unavailability of the necessary financials. Since this research is focusing solely on buy-outs, VC transactions also needed to be removed. This is done in step three were 21 companies are removed. After this, the portfolio companies that were involved in a buy-back exit (eight transactions) were removed, since this research is only focusing on the exit modes SBO and TS. Sixteen transactions were removed since they involved only the transaction of a minority stake (< 50%). The final step was to remove the companies (sixteen) of which certain additional information (like management replacement, exact transaction date) was not available after a search in Mergermarket or LexisNexis5. After the removal of all the companies based on the above criteria, the sample of this research contains 297 portfolio companies.
Table 3-1: Roadmap to sample
3
Mergermarket is a product of the Mergermarket Group that is part of the Financial Times Group. Mergermarket is a tool that is used to find and search in historical deals, but also gives the opportunity to search for an appropriate target for future deals (more information on: htpp://www.mergermarket.com).
4
Amadeus is a comprehensive, pan-European database containing financial information on over 10 million public and private companies in 38 European countries (more information on: http://www.bvdep.com/en/amadeus.html).
5
Criteria # of transactions
Step 1: Number of companies identified after searching inMergermarket database with the following criteria: o Period: January 1, 1998 – June 1, 2009 o Transaction size: > 25 million GBP
o Transactions with an undisclosed deal value are excluded from the sample
o Transaction with a British portfolio company
967
Step 2: Removal of transactions of which no complete financialinformation was available after search -609
Step 3: Removal of VC -21
Step 4: Removal of buy-backs exits -8
Step 5: Removal of minority stake (< 50%) -16
Step 6: Removal of transactions of which no complete information was available after search about Management replacement and holding period-16
Total sample size 2973.2 SAMPLE DESCRIPTION
Following the steps described in the previous section of this chapter leads to a sample with the following characteristics. The sample contains 297 portfolio companies. 167 of these companies were exited by SBO (56.2%), while the other 130 were exited through TS (43.8%). This is visualized in graph 3-1 (below).
Graph 3-1: Exit mode split of the sample
When analyzing the distribution of the total sample at the sector level it is clear that the largest sector present in this sample is the leisure sector (16.16%), followed by the services (other) sector (13.80%) and the consumer: retail sector (12.20%).
The distribution of portfolio companies per exit mode over the industry sectors shows that the overall differences are relatively small in the sample. In most of the sectors the exit mode chosen is divided quite equally (specially due to the small numbers). However, there are some exceptions. In the following sectors the exit mode SBO is chosen substantial more often than the TS: computer services, consumer: retail, consumer: other, industrial products and services and transportation.There are also sectors in which predominantly is exited via TS: media, telecommunication: hardware. A complete overview of the number of portfolio companies per sector can be found in table A-2 in the Appendix.
SBO: 167 transactions TS: 130
