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Mergers and Acquisitions Best Practice

Leveraged Buyouts and Recession

by Louise Scholes and Mike Wright

Executive Summary

  • After unprecedented levels of deal activity in 2007, the descent into recession in 2008 and 2009 presented both challenges and opportunities for the buyout and private equity market.

  • We have seen higher failure rates of buyouts as a consequence of highly leveraged transactions running into difficulties.

  • Private equity-backed and larger buyouts appear less likely to fail than other buyouts. In failed buyouts secured creditors on average recover about 60% of their loans.

  • The increase in general business failure associated with recession introduces opportunities for buyouts to rescue and turn around these failing firms, with retail sector deals especially prevalent in recent years.

  • Private equity firms can take advantage of the increased supply of failing firms provided that they have the necessary means (financial and management skills) to turn the businesses around.

  • Private equity firms have been less in active in recent years in buying failed firms, although there have been some significant transactions.

  • Buyouts of failed firms are disproportionately more likely to fail again than buyouts from other vendor sources.

  • Debt buybacks and payment-in-kind loans (PIK) have been employed to reduce debt burdens.

  • Debt-for-equity swaps and covenant resets were a feature of the recent recession.

  • The buyout market is now showing signs of consolidation after the 2008–2009 collapse, but recovery is slow.

  • Private equity firms specializing in turnarounds have become a feature as more opportunities for restructuring arise.

Introduction: The Buyout Market in Europe

The buyout market in Europe involves management buyouts and buyins of firms with or without the assistance of private equity. A management buyout is the purchase of a business by its own management, whereas a management buyin involves the purchase of a business by an external management team. Buyouts are economically very important in terms of business regeneration and survival in Europe and the United States. In the United Kingdom, buyouts account for about half of all merger and acquisition (M&A) activity. According to the European Private Equity and Venture Capital Association (EVCA), investments in buyouts before the current recession accounted for 79% of all private equity and venture capital investments in Europe in 2007. The buyout market in Europe reached a record €179 billion from 1,515 transactions by the end of 2007 (Figure 1). Following the recession, the value of the European buyout market dropped sharply in 2009 as banks stopped lending for the larger deals, but the market has since shown signs of recovery/consolidation and in 2012 reached €52.5 billion from 565 deals. The UK buyout market has always been the largest contributor to the European total, with €20.5 billion from 374 buyouts in 2012, with secondary buyouts having a reasonably high profile.

Note: Europe is defined here as Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

As recessionary conditions took hold, there was a fall in the number of large deals, and a rise both in failures of buyouts and in buyouts of failed firms. The private equity industry may struggle as investments fail or underperform, but potentially it can restore the balance by buying and reviving failing companies. The industry has survived despite the recessions of the past and, provided that it can adapt, will survive the most recent recession and in fact is showing signs of recovery.

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Further reading

Articles and Reports:

  • Gilligan, John, and Mike Wright. “Private equity demystified: 2012 update.” ICAEW Corporate Finance Faculty, 2012. Online: tinyurl.com/4xgeu8f
  • Wilson, Nick, Mike Wright, and Ali Altanlar. “Private equity, buy-outs, leverage and failure.” CMBOR/CMRC, March 2010.
  • Wright, Mike, Andrew Burrows, Rod Ball, Louise Scholes, Miguel Meuleman, and Kevin Amess. “The implications of alternative investment vehicles for corporate governance: A survey of empirical research.” OECD, July 2007. Online at: www.oecd.org/daf/ca/39005553.pdf

Websites:

  • British Private Equity and Venture Capital Association (BVCA): www.bvca.co.uk
  • Centre for Management Buy-Out Research (CMBOR), Imperial College Business School: tinyurl.com/89svv2l
  • European Private Equity and Venture Capital Association (EVCA): www.evca.com

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