Section II – Recommended approach to measure value creation in LBO operations.. 44 The Leveraged Buyouts (LBO) industry has been the subject of many. A secondary buyout (SBO) is a leveraged buyout (LBO) of a including secondary, tertiary, quaternary and quinary LBOs, and the term buyout. 11/What are the three types of risks that the shareholder ofan LBO fund runs? 12/ Can an LBO More questions are waiting for you at
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Every period sees the vernimmfn of a different form of organisation, which provides an appropriate response to the problems of the day, and then, after having served its purpose, is eventually phased out.
It was financial companies like Paribas, Mediobanca, Deutsche Bank, Suez and Investor that until the late s provided equity capital in an environment where this was very scarce indeed.
: Some of the graphs and statistics reproduced in the book
The strong demand for corporate governance which has emerged since the early s has considerably helped the development of LBOs in Europe. The way they are organised results a level of corporate governance that is, to date, unequalled. Has any value been created though? Higher returns only equal higher value if the risk is constant.
We shall demonstrate that this is not so. The extra risk neutralises the extra return and the value remains constant. If we now assume that interest on the LBO debt is tax deductible because it can be set off against the profits of the company being bought, the IRR rises to We can see that the tax advantage, which is often held up as THE source of value creation in LBOs is relatively minor when compared with the impact of the company’s improved operating performance under an LBO, as illustrated by the graph below:.
This is a gain in IRR that amounts to three times the amount of tax deductible interest on LBO debt and one-and-a-half times more than the impact of a leverage effect that fails to create value.
The improved operating performance brought about by and LBO, whatever form this may take — higher volumes of business, growth in margins, activity refocus, improved capital employed reduction of working capital requirement, greater optimisation of investments — is thus the main score of value creation in LBOs. Steven Kaplan 2 highlighted this as early as by showing that, in a given sector, the best operating performances were recorded by companies that had undergone LBOs.
Another illustration is provided by a comparison of the performance of Legrand and Schneider Electric, which was forced in to sell the Limoge-based group Legrand through an LBO:. Although Schneider Electric recorded an outstanding performance, raising its operating margin by 2. Part II of this article will be published in the February edition of the Vernimmen.
Journal of Financial Economics, Octobervolume 4, pages to The average IPO discount price at which shares were sold to the public compared to the share price five trading days after the IPO is rather low at 6.
On the contrary, the valuation of some of them was very stretched: Entrepreneurial spawning While the factors that determine choices made by venture capital-backed entrepreneurs have often been analysed 1very few research papers have been written on what motivates these entrepreneurs.
Three US researchers 2 have studied this issue, focusing mainly on employees of listed firms who decide to become entrepreneurs themselves. They account for almost half of the founders of venture capital-backed firms.
The authors identify and test two types of motivating factors. The first is symbolised by the example of Fairchild Semiconductors, a particularly innovative firm. Between andone third of entrants to the semiconductor industry in the USA had at least one founder who had worked for Fairchild in the past Intel is but one example.
Employees of such companies are likely to have a lower risk aversion level than those of less innovative listed companies, because of the less predictable nature of their business. Add to this the fact that they have acquired very specific experience and are integrated into supplier, customer and investor networks, and this can make them better suited to and more keen on launching their own ventures. The other explanation put forward is that employees decide to set up on their own because their companies fail to provide them with the resources they need to develop their ideas.
This is mainly the case of large, mature, highly bureaucratic companies. The authors take the example of Xerox, which set up an enormously fertile research centre, but failed to commercialise the innovations and inventions of its researchers.
Many of them patented their inventions and went off to set up their own companies. The main reasons why companies like Xerox fail to exploit new patents internally include distance between management and inventors and concern that too much diversification will impact negatively on the value of the firm.
Definition for : Buyout, LBO, Leveraged BuyOut
Data collected by the authors on the creation of venture capital-backed firms in the USA between and show that the Fairchild model is behind more such companies than the Xerox model. This is in line with the network effects referred to above. Additionally, firms set up by these employees are relatively speaking more often involved in different activities than the original company.
So there is no sectorial justification for this effect. Similarly, regressions show that innovative companies, especially in sectors that are of special interest to venture capitalists IT and healthhave a higher level of entrepreneurial spawning, and the same goes for firms that were themselves venture capital-backed.
Letter number 13 of February 2006
This study could help explain the political difficulties involved in encouraging the creation of new businesses in regions where there are few innovative companies to start with. Encouraging investment is not enough to encourage the development of a network of innovative companies and investors.
The ability to attract entrepreneurs who already have experience in venture capital-backed firms is a much more important factor. Scharfstein, Journal of Finance April There has been less comments on why companies decide to delist, which is also lo interesting topic for analysis. A company is sometimes delisted after it has been taken over. Generally, when the acquiring company is a trade buyer, management is keen to implement synergies with its own assets and the presence of minority shareholders can hamper their progress.
Additionally in some countries, investors have to obtain a vernimmen percentage of the share capital e. In these cases, delisting is the natural path to follow.
Whatever the circumstances of the takeover, we see that once a takeover bid has been launched, the delisting process is relatively simple. There are occasions, however, when the issue of delisting comes up for a shareholder that has controlled a listed company for a certain period of time. In these cases, the cost of listing 1 has to be weighed against the benefits of listing when deciding whether the company should remain listed or not. A company or the shareholder will first start considering a public to private buyout when the reasons why it decided to list its shares in the first place have, for the most part, become irrelevant.
This is especially the case if:. The company no longer needs large amounts of outside capital and the shareholders themselves are able to meet any requirements it may have. The company no longer has any ambition to vernimmmen capital on the market or to pay for acquisitions in shares The stock exchange no longer provides minority shareholders with sufficient liquidity which is often rapidly the case for smaller companies which only really benefit from liquidity at the time of their IPO.
Listing then becomes a theoretical issue and institutional investors lose interest in the share The company no longer needs the stock exchange in order to increase awareness of its products or services. The second reason why companies delist is financial. A large shareholder, whether a majority shareholder or not, may consider that the share price does not reflect the intrinsic value of the company.
: Glossary definition : LBO
Turning a problem into an opportunity, such a shareholder could offer minority shareholders an exit, thus giving it a larger share of the creation of future value. A public tender offer must be launched in order to delist a company.
Delisting is possible if the majority shareholder exceeds a threshold, as it is then obliged to acquire the rest of the shares.
This is known as a squeeze-out. In practice, this amounts to forcing minority shareholders to sell any outstanding shares. Because this is a form of property expropriation, the price of the operation is analysed very closely by the market regulator. In most countries, a fairness opinion has to be drawn up by an independent, qualified, financial expert.
In the USA and for dual-listed companies, companies can delist without expropriating the shares of minority shareholders. The minority shareholders remain shareholders of an unlisted company which is still required to register with the SEC. Getting rid of SEC formalities has become such a headache for non US companies 4that some of them are now thinking twice about listing or dual listing on the other side of the Atlantic. This is one of the reasons why the SEC is looking at ways of providing companies that are already listed outside the USA with a lot more flexibility in the whole deregistration process.
Stock exchange fees, publication of annual report, meetings with analysts, employment of investor relations staff, and indirect costs: Challenge ahead for LBOs part one Over the last 20 years, the LBO 1 has become very much a part and parcel of the financing landscape, although its key competitive advantage — the introduction a new form of corporate governance — is rarely fully appreciated.
This new method of governance is probably one of the most efficient that currently exists, but it does not come without its own problems. LBO funds will have to find solutions to these problems if they want to see their strong growth continue into the future.
This is especially the case if: Listing then becomes a theoretical issue and institutional investors lose interest in the share The company no longer needs the stock exchange in order to increase awareness of its products or services The second reason why companies delist is financial.
Accordingly, it is not surprising to note, that even though there is no change in control, tender offers launched for the purpose of delisting a company are made at a premium that is equivalent to the premium paid for takeovers 3.