A Note on Secondary Buyouts-Creating Value or Recycling Capital

Dirk Schiereck,Jana Kitzmann

doi:10.4236/ib.2009.12015

Abstract

This paper analyzes whether secondary buyouts of private equity (PE) investors in general create value and therefore are a suitable alternative to exit strategies like trade sales and IPOs. Theoretically, two conflicting approaches might explain the use of secondary buyouts as an exit channel of private equity investors: the capital recycling effects and different potential sources of value creation. We present empirical tests of these approaches. The profitability of secondary buyouts is assessed by a comparison of exit multiples realized with secondary buyouts and trade sales. The results are not unequivocal, but overall we interpret our findings in a way that awards secondary buyouts a profitability that is not significantly different from trade sales. Therefore, we argue that secondary buyouts have the potential for adding value that arise from different sources like the reduction of agency costs or the functions of the financial investor. Secondary buyouts should thus not be seen as a second best alternative for recycling the PE investors’ capital in situations where alternative—and supposedly more attractive—exit channels are unavailable.

Highlights

The profitability of a private equity (PE) investments critically depends on the realization of a successful exit strategy to terminate an investment [1,2] Throughout the 1990s and until the year 2000, PE investments were primarily exited through initial public offerings (IPOs) [3]
The central subject of examination in this paper has been the question whether secondary buyouts in general create value and are a suitable alternative to exit strategies like trade sales and MBOs
It was assumed that secondary buyouts would be potentially value adding exit channels, if their profitability would be comparable to that of trade sales

Summary

Introduction

The profitability of a private equity (PE) investments critically depends on the realization of a successful exit strategy to terminate an investment [1,2] Throughout the 1990s and until the year 2000, PE investments were primarily exited through initial public offerings (IPOs) [3]. PE investments can be defined as minority participations in the equity of companies that are not publicly listed at a stock market [11] These kinds of investments have “a strict finite life with an expected duration of a few years [11]1 and the nature of the investment usually requires a high degree of direct involvement by the investor.” [12,13] The overriding importance of an efficient exit strategy thereby results from the fact that most of the PE investor’s return arises in the form of capital gains at the time of the exit, and not through cash flows during the investment period [8,9].

Secondary Buyout Exits and Their Impact on Exit Values

Capital Recycling By Secondary Buyout

Value Creation Effects

Data and Methodology

Results

Conclusions and Outlook