Private Equity Lemons? Evidence on Value Creation in Secondary Buyouts

Abstract

The sale of a company, where both buyer and seller are private equity funds, is commonly known as a secondary buyout. While the empirical evaluation of value creation and its drivers on deal level has been one of the focus areas of private equity research, this paper presents a specific analysis of the value creation potential of secondary buyouts compared to primary buyouts by focusing on two central issues. It analyzes whether secondary buyouts generate lower returns than primary buyouts and how the value creation profile of secondary buyouts compare to primary buyouts with a specific analysis of the drivers leverage, operational improvements and pricing. Using a sample of 910 realized buyouts transactions (including 115 secondary buyouts), we find little evidence that secondary buyouts generate lower equity returns or offer fundamentally lower operational value creation potential. On the other hand, we can show that secondary buyouts obtain more leverage than primary buyouts even after having controlled for debt market conditions, which can be motivated with reduced informational asymmetries in a secondary buyout setting. Furthermore, we find evidence that secondary buyouts are more expensive than other buyouts, which is not surprising since the acquiring private equity sponsors is purchasing the asset from a seller with similar market timing and negotiation skills.