The Determinants of Buyout Returns: Does Transaction Strategy Matter?

Abstract

This paper reexamines one of the most studied questions in the scholarship of leveraged buyouts (LBOs): how do LBO sponsors create value for their investors in take-private acquisitions? In so doing, the paper makes two significant contributions to our understanding of LBOs. Most importantly, the paper provides the first-ever analysis of the equity returns to LBO sponsors. Due to data limitations, prior studies have traditionally relied on total returns to an LBO (that is, returns to both debt and equity investors) to analyze the source of LBO value creation. Drawing on a unique database of LBO transactions, this paper examines instead the actual internal rates of return (IRRs) realized by LBO sponsors on a deal-by-deal basis, thereby permitting a direct analysis of how LBO sponsors create value for their investors in leveraged buyouts. Second, the paper demonstrates how the traditional approach to examining the determinants of LBO returns overlooks a number of important LBO transaction strategies that are used to enhance a sponsor’s equity returns. In particular, the paper demonstrates that a significant component of LBO sponsor returns stems not from operating performance changes but from timing tactics that LBO sponsors use to accelerate the liquidation of their investments and thereby increase their IRRs. Among other things, this latter finding helps explain the gradual bias of private equity firms away from IPOs as an exit strategy for their portfolio investments and towards cash acquisitions.