Acquisitions of private-equity-backed private companies:Insights from acquirer’s choice of target and the implications on deal value through the subprime crisis

Abstract

Objective: This study explores the characteristics of worldwide acquisitions of private-equity-backed (PE)  private companies. It examines the impact of the subprime crisis, the acquirer’s choice of target, and the implications on deal value.

Research Design & Methods: This study uses deal-level data on worldwide PE-backed private company acquisitions that were completed between 2000 and 2017. Research methods to test the hypotheses include data visualization, comparative analysis, and regression analysis.

Findings: Data visualization indicates that North America was the most popular region for PE-backed private company acquisitions, followed by Europe and Asia. Industry sectors such as the services sector, the technology sector, the manufacturing sector, and the healthcare, and biotechnology sectors were popular. Comparative analysis indicates that financial acquirers preferred targets with larger revenues, larger core profits and operational profitability. Regression analysis indicates that acquirer characteristics such as acquirer type and experience levels, and deal characteristics such as deal location and percentage of stake acquired influence deal size. However, target company information and performance supersede acquirer characteristics. The subprime crisis in 2008 was a minor deterrent in the acquisition activity for both financial buyers and strategic buyers resulting in larger value deals with targets with smaller revenues.

Implications & Recommendations: This study provides insights into the importance and relevance of signals in PE-backed private company acquisitions by examining the characteristics of such acquisitions, the acquirer preferences, and the determinants of deal value. Private companies are less visible and less transparent as compared to public companies, making them obscure and difficult to value. Therefore, strategic acquirers and financial acquirers rely on signals to assess the viability of the potential target, with PE backing serving as a notable certification. This study indicates that PE-backing influences deal value and acquirer’s preferences. Despite the 2008 financial crisis influencing acquisition activity, both sets of acquirers were able to leverage their experiences into their respective acquisitions. Higher total and relevant experience seemed to work favourably for acquirers, who profited from increased bargaining power.

Contribution & Value Added: Firstly, this study enriches and adds to the knowledge of the literature on acquisitions, particularly private company acquisitions and the role played by PE in the same. Next, this study adds to the literature on the subprime crisis and the impact of the crisis on acquisition activity. Further, this article provides insights into strategic decision-making by the two dominant acquirers- strategic acquirers, and financial acquirers- when they are limited by a target pool and the interpretation of signals by the target. Finally, the examination of PE-backed private company acquisitions adds to the study and practice of entrepreneurial finance by examining the role of PE as a signal to deal with quality to encourage acquisitions of privately held targets.

Keywords

private company acquisitions, private equity, deal value, financial buyers, strategic buyers

References

1. Acharya, V.V., Gottschalg, O., Hahn, M., & Kehoe, C. (2011). Corporate governance and value creation: evi-dence from private equity’, Working Paper (New York University-Leonard N. Stern School of Business, 2011). https://doi.org/10.2139/ssrn.1324016
2. Achleitner, A., & Figge, C. (2014). Private equity lemons: Evidence on value creation in secondary buyouts. European Financial Management, 20, 2, 406-433. https://doi.org/10.1111/j.1468-036X.2012.00644.x
3. Achleitner, A.K., Braun, R., & Engel, N. (2011). Value creation and pricing in buyouts: empirical evidence from Europe and North America. Review of Financial Economics, 20(4), 146-161. https://doi.org/10.1016/j.rfe.2011.09.001
4. Akerlof, G.A. (1970). The market for “lemons”: Quality uncertainty and the market mechanism. Quarterly Journal of Economics, 84(3), 488-500. https://doi.org/10.2307/1879431
5. Andrade, G., Mitchell, M., & Stafford, E. (2001). New evidence and perspective on mergers. Journal of Eco-nomic Perspectives, 15, 103-120. https://doi.org/1257/jep.15.2.103
6. Andriuskevicius, K. (2015). Opportunities and challenges of value creation through merger and acquisitions in cyclical economies. Procedia, Social and Behavioral Sciences, 213, 764-769. https://doi.org/j.sbspro.2015.11.471
7. Arikan, I. (2005). In the market for firms, how should a firm be sold?. In G.L. Cooper, & S. Finkelstein (Eds.), Advances in mergers and acquisitions (vol. 4, pp. 181-208). Greenwich, CT: JAI Press.
8. Austin, J.E., & Leonard, H.B. (2008). Can the virtuous mouse and the wealthy elephant live happily ever after?. California Management Review, 51, 77-102. https://doi.org/10.2307/4116646
9. Bargeron, L.L., Schlingemann, F.P., Stulz, R.M., & Zutter, C.J. (2008). Why do private acquirers pay so little compared to public acquirers?. Journal of Financial Economics, 89, 375-390. https://doi.org/10.1016/j.jfineco.2007.11.005
10. Baziki, S.B., Norback, P.J., Persson, L., & Tag, J. (2017). Cross-border acquisitions and restructuring: Multina-tional enterprises and private equity firms. European Economic Review, 94, 166-184. https://doi.org/10.1016/j.euroecorev.2017.02.012
11. Barry, C.B., Muscarella, C.J., Peavy, J., & Vetsuypens, M.R. (1990). The role of venture capital in the creation of public companies. Journal of Financial Economics, 27(2), 447-471. https://doi.org/10.1016/0304-405X(90)90064-7
12. Bernanke, B.S. (1983). Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depres-sion. The American Economic Review, 73, 3, 257-276.
13. Boone, A.L., & Mulherin, J.H. (2007). How are firms sold?. The Journal of Finance, LXII(2), 847-874. April 2007. https://doi.org/10.2139/ssrn.642306
14. Brander, J.A., & Egan, E.J. (2017). The winner’s curse in acquisitions of privately held firms. The Quarterly Review of Economics and Finance, 65, 249-262. https://doi.org/10.1016/j.qref.2017.01.010 1062-9769
15. Bruining, H. (1992). Performance improvement post-management buyout. PhD diss., Erasmus University Rotterdam, Haveka.
16. Bull, I. (1989). Management performance in leveraged buyouts: An empirical analysis. Journal of Business Venturing, 3, 263-78.
17. Capron, L., & Shen, J.C. (2007). Acquisitions of public vs private firms: Private information, target selection, and acquirer returns. Strategic Management Journal, 28, 891-911. https://doi.org/10.1002/smj.612
18. Cerrato, D., Alessandri, T., & Depperu, D. (2016). Economic crisis, acquisitions, and firm performance. Long Range Planning, 49(2), 171-185. https://doi.org/10.1016/j.lrp.2015.12.018
19. Cornelli, F., & Karakas, O. (2008). Private equity and corporate governance: Do LBOs have more effective boards?. In J. Lerner and A. Gurung (Eds.). The global impact of private equity report 2008, globalization of alternative investments, Working Papers (vol. 1, pp. 65-84). New York: World Economic Forum.
20. Cotter, J.F., & Peck, S.W. (2001). The structure of debt and active equity investors: The case of the buyout specialist. Journal of Financial Economics, 59, 101-47. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=251890 on July 1, 2023.
21. Cressy, R., Malipiero, A., & Munari. F. (2007). Playing to their strengths? Evidence that specialization in the private equity industry confers competitive advantage. Journal of Corporate Finance, 13, 647-69. https://doi.org/10.2139/ssrn.964367
22. Deeds, D., DeCarolis, D., & Coombs, J.E. (1999). Dynamic capabilities and new product development in high technology ventures: An empirical analysis of new biotechnology firms. Journal of Business Venturing, 15(3), 211-229. https://doi.org/10.1016/S0883-9026(98)00013-5
23. Draper, P., & Paudyal, K. (2006). Acquisitions: Private versus public. European Financial Management, 12(1), 57-80. https://doi.org/10.1111/j.1354-7798.2006.00310.x
24. Faccio, M., McConnell, J., & Stolin, D. (2006). Returns to acquirers of listed and unlisted targets. Journal of Financial and Quantitative Analysis, 41(1), 197-220. https://doi.org/10.1017/S0022109000002477
25. Farinós Viñas, J.E., Herrero, B., & Latorre Guillem, M. (2013). Value Creation When Acquiring Public vs Pri-vate Firms. Spanish Evidence (September 2, 2013). https://doi.org/10.2139/ssrn.2343558
26. Fuller, K., Netter, J., & Stegemoller, M. (2002). What do returns to acquiring firms tell us? Evidence from firms that make many acquisitions. The Journal of Finance, 57(4), 1763-1793. https://doi.org/10.1111/1540-6261.00477
27. Gemson, J. (2021). Private company acquisitions in the market for corporate control: A comparison between private equity and corporate acquirers. The Quarterly Review of Economics and Finance, 81, 342-357. https://doi.org/10.1016/j.qref.2021.06.014
28. Gompers, P.A., & Xuan, Y. (2006). The role of venture capitalists in the acquisition of private companies. Harvard Business School and NBER, Harvard Business School. Retrieved from http://ssrn.com/abstract=563822. on July 1, 2023.
29. Gorbenko, A.S., & Malenko, A. (2014). Strategic and financial bidders in takeover auctions. The Journal of Finance, LXIX(6), 2513-2555. https://doi.org/10.2139/ssrn.1559481
30. Gottschalg, O., & Wright, M. (2008). Understanding the buyers’ role in private equity returns – the influence of skills, strategy and experience. CMBOR Occasional Paper.
31. Guo, S., Hotchkiss, E., & Song, W. (2007). Do buyouts (still) create value?. SSRN Working Paper.
32. Hammer, B., Hinrichs, H., & Schweizer, D. (2022). What is Different About Private Equity-Backed Acquirers?. Review of Financial Economics, 40(2), 117-149, https://doi.org/10.2139/ssrn.2832444 on 17 November 2023.
33. Heaton, J.B. (2002). Managerial optimism and corporate finance. Financial Management, 31, 33-46.
34. Henderson, A.D. (1999). Firm strategy and age dependence: a contingency view of the liabilities of newness, adolescence, and obsolescence. Administrative Science Quarterly, 44, 281-314. Retrieved from https://www.statista.com/statistics/267369/volume-of-mergers-and-acquisitions-worldwide/ on 17 No-vember 2023. https://doi.org/10.2307/2666997
35. Jensen, M.C. (1986). The agency cost of free cash flow, corporate finance and takeovers. American Economic Review, 76, 323-329. https://doi.org/10.2139/ssrn.99580
36. Jensen, M.C. (1989). The eclipse of the public corporation. Harvard Business Review, 5, 61-74.
37. Jensen, M.C., & Meckling, M.H. (1976). Theory of the firm: Managerial behavior, agency costs and the own-ership structure. Journal of Financial Economics, 3, 305-360. https://doi.org/10.1016/0304-405X(76)90026-X
38. Jensen, M.C., & Ruback, R.S. (1983). The market for corporate control: The scientific evidence. Journal of Financial Economics, 11, 5-50. https://doi.org/10.1016/0304-405X(83)90004-1
39. Kalsie, A., & Singh, N. (2022). Measurement of synergy in merger & acquisitions: A panel data approach using composite variable (principal component analysis). Journal of Corporate Accounting & Finance, 33, 36-51. https://doi.org/10.1002/jcaf.22523
40. Kaplan, S.N. (1989). Management buyouts: evidence on taxes as a source of value. Journal of Finance, 3, 611-32. https://doi.org/10.1111/j.1540-6261.1989.tb04381.x
41. Kaplan, S.N., & Stromberg, P. (2009). Leveraged buyouts and private equity. Journal of Economic Perspectives, 23(1), 121-46. https://doi.org/10.1257/jep.23.1.121
42. Leslie, P., & Oyer, P. (2009). Managerial incentives and value creation: evidence from private equity. Working Paper (Rock Center for Corporate Governance – Stanford University, 2009). https://doi.org/10.2139/ssrn.1341889
43. Luypaert, M., & Van Caneghem, T. (2017). Exploring the double-sided effect of information asymmetry and uncertainty in mergers and acquisitions. Financial Management, Winter, 2017, 873-917. https://doi.org/10.1111/fima.12170
44. Lys, T.Z., & Yehuda, N. (2016). Do Acquisitions of Private Targets Create Higher Value? (November 30, 2016). Available at SSRN: https://ssrn.com/abstract=2877589 or https://doi.org/10.2139/ssrn.2877589 on July 2, 2023.
45. Malone, S. (1989). Characteristics of smaller company leveraged buyouts. Journal of Business Venturing, 4, 345-59. https://doi.org/10.1016/0883-9026(89)90006-2
46. Manne, H.G. (1965). Mergers and the market for corporate control. The Journal of Political Economy, 73(2), 110-120. https://doi.org/10.1086/259000
47. Mitchell, M.L., & Mulherin, J.H. (1996). The impact of industry shocks on take-over and restructuring activity. Journal of Financial Economics, 41, 193-229. https://doi.org/10.1016/0304-405X(95)00860-H
48. Moeller, S.B., Schlingemann, F.P., & Stulz, R.M. (2004). Do shareholders of acquiring firms gain from acquisi-tions?. Journal of Financial Economics, 73(2), 201-228. https://doi.org/10.2139/ssrn.383560
49. Muscarella, C., & Vetsuypens, M. (1990). Efficiency and organizational structure: A study of reverse LBOs. Journal of Finance, 65, 1389-413. https://doi.org/10.1111/j.1540-6261.1990.tb03720.x
50. Opler, T.C. (1992). Operating performance in leveraged buyouts. Financial Management, 21, 27-34. https://doi.org/10.2307/3665678
51. Pazarskis, M., Drogalas, G., & Koutoupis, A. (2018). Mergers and accounting performance: Some evidence from Greece during the economic crisis. Accounting and Management Information Systems, 17, 1, 31-45. https://doi.org/10.24818/jamis.2018.01002
52. Ragozzino, R., & Reuer, J.J. (2007). Initial public offerings and the acquisition of entrepreneurial firms. Stra-tegic Organization, 5(2), 155-176. https://doi.org/10.1177/1476127007079139
53. Roll, R. (1986). The hubris hypothesis of corporate takeovers. Journal of Business, 59, 197-216. https://doi.org/10.1086/296325
54. Sahlman, W.A. (1990). The structure and governance of venture capital organizations. Journal of Financial Economics, 27(2), 473-521. https://doi.org/10.1016/0304-405X(90)90065-8
55. Sanders, W.M.G, & Boivie, S. (2004). Sorting things out: valuation of new firms in uncertain markets. Strate-gic Management Journal, 25, 2, 167-186. https://doi.org/10.1002/smj.370
56. Singh, H. (1990). Management buyouts: Distinguishing characteristics and operating changes prior to public offering. Strategic Management Journal, 11, 111-29.
57. Sousa, M. (2010). Why do private equity firms sell to each others?. Working Paper (University of Oxford – Said Business School, 2010.
58. Spence, A.M. (1974). Market signaling: Informational transfer in hiring and related screening processes. Cambridge, MA: Harvard University Press.
59. Stromberg, P. (2007). The new demography of private equity. Swedish Institute for Financial Research. Stock-holm School of Economics Working paper.
60. Shleifer, A., & Vishny, R.W. (1989). Management entrenchment: The case of manager-specific investments. Journal of Financial Economics, 25, 123-139. https://doi.org/10.1016/0304-405X(89)90099-8
61. Sułkowski, Ł., Seliga, R., & Woźniak, A. (2019). Strategic Challenges of Mergers and Acquisitions in Higher Education Sector. Entrepreneurial Business and Economics Review, 7(2), 199-215. https://doi.org/10.15678/EBER.2019.070211
62. Tang, Q., & Lei, W. (2018). Identifying M&A targets and the information content of VC/PEs. China Journal of Accounting Research, 11, 33-50. https://doi.org/10.1016/j.cjar.2016.08.002