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Despite the fact that buyout investments represent a considerable part of private equity investments, few studies have been done related to the financial structure and exit routes in Leveraged Buyout (LBO) projects. The main topic often mentioned in the literature is the impact of LBO firm (hereafter he) on the performance of the acquired firm (called also Op Co or target). In the late 1980s, many papers focused on the investigation of other determinants of the targets performance (after the exit of the LBO firm).
An important element of the buyout investment is the contractual agreement to end the project and to repay the parties within a specified period of time. The exit is the most important and last way the LBO firm can realize a high positive return on the investment: he invests in buyouts with the aim of exiting after 3-5 years. He wants to get his money back quickly in order to invest it in a new deal. Consequently, there must be a clear route for him to exit the buyout.
In this paper, we shed light on the topic of exit choices in buyout investments and aim at investigating the following question: does the financial structure in LBO solve the agency conflicts between the entrepreneur (hereafter she) and the LBO firm?
We focus on the agency conflicts related to the choice of the exit route under moral hazard. The exit route and timing are crucial for financing. The entrepreneur must know that the LBO firm will eventually want to exit the buyout, and that very often this means that the project will be sold to another company (trade sale) or to another LBO firm (secondary LBO). If the target turns out to be non-performing, it is abandoned, showing the ability of the LBO firm to filter out good from bad investments.
The choice of the exit date and route may lead to agency conflicts between the entrepreneur and the LBO firm. The three main possible exit channels are Initial Public Offerings (IPO), sales2 and write-offs (typically called quick-flips).
An IPO results in the highest valuation of the target and is very often the preferred exit vehicle. The entrepreneur favors an IPO because it preserves the target’s independence and ensures the liquidity of its securities. If the company is going public, the entrepreneur keeps the control and gets private benefits3 because she shares the control with a large number of investors who usually face information asymmetry. In order to get an IPO exit, the entrepreneur may take very risky decisions which can, for example, be asking for additional funds from the bank (hereafter he) and other financiers, investing in new mergers and acquisitions which are not valuable for the buyout, hiding important information to the LBO firm, recruiting new staff to control the majority of voting rights and to get more private advantages. However, in contrast with a sale, such exit does not end the LBO firm’s involvement with the target. He may be restricted for many reasons, from selling any or a portion of his shares in the offering.
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