Many companies that have been acquired by private equity firms have experienced accelerating growth in assets, earnings, and other key performance metrics during the PE ownership period. But once their PE owners leave, their futures become less rosy —particularly for larger and older companies.
Take asset growth, for example. In the last two decades, the assets of portfolio companies grew by an average of 13 percent each year during the PE holding period. The number dropped to 10 percent after their owners exited, according to a recent paper published by Paul Lavery from the Adam Smith Business School at the University of Glasgow and Nick Wilson from the Credit Management Research Centre at Leeds University Business School. The annual growth rate in sales, earnings, and market share also slowed significantly during the post-exit period, according to the paper.
The authors argue that common PE strategies to grow companies, including cost cutting and providing management expertise, might “extract resources from otherwise healthy companies, [which] can leave the firms financially vulnerable to change in monetary conditions and in downturns, particularly when the PE exits.”
The findings are based on a study of 1,244 buyout deals from 2000 to 2020, most of which were private-to-private transactions and divisional buyouts in the U.K. About 80 percent of the exits were sales to another company. Only 7 percent of exits were done via an initial public offering.
The authors pointed out that the slower growth rates during the post-exit period could prompt conflicts of interest between PE sponsors and the portfolio companies’ management teams. “PE [firms] are primarily concerned with how well their portfolio companies grow and perform during their ownership period of the company, as this is likely to have an impact on the final return they earn,” they wrote. “On the other side…the portfolio company is likely to be considerably more interested in their long-term dynamics and performance.”
Once PE owners leave, larger and older companies are at higher financial risk than their smaller and younger peers, in part because of higher leverage. They are more likely to declare insolvency, according to the paper. “This aligns somewhat with concerns of critics of PE who assert that leveraged buyouts of companies can often leave the target firm with an unsustainable amount of debt on its balance sheet and can consequently have severe consequences on its ability to survive in the long run once the PE investor has exited the firm,” according to the authors.
But companies that have had PE owners at some point are still better off than peers untouched by sponsors. The average annual growth in assets is 3 percentage points higher for companies that have been previously backed by PE firms than for those that have not.
“We find that while portfolio company growth slows considerably during the post-exit period relative to the PE holding period, the outperformance of PE-backed companies relative to matched control companies persists in the long run after the PE investor has exited the company,” the authors concluded.