Public-to-private buy-outs, distress costs and private equity

Abstract

This article extends previous work by testing the financial distress costs hypothesis in the context of the UK, a contract-based distress resolution system, and by considering the role of private equity firms. Using a hand-collected dataset covering 115 public-to-private buy-outs (PTPs) completed in the period 1998 to 2001 and 115 randomly selected firms that remained public, we find contrasting evidence to that for US PTPs. Consistent with the financial distress costs model, firms going private are more likely to have better asset collateralization, have less debt and be more diversified. However, we also find that UK PTPs are more likely to be younger, experience poor stock market performance and be smaller than firms remaining public. In addition, PTPs did not have lower R&D or higher free cash flows. Our results therefore, indicate that in the UK financial distress costs may not be central to the decision to go private.We also find that private equity providers are more likely to be involved in the process if the firm going private is more diversified, has a higher Q ratio and had been quoted for a shorter period of time and have lower board shareholdings. This suggests that private equity providers are more interested in growth prospects than potential financial distress costs.

Acknowledgement

We would like to thank David Laing for research assistance. We would also like to thank an anonymous referee for a number of helpful comments.

Notes

¹ For example, during the period under study, 1998–2001, senior secured and subordinated mezzanine debt provided an average of 65.7% of the funding for all public-to-private deals in the UK.

² We also developed the analysis to differentiate between MBOs and non-MBOs. We find that MBOs are smaller, have better share performance, higher board ownership and higher debt. This provides limited evidence that MBOs are characterised by the desire to minimize financial distress costs.