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The Leverage Buyout process in Private equity: theoretical exploration and comparison (Management Project)

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The Private equity industry is receiving a lot of attention in the daily news. The Private equity firms are acquiring other companies through a Leverage buyout transaction (LBO). The ownership period is short with an average ownership of five to seven years. The business strategy of the PE firms is only focusing on generating the highest possible profit in a resale over this period. The PE firms’ target companies are companies they think have potential to grow or improve under their management. In the daily press these improvements is often associated with cost-cutting to improve efficiency (Mills 2006).

This business strategy seems to be contradicting general Merger and Acquisition motives defined in theory, as the theories are mainly focusing on long term integration and achieving synergies. Additionally, the focus on profit should lead one to believe that PE firms are highly focused on the financial aspects of the acquired company, hence heavily relying on financial valuation methods. These naïve conditions have lead to this research.

Theorists argue that an acquisition is a homogenous process where every step in the process affects the final outcome. Nevertheless most research in merger and acquisitions often focus on integration and synergies of the post-deal. These theories often neglect the more basic financial criteria that have to be met for the acquisition to be feasible in the first place. Other schools of theories are focused on the financial valuation of an LBO and the financing of it, excluding other aspects than financial.

The purpose of this thesis will be, from an academic point of view, to explain the transaction process of an LBO leading the way for the final acquisition by PE firms. This will be facilitated by drawing from and combing the more general Merger and Acquisition process theory with the more financial valuation theory.

A holistic framework is created, based on and by combining Haspeslagh & Jemison’s (1991) process model and the Watson Wyatt Deal Flow Model in (Galpin & Herndon 2000), this created framework identifies, where in the LBO process the valuation and due diligence takes place. The framework aims at identifying and explaining from an academic point of view, how the transaction process is constructed. Through this framework it will be evident what methods are attributed, by scholars, to the financial valuation in regard to a successive outcome. The created framework will be compared to the qualitative data collected through interviews with professionals from the industry. It will with an explorative angle be tried proven, whether the created framework has any explanatory value, relating theory perspectives with the practical LBO transaction as seen in the examples.

Based on the research and the findings, conclusions are made. It is apparent that the accepted general Merger and Acquisition theory is not fully applicable with the actual LBO transaction as identified in this research process, and that the methods used for valuation, is not utilized in the same manor as the theorist predict
Source: Umeå University
Author: Bruun, Claus

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