This article was downloaded by: [University of Waikato]On: 30 June 2014, At: 22:51Publisher: RoutledgeInforma Ltd Registered in England and Wales Registered Number: 1072954 Registeredoffice: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK

Venture Capital: An InternationalJournal of Entrepreneurial FinancePublication details, including instructions for authors andsubscription information:http://www.tandfonline.com/loi/tvec20

Financial restructuring and recoveryin private equity buyouts: the UKevidenceMike Wrightab, Robert Cressyc, Nick Wilsond & Hisham Faragc

a Centre for Management Buy-out Research, Imperial CollegeBusiness School, London, UKb University of Ghent Business School, Ghent, Belgiumc Department of Accounting and Finance, Birmingham BusinessSchool, University of Birmingham, Birmingham, UKd Credit Management Research Centre, Leeds University BusinessSchool, Leeds, UKPublished online: 08 Jan 2014.

To cite this article: Mike Wright, Robert Cressy, Nick Wilson & Hisham Farag (2014)Financial restructuring and recovery in private equity buyouts: the UK evidence, VentureCapital: An International Journal of Entrepreneurial Finance, 16:2, 109-129, DOI:10.1080/13691066.2013.863065

To link to this article: http://dx.doi.org/10.1080/13691066.2013.863065

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Financial restructuring and recovery in private equity buyouts: theUK evidence

Mike Wrighta,b,1, Robert Cressyc*, Nick Wilsond,2 and Hisham Faragc,3

aCentre for Management Buy-out Research, Imperial College Business School, London, UK;bUniversity of Ghent Business School, Ghent, Belgium; cDepartment of Accounting and Finance,Birmingham Business School, University of Birmingham, Birmingham, UK; dCredit Management

Research Centre, Leeds University Business School, Leeds, UK

(Final version received 4 November 2013)

A large literature has adumbrated the value-added role of private equity (PE) firms inbacking buyouts. The present paper examines a different and hitherto unexploredissue: the role of financial restructuring in PE buyouts in the UK both before and afterthe financial crash of 2007. The UK evidence indicates that while PE buyouts hadgreater financial risk than comparable public limited companies (PLCs), they (1)already contained provisions to optimize recovery rates under insolvency, raisingtheir recovery rates significantly relative to controls; and (2) rapidly adjusted thecapital structures of new deals in response to the changes in financial and economicclimate from 2007 onward resulting in failure rates somewhat lower than PLCs andnon-PE buyouts. Non-PE management buyins (MBIs) by contrast have much higherfailure rates than any other category throughout the 12-year period. Our analysisoffers important implications for policymakers. First, it shows that there has beengreater adjustment over time in the leverage and cash position of buyouts than forother private companies and matched PLCs. Second, policymakers need to recognizethat while PE buyouts are highly leveraged, non-PE-backed buyouts are more or lesswell managed. Third, ceteris paribus, PE-backed deals are not riskier than thepopulation of non-buyouts; active involvement by PE firms in helping portfoliocompanies deal with trading difficulties plays an important role. Fourth, thegovernance mechanisms in PE buyouts result in greater preservation of value when aportfolio firm enters formal bankruptcy than is the case for PLCs.

Keywords: buyouts; bankruptcy; insolvency risk; financial distress; failure

1. Introduction

The global private equity (PE) market has well-known cyclical features and is therefore

characterized by peaks and troughs (see, e.g., Kaplan and Schoar [2005] for the USA and

Wright, Jackson, and Frobisher [2010] for the UK). The first peak of the UK PE market

occurred in 1979–1989 and the second peak in 2007 (Wilson and Wright 2011). These

peaks and troughs are quite dramatic in character and the extent of the PE activity

decline after the 2007 financial crisis was as vertiginous as its rise in the preceding years

was meteoric. During the boom years, leverage in PE deals rose sharply, driven by

favorable credit conditions, including the availability of debt from a wider variety of

domestic and foreign sources than hitherto and by lower interest rates (Axelson et al.

2010; Hackbarth, Miao, and Morellec 2006). Default risks driven down by booming

q 2014 Taylor & Francis

*Corresponding author. Email: r.cressy@bham.ac.uk

Venture Capital, 2014

Vol. 16, No. 2, 109–129, http://dx.doi.org/10.1080/13691066.2013.863065

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product demand also appear to have been lower than in the past. The 2008 global

financial crisis, however, severely restricted subsequent debt availability for PE deals.

The Centre for Management Buy-out Research’s (CMBOR) tracking of new deals since

the onset of the financial crisis indicates a marked shift in capital structures in those PE

deals that have in fact been completed (CMBOR 2011; Figure 1).

Since the aftermath of the crisis has been characterized by lower debt availability

and limited life funds seeking suitable returns and lower risk, investors have

accommodated these criteria by increasing the proportion of equity in new investments.

Indeed, a number of sizeable deals have been completed without the use of any debt

whatsoever (CMBOR 2011). However, by the middle of 2012 it appears that debt

conditions, in the UK at least,4 began to ease and the share of debt in financing

these structures bottomed out. While UK PE firms have rapidly adjusted the capital

structures of new deals, the high leverage of preexisting deals has increased the

insolvency risk for firms unable to adjust capital structure prior to or during the

downturn.

In this paper, we argue and find empirical support for the claim that PE investors –

by contrast with public limited companies (PLCs) – while being financially more risky

due to their higher leverage, (1) already had in place prior to the crisis measures to

maximize debt recovery under failure; and (2) were likely to act more proactively to

restructure finances of companies with debt-servicing problems when insolvency

occurred. PE companies are repeat players in debt markets. We argue, therefore, that

the objective of this strategy has been to both avoid insolvency risk and to preserve

asset value in the event of insolvency. As a result, comparison of a matched sample of

UK PE buyouts with PLCs over the period shows that secured debt recovery rates of

the former are about twice that of the latter. Drawing on data comprising virtually the

whole population of UK companies and the population of UK buyouts, we provide

strong evidence to support our contention. The remainder of the paper is structured as

follows. In Section 2, we review the extant literature and develop a set of hypotheses to

be tested. Section 3 presents the data-set used in the analysis. Section 4 describes the

statistical methodology used in the empirical analysis. Section 5 presents the findings

and compares hypotheses with outcomes, and finally, Section 6 summarizes and

concludes.

Figure 1. Changes in debt in new buyout capital structures, UK (1997–2011). Source: CMBOR/Ernst & Young/Equistone.

M. Wright et al.110

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2. Literature review and hypothesis development

It is commonly believed that PE investments are not randomly selected from the population

of firms and there is some evidence to support this claim (e.g., Amess andWright 2007). The

evidence suggests that PE investors target profitable companies in lower-risk sectors with

the scope for efficiency and profit improvements, and therefore create companies that show

scope for improved performance (profitability). Their corporate governance structure offers

advantages that are well-documented, and include a powerful set of carrots and sticks that

help to motivate management (see Jensen [1989] for the seminal article in this area). We

therefore argue that buyouts and non-buyouts differ from the population of companies and in

particular from PLCs in terms of financial characteristics.

The outside financial options for the majority of businesses (with typically less than

10 employees) are very limited; such firms therefore tend to rely on owner equity and

bank finance to finance start-up (and for a small minority) expansion (e.g., Cressy 1996;

Cressy and Olofsson 1997). Control aversion on the part of small and medium enterprise

(SME) management implies they use little, if any, outside equity and this fact is

responsible for their higher debt-equity ratios and leverage. We therefore expect that

over the period of our study, privately held companies will have the highest leverage of

all categories of company.

It has been understood since the publication of the seminal paper of Jensen almost 25

years ago (Jensen 1989) that solvent PE-backed buyouts are, due to their superior

management structure, more efficiently managed than their PLC counterparts. However,

they are also likely to be more highly leveraged as a result of the financial engineering

employed to raise return on equity (ROE) and the internal rate of return (IRR) for

investors (see, e.g., Cressy, Munari, and Malipiero 2007; Wright and Wilson 2011).

They are thus subject to higher financial risk than PLCs. However, we expect the

managerial superiority of the PE form to extend to private equity firms’ (PEFs) ability to

manage insolvency risk in the face of higher leverage, because PE firms are repeat

players in the market. Covenants on higher levels of debt in PE deals are also expected

to trigger distress or formal insolvency processes sooner than in PLCs (Jensen 1989).

Instruments of this superior financial management will also include provisions for higher

interest coverage, which is likely associated with lower chances of bankruptcy. We can

formalize our expectations therefore in the following hypothesis:

Hypothesis 1: PE buyouts have both higher leverage and higher interest coverage

than their PLC counterparts.

Another example of the proactive behavior of PE firms is the likely timeliness of

their response to changing economic conditions. PE companies take their buyouts private

in order to bring about improvements to the efficiency and to invest for growth without

the ‘constraints’ that dispersed shareholdings or the dominance of a large shareholder

with conservative ambitions may bring. Thus we argue:

Hypothesis 2: PE buyouts will be quickly refinanced (swapping equity for debt) in

response to impending distress and to improving economic conditions

(financing growth).

A simple accounting identity (Cressy 2009) implies that higher leverage is associated

with higher financial risk as well as higher ROE. Therefore, we expect that PEFs, with

their greater leverage, will have higher failure rates than their PLC counterparts.

However, at similar levels of leverage, we expect PEFs will have lower failure rates than

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non-PE buyouts due to higher quality financial management. As the economy moves

from a financial crisis to an economic recession, failure rates of all company types are

determined more by demand and will tend to converge. As discussed above, PE buyouts

are not a set of firms randomly selected from the population. Thus, there should be

important differences in the characteristics of PE-backed firms and PLCs. However,

from the Jensen argument, if we control for company differences, we expect PE-backed

buyouts to have the same or possibly lower failure hazard (ex ante chances of imminent

failure) than PLCs. Based on the above discussion, we formulate our third hypothesis:

Hypothesis 3: Post-2007 financial crisis PE buyouts will, due to better management

(the Jensen effect), initially have lower failure rates than their PLC

counterparts and non-PE buyouts.

Management Buyins (MBIs) involve the purchase of a company’s equity and the

replacement of some or all of its existing management. Such companies are typically

badly run and often present more of a challenge to turn around than management

buyouts (MBOs) where incumbent management continues to run the company (but

typically with less control) (Wright et al. 1996). For this reason, we expect MBIs to have

larger failure rates than MBOs. Hence, we state our fourth hypothesis:

Hypothesis 4: MBIs have higher expected failure rates than MBOs, controlling for

other relevant factors.

Examining debt recovery in PE buyouts in comparison with PLCs, further we note

that Board seats in the investee companies of PE firms, together with significant equity

stakes in the company and close monitoring of financial information are expected to

bring about more timely action under financial distress than would be the case if the

company were run by the outside directors of listed corporations. Non-executive chairs

in listed corporations, by contrast, need to play a strong role in managing relationships

between incumbent senior managers and new managers brought in to resolve financial

distress. But this mechanism may be more problematic than in PE-backed deals where

PE firms’ management has a greater financial incentive to be actively involved in this

process. In addition, PLCs are more likely to inject further cash to resolve financial

problems than in PE firms managing buyouts.5 These problems can be avoided if the

business is taken private, which is the PE solution. Because of the lack of active

involvement by PLC investors, there is also greater potential for insiders in listed firms,

who are more prevalent in UK than US boards, to dominate outside directors. We also

expect, as intimated previously, that since PEFs are repeat players in the financial

markets and specifically use debt from creditors whom they may wish to access in

future, PEFs will devise measures to ensure as far as possible that if a buyout fails the

creditors will receive maximum protection.

Changes to insolvency legislation in the UK were introduced in the Enterprise Act

2002, which came into force in 2003 and aimed to promote a corporate rescue culture

that would increase the likelihood of the continuation of a business as a going concern

rather than its assets being sold off and the company liquidated. Prior to the Act, the

‘administrative receiver’ was only accountable to the ‘charge-holder’ (i.e., creditors who

had obtained a fixed or floating charge on assets) and therefore had little incentive to act

in the interests of other creditors and/or rescue a company from impending bankruptcy.

To avoid this outcome, the 2002 Act gave greater weight and negotiation rights to other

creditors (Acharya, Sundaram, and John 2011). As mentioned above, PE buyouts are

likely, as a result of debt covenants, to have higher recovery rates under bankruptcy than

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PLCs. As we have seen, there are reasons to believe that the superior management

efficiency of the buyout form extends to recovery rates under financial distress. This

leads to our next hypothesis:

Hypothesis 5: PE buyouts have higher recovery rates of secured debt under

bankruptcy than PLCs.

The mode of recovery thus has the potential to affect the recovery rate for secured

creditors. We expect that insolvent companies entering into receivership or administration,

the UK’s formal bankruptcy regime for firms, will have higher recovery rates.6 Given that

the changes in bankruptcy legislation were intended to both speed up the process of debt

recovery and increase the proportion of debt recovered, we can therefore hypothesize:

Hypothesis 6: Recovery rates will be higher for Administration than Receivership

regardless of firm type (buyout vs. non-buyout) and the time to recovery

will be lower for Administration than Receivership, controlling for other

relevant factors.

The empirical evidence shows that buyouts are more likely than non-buyout private

firms to be financed by syndicates of lenders, as lenders seek to spread the risk from higher

leverage. Lack of coordination among multiple lenders might in turn seem a priori to create

inefficiencies in the bankruptcy processwith lower overall secured creditor recovery rates as

a result. While this is the theory (Asquith, Gertner, and Scharfstein 1994) in the UK at least,

this appears not to be the case (Citron and Wright 2008). Thus we expect that:

Hypothesis 7: Syndicated loans have no lower recovery rates under financial distress

than non-syndicated ones, controlling for other factors.

3. The data

We use a new and unique data-set (see Wright and Wilson [2011] for the full details)

which includes nearly 9 million firm-year observations on public and private firms in the

UK over the period 1995–2011 (a period chosen to encompass the recent recessionary

cycle) plus the CMBOR database on buyouts which incorporates PE and non-PE-backed

buyouts over the same period (CMBOR 2011). In addition to this, we create a parallel

matched sample of failed PE buyouts and PLCs over a similar period to which

insolvency information from the annual receiver/administrator abstract of receipts and

payments is added to identify the annual proportion of secured debt recovered under

insolvency.7 Our data on UK trading company accounts (privately held companies and

PLCs) comes from the Companies House database. Using CMBOR data, information on

UK management buyouts formed during the sample period, we select a matched sample

of non-buyout companies. The data are thus a panel and, importantly, include

observations for several years pre- and post-buyout for the buyout subsample.8 For

definitions of the variables in these datasets see Table 1.

4. Econometrics

Our analysis of the data uses two main statistical methods, linear regression and survival

analysis. The former is standard in the literature and requires no explanation. The latter

is less frequently used and we explain it for the general reader. We model the hazard of

failure of a firm. A hazard rate is basically the probability that an individual firm will

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fail in the next period (year) given that it has not failed to date. Failure time is the time

to the failure event. Other outcomes are treated as ‘censored’ (i.e., we do not know the

outcome in the period of the study). We describe the continuous time version of the

model, thus: if T is the year in which company fails, then the hazard of failure, h(t), is

written:

hðtÞ ¼ Pr ðt # T , t þ DtjT $ tÞ ¼ f ðtÞDt½12 FðtÞ� ð1Þ

Table 1. Variable definitions.

Variable Definition

Hirschman–Herfindahl Index Hirschman–Herfindahl Index of industrial concentrationAge dummy ,3 years ¼ 1 if company less than 3 years oldAge dummy 3–10 years ¼ 1 if company at least 3 years and less than

10 years oldAge dummy .10 years ¼ 1 if company at least 10 years oldCash/TA Cash/book value of total assetsInventory/working capital Stocks and work in progress/working capitalTrade creditors/total liabilities Trade creditors to the book value of total liabilitiesTrade debtors/total assets Trade debtors to total assetsGross margin (Sales-cost of sales)/salesROA Net income to the book value of total assetsRetained profit/total assets Ratio of retained earnings to the book value of total

assetsTotal debt/TA Ratio of total debt to total assets as a proxy for leverageInterest coverage EBIT/interest expenseOperating cash flow/TA Ratio of operation cash flow to total assetsAudit qualification_Going-concern ¼ 1 if an audit qualification to the firm’s accounts

in the last year; ¼ 0 elseAudit qualification_Severe ¼ 1 if an audit qualification to the firm’s accounts

in the last year classified as ‘severe’; ¼ 0 elseChange of auditor ¼ 1 if auditor changed in the last year; ¼ 0 elseCreditor charge on assets ¼ 1 if charge in the last year; ¼ 0 elseLate filing accounts ¼ 1 if accounts filed at Companies’ House were late

in the last year; ¼ 0 elseLate filing last accounts (days) Number of days late in filing accounts with Companies’

HouseIndustry risk (weight of evidence) A measure of industry riskLog age Natural logarithm of company ageSubsidiary company ¼ 1 if majority of shares owned by another company;

¼ 0 elseFamily company ¼ 1 if majority of shares owned by a single family;

¼ 0 elseListed company ¼ 1 if PLC listed on the London Stock Exchange;

¼ 0 elsePE backed pre-2003 ¼ 1 if firm was PE backed and the buyout occurred

before 2003; ¼ 0 elsePE backed post-2003 Ditto, post-2003MBO pre-2003 ¼ 1 if firm subject to a management buyout (non-PE

backed) pre-2003; ¼ 0 elseMBO post-2003 Ditto, post-2003MBI post-2003 ¼ 1 if firm was subject to a management buy in

pre-2003; ¼ 0 elseMBI pre-2003 Ditto pre-2003

M. Wright et al.114

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where f(t)Dt is the probability that the event will occur in a ‘small’ time interval Dt andF(t) is the corresponding cumulative distribution function. Implicitly, the conditioning

also includes a set of covariates, x, that may influence the position of the hazard

function. The Cox hazard function for firm, j, takes the specific form:

hjðtÞ ¼ h0ðtÞ exp ðxjtbÞ ð2Þ

where h0(t) is an unspecified baseline hazard function of time, and xjt is a vector of

covariates for firm j that may be time-varying.9 b is a vector of fixed coefficients.

5. Findings

5.1. Differences between company types and financial characteristics

Table 2 shows that as predicted, there are indeed major differences between the various

company types, in particular between buyouts and non-buyouts, in terms of financial

structure. The annual trends in return on assets (ROA), gross margin, debt/TA, and

coverage in Table 2 (illustrated graphically for ROA in Figure 2c) indicate that over the

period, for PE firms, ROA and gross margin peak in 2007 and decline thereafter, falling

back to almost 1999 levels or, in some cases, to below them.

Meanwhile, leverage, measured by debt to total assets, peaks in 2006 while interest

coverage increases monotonically until 2010.10 We note that leverage throughout the

period 2004–2010 is over 50% higher11 in PE-backed companies than in PLCs, which,

surprisingly, have slightly lower leverage than private company controls. This is

consistent with H1. However, with the economic crisis, leverage of all company types

converged in 2009–2010 (see Figure 2a). A faster response rate of PEFs to the crisis is

also consistent with Figure 2a, which shows the curve for PE buyouts.

Crossing that of PLCs at around 2009: PE firms deleveraged quicker.12 Figure 2b

(also derived from Table 2) shows that interest coverage is always higher for PE-backed

firms than PLCs in the period, except in 1999. The divergence grows dramatically,

however, slows after 2004 and accelerates again in 2008, at the beginning of the

financial crisis. This pattern is consistent with H1 and suggests again that PE firms

respond quicker to the downturn than PLCs.13

For public companies, gross margin and coverage were higher in 2008 and 2009 than

they had been in 2007, but drop again as the economymoves into recession. Profit measures

indicate some recovery during 2010 for all surviving firms. PE companies show a sharply

rising trend in coverage from 2006 onward that far outstrips the rises for other company

types. This again suggests a higher degree of financial prescience on behalf of PE firms.

PLCs had the highest cash to total assets throughout the period, rising from about 10% in

1999 to a peak of 17% in 2006 and falling back to 14% in 2010. PE-backed buyouts were

lower throughout the period but showed a steady upward trend from 8% in 1999 to about

10% in 2010, including the recessionary period after 2007.

5.2. Buyout refinancing

Further investment by PE firms into portfolio companies can contribute to the changes in

leverage we observe. It is clear from Table 3 and Figure 3 that refinancing of PE-backed

buyouts is quite extensive from year to year. While numbers have declined over the 12-year

period examined, with about 100 such refinancings occurring in the year 2000, falling

dramatically to one-fifth of that figure in 2012, the total value and average size of refinancing

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Table

2.

Profitabilityandrisk

over

time:

PE-backed,PLCs,andmatched

privatecompanies.

Year

PE-backed

PLCs

Matched

private

ROA

Gross

margin

Debt/TA

Coverage

ROA

Gross

margin

Debt/TA

Coverage

ROA

Gross

margin

Debt/TA

Coverage

1999

7.13

30.66

37.06

20.88

4.82

31.84

23.36

21.28

5.69

29.61

37.89

30.50

2000

5.60

30.60

37.59

22.00

2.67

34.98

21.92

18.51

5.05

28.63

38.40

30.04

2001

5.32

31.41

36.91

21.45

20.32

38.13

22.06

14.68

4.82

30.02

38.88

29.96

2002

4.87

33.28

37.86

21.75

21.39

38.87

23.22

14.31

4.56

32.13

39.15

31.14

2003

5.66

35.03

37.89

25.09

20.06

39.20

23.95

17.50

4.93

33.05

39.16

32.29

2004

7.19

35.86

36.12

23.84

1.21

41.18

23.27

17.97

5.78

33.99

38.68

27.92

2005

8.64

37.16

34.64

25.97

1.49

41.54

21.64

15.68

5.87

34.81

38.07

25.76

2006

8.74

37.15

34.50

26.71

1.17

42.04

21.98

16.14

6.24

35.06

37.68

25.34

2007

10.13

37.40

34.28

30.50

1.74

42.34

22.30

18.18

6.54

34.75

37.46

25.93

2008

9.21

36.42

30.58

35.27

1.44

38.35

24.29

17.10

5.72

31.37

36.33

26.50

2009

6.72

33.72

24.70

36.29

20.20

36.75

22.82

16.35

4.50

28.16

26.89

29.36

2010

7.30

31.86

14.52

47.11

2.12

31.64

17.48

21.03

5.40

25.19

16.90

36.46

Note:Thetable

presentsannual

meanvalues

forselected

financial

variablesbroken

downbyPE-backed

buyouts,matched

privatefirm

s,andlisted

corporations(‘PLCs’)duringthe

period1999–2010.Thevariablesmeasure

both

profitabilityandfinancial

risk

andareusedin

thesubsequentregressionanalysis.ROA

isnet

income/totalassets£100.Gross

margin

isdefined

as(Sales-costofsales)/Sales

£100.Debt/TA

isdefined

as(thebookvalueoftotaldebt)/(bookvalueoftotalassets)£100.Coverageisdefined

asEBIT/(interest

expenses)£100.

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Per

cent

0

5

10

15

20

25

30

35

40

45

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

PE-BACKED PLC PRIVATE

Figure 2a. Leverage by firm type, UK (1999–2010).

Per

cent

0

5

10

15

20

25

30

35

40

45

50PE-BACKED PLC PRIVATE

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Figure 2b. Interest coverage by firm type, UK (1999–2010).

Per

cent

–2

0

2

4

6

8

10

12

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

PE-BACKED PLC PRIVATE

Figure 2c. ROA by company type, UK (1999–2010).

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showsmuch less of a trend. The latter reaches a peak of £200million in 2005, falls to a trough

of £16 million in 2005 and rises again to a local peak of £87 million in the recovery year of

2012. Thus, much of the refinancing occurs before the recession hits in 2007, again

consistent with H2 (see Table 3 and Figure 3).

To add local color to the overall picture, note that additional investment may be to

deal with underperformance or distress and may involve debt and/or equity. For

example, the £440 million distressed buyout of the leisure group Park Resorts in 2007

underwent three refinancings between 2008 and 2012. The first involved a £45 million

equity injection in 2008, and debt injections of £25 million and £46 million in 2009 and

2012, respectively. The retail group Stead and Simpson, a £50-million buyout in 2005

underwent a £8-million debt refinancing in 2007 but entered bankruptcy the following

year. Similarly, IMO Car Wash, a £450-million buyout in 2006 underwent a debt

refinancing of £25 million in 2008 to address performance difficulties but entered formal

bankruptcy in 2009. But refinancing may also be undertaken to fund growth. Thus, for

0

50

100

150

200

250

Number Value £100m Average £m

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Figure 3. PE-buyout refinancings’ number, value, and size, UK (2000–2012).

Table 3. Refinancing of UK PE-buyouts.

Period Number Value (in £ million) Average (in £ million)

2000 98 4225 432001 78 4191 542002 85 3720 442003 56 2508 452004 91 10,579 1162005 63 12,608 2002006 60 7769 1292007 62 8697 1402008 60 4018 672009 61 955 162010 46 1731 382011 42 741 182012 19 1655 87

Note: The table reports numbers and value of PE buyouts refinanced for the UK in the period 2000–2012. Theyear 2012 figure is to the end of Q2 only. Refinancing occurs if a buyout’s financial structure (debt/equity) orthe duration of its debt is altered. This may involve injections of cash or restructuring of a company’s finances.Source: CMBOR/Equistone Partners and Ernst & Young.

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example, the £70-million 2008 Crown Paints buyout received £25 million in 2010 to

fund expansion before being sold in 2011 to the Danish Group Hempel. Likewise, the

£23-million 2007 buyout of TGI Friday was sold in 2010 to the US group Carlson Inc

after receiving a £11-million debt injection to fund expansion in 2008.

5.3. Buyouts and insolvency risk

Table 4 and Figure 4 illustrate that the trend in failure rates for all companies in the

period is downward, although there is some fluctuation at the beginning and end of the

period. In particular, the onset of the financial crisis in 2007 caused a jump in the failure

rates of all company types, which only leveled out in the two years 2008–2009. MBIs

have the highest failure rates in the latter half of the period, i.e., 2004–2010, consistently

Table 4. Failure rates of buyouts, non-buyouts, and listed companies.

Year Companies Insolvencies

Failure rate (%)

Allcompanies

PEbuyouts

Non-PEMBI

Non-PEMBO Listed

1995–1998 1,74,968 7716 4.41 7.61 15.15 10.36 2.441999 1,33,441 6334 4.75 7.94 5.56 8.05 8.232000 2,84,424 8191 2.88 8.76 9.21 3.88 4.362001 4,00,159 10,556 2.64 6.89 4.90 5.35 4.072002 4,45,758 11,663 2.62 7.07 9.91 6.90 5.702003 5,51,072 11,036 2.00 5.68 4.80 4.07 3.832004 7,23,735 10,437 1.44 4.60 7.06 3.00 1.972005 8,25,976 11,183 1.35 4.15 5.03 2.57 2.452006 9,38,550 12,260 1.31 3.66 4.80 2.82 2.432007 10,48,356 13,142 1.25 3.02 4.73 3.05 2.762008 11,51,106 18,613 1.62 3.81 7.12 3.82 4.272009 13,43,715 20,510 1.53 3.81 7.32 4.48 4.692010 9,16,633 11,872 1.30 2.63 5.73 2.60 2.64

Note: The table reports failure rates of the UK population of buyouts, buyins, and non-buyouts over the period1995–2010 by backing types (PE-backed and non-PE-backed) and compares these with the rates for listedcompanies.

0

2

4

6

8

10

12

Fai

lure

rat

es(%

)

PE buyouts Non-PEMBI Non-PEMBO PLCs

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Figure 4. Failure rates by firm type, UK (1999–2010).

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with H3, followed by PE-backed buyouts, though the latter declines more sharply after

the onset of the financial crisis in 2007. PLCs, being more operationally diversified and

less highly geared, have the lowest failure rates pre-financial crisis. PE-backed buyouts

with their higher gearing, have persistently higher failure rates than MBOs until about

2007, the onset of the financial crisis, but by 2010, the failure rates of all company types,

apart from MBIs, converged on about 3%. PE-backed buyouts have a lower failure rate

than non-PE-backed buyouts. For instance the failure rate of non-PE-backed buyouts is

around 5.7 % in the period since 1998, whereas PE-backed ventures have a failure rate

of 5.3% in the same period. Reflecting the change in the bankruptcy regime, we find that

buyouts deals undertaken pre-2003 have a significantly higher failure rate than those

completed post-2003.

5.4. Differences between buyouts and non-buyouts

We have argued above that firms subject to buyouts are not a random sample from the

population, already apparent from the analysis of Table 2 above for solvent companies.

However, Table 5 also shows that these differences extend into bankruptcy. Solvent buyouts

tend to be inmore concentrated industries asmeasured by theHirschman–Herfindahl Index,

though buyouts that fail tend to be in slightly less concentrated sectors. This likely reflects the

success of buyouts as a result of consolidation activities: buyouts that fail to consolidatemay

become insolvent. Solvent buyouts are also significantly larger (as measured by total assets)

than non-buyouts but for failed companies, the differences are smaller. This may reflect

diversification, which tends to increase with size, but also market power. Solvent buyouts

have much higher leverage than non-buyouts: 21% versus 4%, a ratio of 5:1. Insolvent

buyouts have twice the leverage (40%) of solvent buyouts (21%), suggesting that leverage is

part of the reason for insolvency. Interest coverage for solvent buyouts (at 128%) is twice

that of non-buyouts (registering at 64%), whereas for insolvent buyouts the ratio is virtually

identical at 44%. Table 5 also shows that buyouts, as compared with non-buyouts, have

significantly lower delays in filing their accounts and this is true regardless of the solvency

outcome. This again is consistent with the superior financial efficiency of the buyout form.

5.5. Regression analysis of bankruptcy risk

These differences in the two samples of firms under conditions of solvency and

insolvency are new and interesting findings. However, pairwise comparisons do not hold

other variables constant. Therefore, we next perform an analysis of failure using

regression methods controlling for a range of other financial and nonfinancial factors in

the failure process. We control, in particular, for the level and direction of leverage with

debt/total assets and the annual change in this ratio, since we wish to determine whether,

controlling for leverage, buyouts are more risky than non-buyouts. The results (Table 6)

are interesting, and show, as expected, that a greater likelihood of failure is associated

with firm size but increasing returns set in so that beyond a certain size the relationship

becomes negative. Older firms are less likely to fail, in line with a large volume of

industrial economics literature. Regarding firm types, these are classified into family-

owned businesses, PE buyouts (pre- and post-2003), MBOs (pre- and post-2003), and

MBIs (pre- and post-2003). The control group is defined as those companies that are

neither family-owned nor involved in buyouts or buyins.

What is clear is that relative to controls, and given leverage, PLCs tend to be more

subject to imminent risk of failure with a hazard rate that is 73–77% higher than control

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Table

5.

Failedandnon-failedbuyouts

andnon-buyouts.

Variable

Panel

A:Non-failedcompanies

Panel

B:Failedcompanies

Non-buyouts

Buyouts

Sig.

Non-buyouts

Buyouts

Sig.

Hirschman

–HerfindahlIndex

(sectorandyear)

380.40

495.03

0.000

472.05

466.11

0.000

LogTA

11.85

15.14

0.000

12.4107

14.9096

0.000

Logage

7.8401

8.4804

0.000

7.8680

8.4118

0.000

Agedummy,3years

0.1441

0.0553

0.000

0.1410

0.0729

0.000

Agedummy3–10years

0.5015

0.3345

0.000

0.5558

0.3808

0.000

Agedummy,10years

0.3417

0.6101

0.000

0.3032

0.5462

0.000

Cash/TA

0.2750

0.1073

0.000

0.1089

0.0575

0.000

Inventory/workingcapital

3.6175

7.2840

0.000

8.6929

13.0399

0.000

Tradecreditors/totalliabilities

0.5644

0.3744

0.000

0.5867

0.4012

0.000

Tradedebtors/totalassets

0.2572

0.2938

0.000

0.3593

0.3262

0.000

Profitmargin

20.0699

0.0048

0.000

20.2509

20.1899

0.000

ROA

0.2642

0.0657

0.000

20.0002

20.0455

0.000

Retained

profit/totalassets

0.0869

0.0121

0.000

20.2254

20.1533

0.000

Totaldebt/TA

0.0386

0.2064

0.000

0.2167

0.4152

0.000

Interest

coverage

63.6792

128.3930

0.000

44.1596

44.3599

0.000

Operatingcash

flow/TA

0.0108

0.0520

0.000

0.0080

0.0274

0.000

Auditqualification_Going-concern

0.0061

0.0204

0.000

0.0323

0.0814

0.000

Auditqualification_Severe

0.0015

0.0026

0.000

0.0099

0.0085

0.000

Changeofauditor

0.0669

0.1297

0.000

0.0965

0.1603

0.000

Courtjudgments/totalliabilities

0.0078

0.0028

0.000

0.0979

0.0427

0.000

Creditorchargeonassets

0.0485

0.2098

0.000

0.1303

0.3189

0.000

Latefillingaccounts

(days)

14.2417

8.0560

0.000

26.0890

16.8940

0.000

Latefillinglast

accounts

(days)

10.2944

6.3089

0.000

30.2452

19.7589

0.000

Industry

risk

(weightofevidence)

0.1057

20.2008

0.000

20.1498

20.4062

0.000

Note:Thetable

reportstestsfordifferencesin

themeansofarangeofvariablesreflectingcompanycharacteristics,nam

ely,financial

risk,operational

risk,andgovernance

by

subsample.In

thefirsttwocolumns,wereportthemeansofnon-failedsubsamplesofnon-buyoutsandbuyouts,andthesignificance

ofthedifferencesbased

ont-tests.Werepeat

thetest

forfailed

companiesusingthelast

setofaccountingandnon-financial

inform

ationavailable

intheyearbefore

failure.

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companies. Next come MBIs (at 62–66% higher) followed by PE-backed buyouts (at

46–51% higher than controls). As expected, the biggest difference is for MBIs

(particularly post-2003), followed by PE-backed buyouts (particularly pre-2003) and

Table 6. Buyouts and insolvency risk.

Variable

Model 1 Model 2 Model 3Coefficient Coefficient Coefficient

(SE) (SE) (SE)

Log TA 1.5779*** 1.5762*** 1.5307***(0.0221) (0.0221) (0.0221)

(Log TA)2 20.0546*** 20.0546*** 20.0538***(0.0008) (0.0008) (0.0008)

Log age 20.1348*** 20.1357*** 20.1202***(0.0052) (0.0052) (0.0052)

Age risk 3–9 years 0.2639*** 0.2637*** 0.2527***(0.0094) (0.0094) (0.0094)

Subsidiary company 20.1101*** 20.1118*** 20.1776***(0.0112) (0.0112) (0.0116)

Herfindahl–Hirschman Index 0.0001*** 0.0001*** 0.0001***(0.0000) (0.0000) (0.0000)

Family company 20.2438*** 20.2434*** 20.2411***(0.0100) (0.0100) (0.0100)

Listed company 0.7338*** 0.7273*** 0.7674***(0.0408) (0.0408) (0.0407)

PE backed pre-2003 0.5071*** 0.5058*** 0.4587***(0.0516) (0.0516) (0.0515)

PE backed post-2003 0.2810* 0.2734 0.2427(0.1244) (0.1252) (0.1259)

MBO pre-2003 0.1676* 0.1650* 0.1451*(0.0700) (0.0700) (0.0697)

MBO post-2003 0.1519 0.1460 0.1425(0.1390) (0.1389) (0.1382)

MBI pre-2003 0.6630*** 0.6617*** 0.6188***(0.1441) (0.1439) (0.1443)

MBI post-2003 1.0789*** 1.0657*** 1.0280***(0.1932) (0.1930) (0.1929)

Change debt/TA – 0.0540*** 0.0302***(0.0057) (0.0060)

Debt/TA – – 0.5579***(0.0172)

Macro-base hazard 2.2102*** 2.2092*** 2.2127***(0.0426) (0.0426) (0.0426)

Constant 217.5837*** 217.5631*** 217.1959***(0.1556) (0.1556) (0.1553)

Industry dummies Yes Yes YesN (Failed) 57,761 57,761 57,761N (total) 3,320,392 3,320,392 3320392Log likelihood 2277014.778 2276977.822 2276471.429LR (x2) 27786.804 27879.398 29444.724Pseudo R2 0.0490 0.0491 0.0508

Note: The table reports estimates of discrete time Cox proportional hazard models of insolvency for the sample.The equations include estimates of the baseline hazard rate from a macroeconomic model. Robust (firm-clustered) standard errors are reported. Overall fit is gauged by log-likelihood statistics x2 and Pseudo R2. Theestimates are for companies that report full accounts.*significance at the 10% level; **significance at the 5% level; ***significance at the 1% level.

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then MBOs. These findings are consistent with H3 and show that controlling for leverage

(size, age, etc.) PE buyouts are indeed less risky than PLCs. Leverage, however, is also,

as predicted in H3, part of the story since it is associated with higher risk, irrespective of

whether the firm is a buyout or not. Thus, we find that a one-unit increase in leverage

increases the hazard of failure by 56%.

5.6. Recovery rates

The governance mechanisms in PE-backed buyouts mean, as we have seen, that if a

portfolio firm enters formal bankruptcy it will do so with expectations of greater

preservation of value than would be the case of publicly listed corporations. In this

section, we test Hypotheses H5–H7 above, regarding recovery rates under different

conditions. To compare the secured debt recovery rates for financially distressed UK

companies across different firm types, we selected matched samples of 100 publicly

listed and PE-owned firms from our overall data-set that became financially distressed

over the period 1995–2009. We then compared the recovery rates of senior debt for the

two samples, taking into account other relevant factors such as size, asset efficiency,

leverage, and time taken to complete the recovery process.

Table 7 presents the results. We find that PE ownership delivers more than twice the

recovery rate than PLC ownership when distress occurs. The mean recovery rate from

PE-backed firms entering formal bankruptcy proceedings is 63% compared to 30% for

Table 7. Secured debt recovery rates PE buyouts versus PLCs, UK (1999–2009).

PE PLC

Averagerecovery rate (%)

No. offirms

Averagerecovery rate (%)

No. offirms

Panel A: Average recovery rate (%) 62.69 27.71Panel B: Recovery rate by year1999 100 1 33.50 82000 62.92 9 45.32 72001 62.48 14 16.43 112002 57.36 13 33.63 112003 64.90 12 15.90 62004 65.65 13 24.99 62005 66.61 10 21.08 52006 72.11 6 14.85 112007 50.85 14 27.55 72008 – – 33.52 192009 100 1 62.66 3

Panel C: Recovery rate by industryManufacturing 61.91 57 33.25 30IT and communication 52.60 6 32.53 16Financial 53.60 2 20.18 10Wholesale 68.77 10 16.86 9Retail 91.00 3 25.19 8Service 57.36 15 25.53 23

Panel D: Recovery rate by number of creditorsSingle creditor 68.57 50 25.49 72Multiple creditors 54.25 43 34.37 24

Note: Table provides recovery rates of secured debt defined as the percentage of secured debt recoveredfrom an insolvent company from the time the Receiver or Administrator is appointed until the time he/sheleaves.

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publicly listed corporations (Table 6, Panel A). There is some considerable variation

around these average rates. In some cases, all the outstanding secured debt was

recovered. For example, in the failed PE-backed real estate group Greycoat City Estates

in 2004, recovering all the secured debt to one lender was completed in 315 days. In the

case of the failed textile manufacturer The Rope Company, 40% of the £10.8-million

secured debt was recovered for one lender but the process took 686 days. As an example

from PLCs, the 2006 failure of the financial intermediation firm Millfield Group which

had an outstanding debt to five lenders of £17.1 million resulted in only a 2.9% recovery

rate over a period of 326 days. In contrast, the failed PLC Patient line had £86.8 million

of debt outstanding to four lenders in 2008 resulting in a 53% recovery rate in 213 days.

There is also some variation in recovery rates across different years (Table 7, Panel B),

though the recovery rates in PE cases seem to be less volatile than for PLCs.

We also find that recovery rates vary across industries within firm types (Table 7,

Panel C). For PE-backed failures, the highest recovery rates are in retail (91%),

wholesale (69%), and manufacturing (62%). The recovery rate for failed retail sector

PLCs was only 25%. In contrast, the highest recovery rates for PLC cases are

manufacturing (33%), IT and communications (33%), and services (26%).

Comparing evidence from PE-backed failures with that from a more general

population of small private firms, we find that management buyouts experience fewer

going-concern realizations from formal bankruptcy proceedings (30%), make a lower

average repayment to secured creditors, and are less likely to repay all of the debt owing

to these creditors (Franks and Sussman 2005). These results appear to contrast with

expectations that the covenants accompanying high leverage in buyouts will signal

distress sooner than in firms funded more by equity. However, since these buyouts

entered formal insolvency procedures despite the presence of specialized monitoring

suggests that they are cases that have been most difficult to reorganize through active

private firm involvement prior to formal insolvency.

Buyouts, as we have seen, are more likely than non-buyout private firms to be

financed by syndicates of lenders as lenders seek to spread the risk from higher

leverage. Coordination among multiple lenders in the UK, contrary to theory, does not

seem to create inefficiencies in the bankruptcy process that might otherwise result in

significantly lower overall secured creditor recovery rates (Citron and Wright 2008).

Looking at the evidence from our matched samples, the overall recovery rate for

PE-backed failures is lower for firms with multiple creditors (54.3%) compared to deals

with single creditors (68.6%) (Table 7, Panel D). In both cases, the recovery rates for

PE-backed deals are greater than for PLCs. However, in contrast, the recovery rates for

multiple creditors in failed PLCs (34.4%) are on average higher than where there is only

a single creditor (25.5%).14 Bankruptcy processes take some time to complete, as

insolvency practitioners need to find buyers for all or part of the assets. The mean length

of time to complete this process is a little below 3 years, although in the UK 95% of

repayments are generally made within 2 years (Citron and Wright 2008).

The greater percentage recovery in PE deals is accompanied by a greater average

time to recovery than in PLC deals of 40 days on average (Table 8, Panel A). There are

also considerable differences in the times to recovery between industrial sectors, and

these also vary between PE-backed firms and PLCs except in the case of the wholesale

sector. Average times to recovery are greater in PLC cases than for PE-backed

companies in manufacturing and retail sectors, while the reverse is true for IT and

communication, and financial and service sectors (Table 8, Panel B).

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From Table 8 we can see that the time taken to complete the bankruptcy process has

an important impact on the recovery rate. The longer the time to completion, the lower

the percentage of debt that is recovered. More asset-efficient firms (as measured by the

ratio of total asset/turnover ratio) have higher recovery rates, but deal size is not found to

be significantly related to recovery rates. Moreover, there are little differences between

company types in time to recovery; both on average take around 1000 days or 3 years to

complete.

5.7. Regression analysis of recovery rates

We now control more effectively for other factors in analyzing recovery rates by

employing regression methods. We first estimate the following econometric model with

secured debt recovery rate (RR) as a dependent variable15:

RRi ¼ b0 þ b1PLCi þ b2Adminþ b3Numcredi þ b4Drati þ b5Timei þ b6Vi þ 1i ð3Þ

where, PLC is a dummy variable taking the value 1 if the company was publicly owned

(a PLC) and 0 if PE-backed (a buyout). Admin is a dummy variable taking the value 1 if

the distressed firm passed through Administration and 0 if Receivership. Numcred is the

number of creditors of the company. Drat is secured debt/total assets. Time is the

number of days the firm spends in recovery. V is a vector of industry and macro-controls.

Secondly, we estimate the following model of time to recovery (Time), where TA2 is

the square of TA:

Timei ¼ b0 þ b1PLCi þ b2Admini þ b3Numcredi þ b4TAi þ b5TA2i þ b6Vi þ 1i ð4Þ

Table 9 presents the results of the recovery rates regressions. Thus, PLCs, controlling

for other relevant factors, have recovery rates between 34% and 37% lower than PE

buyouts, consistent with H5. A higher debt ratio (Drat) reduces the recovery rate as a

result (we believe) of having to access lower quality assets for collateral as leverage

increases. Being in Administration (Admin) rather than Receivership, contrary to

expectation (H6), has no significant effect on the recovery rate of secured debt.

Table 8. Time to recovery of secured debt, UK (1999–2009).

PE PLC

Average time torecovery (days)

No. offirms

Average time torecovery (days)

No. offirms

Panel A: Average time torecovery in days

997.56 957.57

Panel B: Average time torecovery by industryManufacturing 999.85 57 1368.86 30IT and communication 1329.40 6 836.00 16Financial 1575.50 2 713.86 10Wholesale 923.13 10 921.11 9Retail 544.50 3 1037.00 8Service 886.85 15 541.05 23

Note: Table reports in days average time to recovery of secured debt from insolvent PE buyouts and PLCs.

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The same is true of the number of creditors (Numcred), consistent with H7. Finally, size

of firm (TA) does not influence the rate of recovery, holding other factors constant.

Company type (PLC) and the number of creditors (Numcred) have no effect on the

time to recovery. However, Administration as recovery mode (Admin) has a powerful

effect in reducing the time to recovery, consistent with H6 (Table 10).

6. Summary and conclusion

A large literature has adumbrated the value-added role of PE firms in backing buyouts. The

present paper examines a different and hitherto unexplored issue: the role of financial

restructuring in PE-backed buyouts in the UK both before and after the financial crash of

2007, and before and after bankruptcy (should this occur). The 2007 crash involved the

demise of significant numbers of such buyouts along with other sorts of buyouts and

non-buyouts. We have shown that PE-backed buyouts already contained provisions to

optimize recovery rates under insolvency and this raised their recovery rates significantly

relative to a control group of PLCs both before and after the crash. However, we found that

PE buyouts rapidly adjusted the capital structures of new deals in response to the changes in

financial and economic climate from 2007 onward. High leverage of preexisting deals of

course increased the insolvency risk of firms unable to adjust their capital structure prior to

or during the downturn.We showed, though, that therewas a greater adjustment over time in

the leverage of buyouts than for other private companies and matched listed corporations.

An area for further research may be to examine differences in the strategic rundown rate of

Table 9. Recovery rate regressions.

Variable Model 1 Model 2

Intercept 0.6459*** 0.5533***(0.1302) (0.1173)

PLC 20.3755*** 20.3400***(0.0607) (0.0578)

Drat 20.00496** 20.00482**(0.0023) (0.00232)

Admin 20.0834 –(0.0622)

Time 20.000106*** 20.0000727**(0.0000407) (0.0000355)

Numcred 20.0282 –(0.0276)

TA 0.00037 –(0.000348)

l 0.1950* 0.1297(0.1148) (0.1099)

Wald x 2 (df) 59.05(12)*** 54.14(9)***N (uncensored) 169 169N (censored) 190 190

Note: The Table shows the results of Heckman selection regressions of the recovery rate (RR) againstexplanatory variables based on Equation (1) (for definitions of variables, see Table 1). Lambda is the inverseMills ratio. Robust standard errors are in brackets. Industry dummies, total assets and GDP growth rate wereincluded in the regression but are excluded from the presentation to save space (a joint test, however, showsthem to be insignificant at conventional levels). Model 2 is a parsimonious version of Model 1 withinsignificant variables dropped.*significance at the 10% level; **significance at the 5% level; ***significance at the 1% level.Source: This table is reprinted from Cressy and Farag (2012). With permission from the publisher.

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debt in different buyouts and the impact on insolvency risk, subject to data availability. We

also showed that PE-backed deals were not ex ante riskier than the population of non-

buyouts, once other factors (in particular the degree of leverage)were controlled for. Further

research might usefully extend analysis to examine differences between deals that are

minority versusmajority PE-backed, again subject to data availability. The data also suggest

that the greater secured creditor recovery rates found for failed PE-backed companies

versus failed listed corporations indicate the benefits of the governance mechanisms in the

former preserving greater value when a portfolio firm enters formal bankruptcy

proceedings.

Taken together, our findings indicate that active involvement by PE firms helps

portfolio companies deal better and in a more timely way with trading difficulties in a

rapidly deteriorating financial climate. Our analysis offers important lessons for

policymakers. First, it shows that there has been greater adjustment over time in the

leverage and cash position of buyouts than for other private companies and matched

PLCs. This resulted in a sharply declining rate of bankruptcy for PE firms over the

12-year period studied and lower rate of bankruptcy for PE buyouts than PLCs post-

2007. Second, policymakers need to recognize that while PE buyouts are highly

leveraged, non-PE-backed buyouts are more or less well managed. Much more prone to

bankruptcy still, and throughout the 12-year period studied are non-PE MBIs. Too little

attention has been devoted to this category of firm reorganization. Third, we have

Table 10. Time-to-recovery regressions.

Model 1 Model 2 Model 3

Intercept 766.04*** 506.87* 471.18**(211.10) (236.47) (227.44)

PLC 16.63 285.725 –(108.74) (114.13)

Admin 2707.64*** 2741.52*** 2735.68***(103.75) (102.44) (100.13)

Numcred 25.209 216.762 –(54.49) (51.78)

TA 3.171* 3.334** 3.014*(1.774) (1.681) (1.622)

TA2 20.00391 20.00376 20.00338(0.00309) (0.00295) (0.00291)

l – 457.07** 388.85**(214.28) (194.18)

R2 0.3624 – –Adj. R2 0.3180 – –Root MSE 617.81 – –F(11,158) 8.16*** – –Wald – 97.48*** 98.25***Wald df 11 9N (uncensored) 169 169 169N (censored) – 190 190CN 12 – –

Note: The Table reports Heckman selection equation estimates of regressions of the time to recovery, Time, ofEquation (2) against various explanatory variables (see Table 1 for definitions of variables). Standard errors arein brackets. Note that industry and macro-dummies were included in the regression but are excluded from thepresentation to save space. CN is the Condition Number of the equation.*significance at the 10% level; **significance at the 5% level; ***significance at 1% level.Source: This table is reprinted from Cressy and Farag (2012). With permission from the publisher.

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shown that, controlling for leverage, PE-backed deals are not riskier than the population

of non-buyouts in the period post-2003; active involvement by PE firms in helping

portfolio companies deal with trading difficulties plays an important role. Fourth, the

governance mechanisms in PE buyouts result in greater preservation of value when a

portfolio firm enters formal bankruptcy than is the case for PLCs. The secured debt

recovery rates for PE buyouts are actually double those of PLCs, like for like. Thus, the

losses associated with PE buyout failure should not be overemphasized in the policy

debate.

Acknowledgements

We would like to thank the editor, Colin Mason, and the referees of this paper for their detailedand insightful comments on an earlier draft that have significantly improved the paper. Anyremaining errors are of course our own.

Notes

1. Email: mike.wright@imperial.ac.uk2. Email: nw@lubs.leeds.ac.uk3. Email: h.farag@bham.ac.uk4. This does not appear to be the case in continental Europe because of the continuing

uncertainty surrounding the Eurozone.5. A listed corporation will need to prepare a formal investment proposal and will have to incur

associated broker fees, as well as obtaining commitment from investors that they will not selltheir shares.

6. We define the time to recovery as the number of days between the first entry of the Receiveror Administrator and the exit date.

7. We note, as a statistic to set the scene and motivate the discussion that follows, that over153,000 UK companies failed in the period under consideration.

8. Specifically, it includes 9491 for each company involved in a buyout; observations for thelast three years pre-buyout.

9. It is easy to show that the predictor does not include an intercept and that is why none isreported in the semiparametric analysis to follow.

10. These trends for a given firm are not unrelated as the accounting identities show (Cressy2009).

11. We are referring to the ratio of the leverage percentages for PE buyouts and PLCs.12. As noted elsewhere in the paper, this effect is in fact an amalgam of two effects: that of

banks’ reluctance to lend and that of PE firms deleveraging voluntarily.13. There may also be a selection effect in operation here; due to their higher financial risk, PE

buyouts may exit the population earlier than PLCs.14. When there are multiple secured lenders, the senior secured lender gains at the expense of

other secured creditors as the lender first registering the charge over assets obtains priority.However, on average, the senior secured creditor achieves a recovery rate of 74% whileremaining secured creditors receive only 32%(Citron and Wright 2008). Evidence on thereturns to subordinated creditors in the UK buyouts is generally lacking.

15. See Cressy and Farag (2012) from which this analysis is taken.

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