LBOs: Job Creators and Growth Stimulants?
David Thesmar, Quentin Boucly, and David Sraer show that, contrary to popular belief, LBOs in France lead to high growth in sales and employment in acquired companies. These bought-out firms grow much faster than SMEs that remain independent, particularly when it comes to family businesses.
Leveraged buyouts (LBOs) occur when a company is bought using loans, creating “leverage” to facilitate the acquisition. The purchase is often carried out through the creation of a parent company (into which capital is injected) that borrows the amount needed for the acquisition. Besides the tax benefits associated with this type of transaction, this mechanism makes it possible to borrow up to the maximum of the target company’s total self-financing capacity—taking into account all of its foresee- able cash flows. This operation has the effect of putting strong pressure on the acquired company. This pressure often translates into restructuring and cost reduction programs, as various studies from the English-speaking world have already con- firmed. Does the same hold true in France?
LBOS AND PROFITS OVER THE LONG TERM
An in-depth study of LBOs occurring in France over a decade has demystified the almost aggressive image of this type of transaction. Professor David Thesmar and his colleagues Quentin Boucly and David Sraer show that LBOs in France create growth and jobs in the acquired companies. “Contrary to a widely held belief, LBOs don’t suffocate companies, but (on average) they allow them to develop. Employment and sales seem to increase by more than 20% in the three years following the LBO,” explains Thesmar. Indeed, their study on 830 LBOs taking place in France between 1994 and 2004 concludes that companies bought in this way experienced high growth immediately after the transaction, in comparison to a panel of companies that remained independent. Specifically, the study shows that LBO companies saw their workforce grow by 13%, their assets by 11%, and their sales by 13% more than companies that remained independent in the four years following an LBO (compared with the three years before the buyout).
In France, employment and sales seem to increase by more than 20% in the three years following the LBO.
LBOS: SOURCE OF GROWTH OR EXCUSE FOR RESTRUCTURING?
The authors did, however, detect a difference in this beneficial effect depending on whether the LBO involves a family-owned SME (small and medium enterprise) or a division of a large corporation sold to an investment fund. In the first case, growth is accompanied by a substantial acceleration in invest- ment, whereas in the second, investment does not increase, and restructuring effects are thus the main goal. “The natural interpretation of this phenomenon is that spin-offs have already reached their critical size within well-managed groups with internal capital markets. In contrast, independent firms are smaller than their critical size, either due to a lack of management or access to capital markets,” explains Thesmar. Family-owned SMEs must “grow to create value,” which requires skills that the initiators of LBOs can provide them with (notably knowledge and useful contacts with banks). The LBO thus brings the needed credibility to the company to convince bankers to loan them enough money.
THE SPECIFIC CASE OF FRANCE
Thesmar points out that although studies in English-speaking countries have been structured in the same way, they have arrived at opposite results, suggesting a negative impact of LBOs on growth. This divergence results from the fact that the tar- get companies in the United States and Great Britain are generally publicly traded, whereas the French companies that Thesmar has studied generally are not. LBO operations in France thus represent an alternative to a capital market that is less devel- oped than in English-speaking countries. In the United States, since companies have more alter- natives to finance their market growth (notably through venture capital financing or trading), LBOs are motivated primarily by restructuring policies.
Based on an interview with David Thesmar and his article “Job-Creating LBOs”, Journal of Financial Economics , co-authored with Quentin Boucly and David Sraer.
APPLICATIONS FOR REGULATORS
According to the authors, “these results are of more interest for the government (administrators and politicians) than for practitioners. While the latter have known for a decade that LBOs make it possible to organize businesses growth, public sector authorities are stuck on the outdated and negative image of the 1980s, illustrated in Oliver Stone’s movie ’Wall Street,’ where value creation resulted from restructuring.” Concretely, the results of this study offer two major insights to regulators and politicians: first, LBOs in France promote growth and employment, and second, these operations allow SMEs to develop. This conclusion is of particular interest for the French government, which is seeking to make its SMEs more competitive internationally. Thesmar concludes: “In France, you often hear complaints that banks do not do their part to support growth. But private equity (the investment funds behind LBOs) do this job quite well.”
The researchers monitored a panel of acquired companies before and after the LBO, comparing them to a control group of companies matched for sector, size, and profitability. The advantage of this method, which is often used in American studies on the same topic, is that it combines methodological simplicity with great analytical power. The data on 830 LBO operations carried out between 1994 and 2004 were drawn from sources well-known to both researchers and practitioners: SDC Platinium and Capital IQ.