Study: Private equity reduces insolvency risk

When a company goes through a buyout, it is more likely to survive with a private equity owner, recent UK research shows.

Businesses that have gone through a buyout are less likely to go bust if there is private equity money involved, according to a joint study from three British universities.

The research, which was partly funded by the British Private Equity and Venture Capital Association (BVCA), suggested that any company that has gone through a buyout – whether backed by a private equity firm or another funding source – is more likely to fail than a company that has not. However, private equity involvement “significantly reduced the risk of buyout failure”.

Leverage levels are equally high for buyout targets regardless of whether private equity firms are involved or not, the study found, but those targeted by private equity firms have higher coverage ratios – the ability to pay interest based on cash flow – than non-private equity-backed peers.

This could be down to private equity firms' ability to target better prospects in risky sectors rather than their operational impact.

“Our finding on the impact of leverage is counter to popular perceptions about private equity ownership,” said Mike Wright, a professor at the Nottingham University Business School, in a statement.

“Private equity firms seem to select the best opportunities from the buyout population in terms of the company's prospective profitability and ability to cover interest and, where problems emerge, private equity firms appear to be more effective at structuring solutions to debt problems.”

Nottingham University's Centre for Management Buyout Research collaborated with Leeds University Business School's Credit Management Research Centre and the University of Birmingham's Entrepreneurship and Innovation Centre.

The study echoes similar conclusions produced last week in the US by the Private Equity Council, a Washington DC-based industry body representing some of the world's largest private equity firms. It concluded that among 3,200 private equity-backed companies acquired between 2000 and 2009, the default rate during the current two-year recession had been 2.8 percent, compared with a 6.2 percent default rate for similarly-financed businesses.