Research finds institutional buyouts can be bad for business

Achieving an impressive exit sale is the goal of many ambitious founders, for whom the capital gain is the chief reward for years of hard work. But selling your business to private equity through an institutional buyout (IBO) is not only likely to be bad for your staff but will damage the company’s performance compared with its peers.

That is the finding of a group of academics from Warwick Business School, Cardiff Business School and Loughborough University’s School of Business and Economics into 106 British IBOs completed between 1997 and 2006.

These highly leveraged transactions, in which one or more institutional investors co-operate to initiate a deal, mostly result in job losses and an overall decline in productivity, the professors found.

Their study tracked the performance, employment and wage figures for each of these companies six years before takeover through to four years afterwards. These results were then compared against a group of companies with similar performance and another group from the same industry.

The IBO companies’ median employment growth was 11 per cent five years before acquisition, falling to 4.8 per cent the year after the deal.

Figures on salary suggest a similar trend with companies seeing a salary reduction from a mean of £29,460 before the IBO to £28,520 following it.

By contrast in that same period industry and size-matched companies saw the mean salary surge from £30,170 to £38,430 while performance-matched companies saw their mean salary rise from £30,890 to £33,810.

Four years after the IBO the mean salary was at £34,010, while in the control firms it was at £44,210 and £42,860 respectively, suggesting the mean workers’ salary at the IBO companies was as much as £10,000 less.

Geoffrey Wood, professor of international business at Warwick, who was part of the study team, says: “Our findings suggest IBOs and their impact on managerial practices do not appear to be an effective mechanism for turning round failing firms.

“I would argue, far from the notion they revitalise the acquired organisation and unlock dormant capabilities and value, our research suggests more often than not the opposite occurs.”

The research also highlighted productivity, measured in the research by calculating real turnover over employees, was lower for the IBO firms than both industry and size-matched companies and performance-matched companies.

“Despite — or because of — pay cuts and job losses, productivity in the sample firms remained significantly lower than in the control firms,” Mr Wood notes.

“This suggests that any supposed disciplinary benefits from job cuts, either in terms of ejecting the lowest strata of performers or incentivising surviving staff, have not resulted in material gains.”

The productivity and profitability of the IBO firms remain lower than for the control firms during the four-year period following the takeover, suggesting that a climate of insecurity in tenure and reward reduces employee productivity and firm profitability.

The negative outcome from IBOs does not imply all private equity acquisition methods are bad, Marc Goergen, professor of finance at Cardiff Business School, says.

“The debate on the effects of private equity acquisitions going forward needs to be much more nuanced, with a view to distinguishing between the types of private equity acquisition and the positive and negative impacts they generate.”