Fund Managers under Pressure: Rationale for Secondary Buyouts

Abstract

Private equity funds are expected to invest in deals that maximize returns for their investors and to realize those returns when they exit their investments. During the last decade an increasing fraction of PE exits have been secondary deals, in which one PE fund sells their portfolio company to another PE fund. On a comprehensive sample of 9,771 LBO deals in the U.S. and in 12 European countries from 1980 to 2010, this paper investigates to what extent secondary deals are outcomes of opportunistic behavior of the sponsor and/or adverse incentives of the PE contract. We report evidence that a secondary deal is significantly more likely if the buyer fund is under pressure to invest and/or if the seller fund is under pressure to exit. Our index for deal pressure measures how close is a fund to the end of its lifecycle/investment period, its degree of inactivity/unused funds and its lack of reputation. Deal pressure also has an impact on deal valuation: Buyers under pressure pay relatively more for the secondary deals that they enter into, while sellers under pressure are willing to accept lower prices for their portfolio firms in secondary buyouts. The latter effect is dominated by the former suggesting that sellers have more bargaining power in secondary transactions.