Conclusions

The early LBOs in the 1980's created significant value by removing financial inefficiencies and improving corporate governance mechanisms. Massive profits from these early transactions attracted many participants including banks, insurance companies, Wall Street firms, pension funds, and wealthy individuals. The demand push from the public junk bond market that began around 1985 fundamentally changed the pricing and capital structure of later buyouts, leading to a sharp increase in post-LBO failures. The recovery of the market for large LBO deals began in 1991, reaching impressive heights again in 1996 and 1997. However, the financial structure and sources of returns for the 1990's deals have been very different from those for the 1980's deals, reflecting a different macroeconomic environment, more intense competition, and increased industry maturity. Looking forward, buyout deals are likely to exhibit a shift to more entrepreneurial businesses, a need for more operational expertise, and an expansion geographically to tap into vast opportunities in Europe and Asia .

Notes:
[1] Cram Down Debt: Debt issued by new buyout firms as part of the payment to the pre-buyout shareholders in order to take the company private. Because the pre-buyout shares are widely held, so is the cram down debt.
[2] Strip Financing: Participation in the long-term debt and equity accounts of an acquired company or buyout. Horizontal strip financing involves each participant's assuming a horizontal layer, i.e., one investor taking senior notes, another senior subordinated notes, another junior notes, and another preferred stock. Vertical strip financing involves the sharing among investors of a portion of each class of debt or equity instruments. The vertical approach was popular because it evenly distributes the risk and liquidation preferences.
[3] Coverage Ratio: Defined as ratio of earnings before payment of interest and income taxes to interest on long-term debt and other contractual long-term obligations.
[4] Multiple Expansion: Industry-wide growth or cyclical expansion.
[5] Multiple Arbitrage: Deal-specific differences between purchase and sale multiples.