Executive summary - Udo Bullmann

long-term competitiveness of the acquired companies, even saving some companies frominsolvency. Finally, there are a number of examples where private equity funds have beengenuinely helpful to some companies, particularly family firms with succession problems andcompanies with serious liquidity issues.Nonetheless, there is a major trend in strategies of certain private equity funds - especially LBOfunds -that has been detrimental to the long-term economic viability of companies. Financialinvestors pursuing leverage buy-outs are following a set of strategies that seem quite similar fromour case studies, connected to this report (annex):LBO funds frequently buy into businesses by acquiring the debts owing to creditors. Theinvestor does not pay the seller the full amount of the debt, but rather a reduced price, such as 40percent. The funds generate revenue by charging interest on the debts that they acquire and/or byselling the debts on at a higher price than they paid for them.In another variant, buyers attempt to convert their amounts owed into participation, i.e. tobecome shareholders. The shares in the business are then sold on to third parties.LBO funds known to fall into this category of investors, are US firms such as Cerberus,Citadel, Oaktree, Lone Star and Apollo. They are often supported in the restructuring process bybanks specialising in this type of business 4 .LBO funds have a short investment horizon when compared with strategic investors. This hasa negative impact on the sustainable and innovative development of target enterprises. Wheretechnically complex or challenging products are concerned, the time for necessary research anddevelopment often exceeds the investment period of such funds. This bears the risk that LBOfunds will limit or cut out altogether investment in innovations and development that are likely tobear fruit only after the end of the period of involvement of the fund, clawing back the moneythus saved into the fund. PE funds are seduced into withdrawing from the enterprise financialresources held in reserve that could be used for future or unforeseen innovation. Such resourcesmay include reserves for R&D, investment funds which are not required for the day-to-dayrunning of the business or undervalued investment objects. Instead of investing in long-termeffective innovation, LBO funds tend to engage in value extraction or asset stripping.LBOs increasingly tend to recover their investment in a company not just by its sale afterrestructuring but by immediate special dividends out of new debt, recapitalisations and very highconsulting fees. This has a negative effect on the capital base, the cashflow and thecreditworthiness of the company. From this follows the danger of under investing in productiveassets, markets and R & D undermining the long-term prospects of the company.Today it is not unusual for a leverage buy-out to be financed by 20% share capital and 80%debt capital. Some part of the debt capital is very quickly paid back by dividends of the targetcompany.Here is a quite well known “flow” of decisions used by LBO funds to maximize their cashflow:• Normally the target company isbought by a series of local holdingIn the case study of Viterra it is described how 90 % of theleverage buyout was financed by loans - an unusual highpercentage for the purchase of stakes in a company.4 Cf. Die ZEIT of 12.5.2005, p. 28.