Merger Arbitrage, 2nd Edition

Chapter 10Buyouts by Private Equity

Private equity funds always pay cash when they acquire a publicly traded company from public shareholders. In a few rare cases, public shareholders have been given the opportunity to continue to participate in the upside through continued equity interests or contingent value rights. Even though buyouts by private equity funds are similar to any other cash merger, they deserve extra attention due to the usually high leverage employed as well as the participation of current management in the buyout group.

Many private equity funds are offshoots of the corporate raiders of the 1980s. Private equity had almost disappeared during the 1970s but made a comeback in the 1980s with the buyout boom. Since then, the industry has become institutionalized, and today many of the largest pension funds and insurance companies view private equity as an asset class in its own right.

The rapid ascent of private equity can be explained at least in part by the incentives that its managers receive from their investors. Like hedge funds, typical fee structures consist of a 2 percent management fee, coupled with a 20 percent participation in any gains.¹ Many investment professionals have launched private equity funds to take advantage of this generous fee structure.

It is important to remember that private equity funds, like many other investors, are not a homogeneous group, but can have vastly different strategies and approaches to their business. Not all funds are ...