The Value of Debt in Leveraged Buyouts

Mathias Hædersdal Eller

Student thesis: Master thesis


The private equity industry is infamous for its use of debt to increase their returns. I will use this thesis to shed light on how the debt is used practically to increase the returns. The analysis of the three case buyouts shows first of all that they have a good fit with a potential leveraged buyout being able to sustain the large service of debt and still be able to grow as businesses at the same time. The initial full LBO models of the buyouts show that the three cases could potentially yield large returns to the respective funds. However they do not show whether it is only because of leverage or only because of a great development of the businesses. In the next set of models I show how the buyout could potentially have been done without the use of any debt to finance them. It is possible, and the returns are decent however compared to the levered buyouts the returns are up to 40 % lower. This off course makes a point for doing leveraged buyouts, but it does not show which factors lead to the higher returns. I later show that the pure leverage effect is actually what is driving most of the value to the investments and not the tax advantage of debt. The tax advantage is there but it is not comparable to the leverage effect. This is the case across all three structures, but there is a slight difference in the distribution between the factors. Another way to take advantage of the tax legislation especially in Sweden (and not Denmark) is the use of a shareholder loan which can increase the returns even further. This is especially advantageous if there is a lot of profit to be taxed. I have also analyzed the performance fee to the private equity company and the overall takeaway is that they potentially can earn quite a lot, but their interest are aligned with those of the investor. The investors on the other hand still are able to get a high return despite of the promote payment.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2013
Number of pages82