PE Buyout Accounting: The Hidden Financial Reality

In Brief

Private equity research has a significant blind spot. When studying PE-owned companies, researchers typically track operating entities rather than the consolidated acquisition vehicles through which PE firms actually control their portfolios. This methodological error leads to dramatic underestimation of both the positive effects (faster growth) and negative consequences (higher leverage, steeper profitability declines) of PE ownership.

Paul Lavery's research demonstrates that correctly tracking consolidated group accounts reveals PE buyouts use substantially more debt than previously understood, while also showing greater declines in profitability compared to matched non-PE firms. The increasing use of offshore holding entities (growing from 5% to 25% of UK buyouts) further obscures financial transparency.

These findings challenge many existing conclusions about PE performance and suggest that much of the academic literature on private equity may have systematically underestimated the most significant impacts that buyouts have on target companies.

Big Picture Context

When PE firms acquire companies, they typically establish tiered acquisition structures (Topco, Midco, Bidco) rather than directly purchasing operating companies. This isolates risk and optimizes tax treatment, but creates challenges for researchers tracking performance. After acquisition, financial reporting occurs at the consolidated level through these new vehicles, while operating entity accounts often fail to reflect the total debt load and group cost structure. The increasing use of offshore holding entities (rising from 5% of UK buyouts in 2000 to over 25% in 2023) further reduces financial transparency.

Key Research Findings

• Operating entity accounts significantly underestimate leverage, growth, and declines in profitability during PE ownership

• Consolidated group accounts show PE-backed firms' return on assets falls by around 5-6% compared to matched non-PE firms

• Return on capital declines by approximately 19 percentage points when measured with consolidated accounts versus just 2-3 points using operating entity accounts

• Shareholder loans represent 35-40% of total liabilities during PE ownership, substantially impacting leverage calculations

• Researchers must adjust for amortization of intangible assets when studying PE performance

By The Numbers

• 13% of UK PE buyouts (2000-2023) involved offshore-registered ultimate holding companies

• Median PE ownership stake in buyouts: 66-67% (when excluding non-voting preference shares)

• Median debt/assets ratio: ~0.65 in consolidated accounts vs. ~0.20 in operating accounts

• Median debt/EBITDA: ~4.0x in consolidated accounts vs. ~0.8x in operating entity accounts

• Median growth in sales over PE holding period: 68% (consolidated) vs. 36% (operating)

• Median debt growth: 357% (consolidated) vs. 15% (operating)

Key Trends To Watch

• Rising use of offshore ultimate holding entities decreases transparency and limits financial data accessibility

• Shareholder loans increasingly used to finance buyouts, especially during economic downturns

• Gross intangible assets become ~40% larger than net intangible assets after five years of PE ownership

• PE ownership stakes in databases often include non-voting preference shares, misrepresenting actual control

• Growth in acquisition-based strategies magnifies discrepancies between operating and consolidated accounts

The Wrap

This research fundamentally challenges how we understand PE performance metrics. Using operating entity accounts dramatically underestimates both the outperformance in growth and the significant increase in leverage during PE ownership. It also understates the relative decline in profitability compared to matched firms. Researchers, regulators, and investors should recognize these accounting complexities when evaluating PE performance claims, as they substantially affect conclusions about PE's impact on acquired companies.