CFA Institute

Private equity (PE) buyouts are intricate financial maneuvers, often shrouded in complexity. By utilizing tiered acquisition structures and strategic vehicles, PE investors can unlock value while safeguarding investments. This article explores the nuances of these frameworks, from the role of acquisition vehicles to jurisdictional intricacies and the rise of offshore registrations. It is the first in a three-part series. When PE investors acquire companies in a buyout, they typically use newly formed acquisition vehicles to do so, rather than directly acquiring the operating companies. These vehicles –- also referred to as holding companies, or special purpose vehicles (SPVs) — are created for the purpose of the buyout and have not traded prior to the transaction closing. The number of acquisition vehicles which are created can vary and will depend on the complexity of the structure of the buyout and the jurisdictions involved. Figure 1 shows what a typical three-tiered acquisition structure may look like. Figure 1: Tiered acquisition structure In this example, Topco, Midco, and Bidco are vehicles which are created to facilitate the buyout of the operating company. A PE fund, very often alongside the target firm’s management team, invest into the newly created Topco acquisition vehicle. This vehicle lends the money into the Midco vehicle, which borrows some amount of debt — typically shareholder debt from the PE fund or junior debt from an external provider — and lends this, plus the money from the Topco vehicle, into the Bidco vehicle. Finally, the Bidco vehicle borrows some amount of external senior debt and uses its total amount of money to buy out all debtholders and shareholders of the operating company.[1] Through this tiered structure, because the senior lender lends to the Bidco vehicle and not to the Topco vehicle, the senior lender has direct rights against the entity which owns the operating company, and therefore the assets of the target group. This structure ensures that the senior lender’s debt is not structurally subordinated to junior debtholders and equity holders. It gives the senior lender prior claim to the underlying assets of the target company. External senior debt providers in buyouts, such as banks, will often favor this structural subordination. The number of different securities which are issued to finance the transaction and the complexity of the buyout are both important factors when forming a buyout structure. For example, in buy-and-build deals, where PE investors acquire one platform company and then bolt-on other targets to the platform, these acquisition structures can become more complex. Differences in jurisdictions also play an important role in determining the transaction structure. For example, in the US Chapter 11 bankruptcy laws offer strong protection for junior lenders, so inter-creditor agreements and contractual provisions may suffice. The strong protections also mean there is less need for the creation of tiered acquisition vehicles as there may be in the United Kingdom or European jurisdictions. Indeed, there may only be two vehicles in a US buyout structure: one for equity holders and another for all debtholders. All debt instruments used to finance the transaction may be loaned into a single entity, where there are contractual provisions and inter-creditor arrangements that achieve the required structural subordination, in the same way that UK and European buyouts do through the layering of different acquisition vehicles. Nevertheless, more complex US buyouts and multi-jurisdictional transactions may involve more elaborate structures. It is also worth understanding the registration of acquisition vehicles in offshore jurisdictions – a popular practice in the United Kingdom in recent years, driven in large part to avoid withholding tax.[2] Many PE investors acquiring UK companies – whether they are based in the United Kingdom, the United States, or elsewhere — have created acquisition vehicles registered in offshore jurisdictions. Popular offshore jurisdictions include the Channel Islands, Luxembourg, and the Cayman Islands. Aside from tax-related reasons, registering these entities offshore may also provide PE acquirers with greater flexibility in receiving dividends from their portfolio companies. For example, distributions under Jersey or Guernsey law (in the Channel Islands) can be made without requiring distributable profits to be available. In a recent research paper, I document a considerable rise in the use of offshore vehicles in buyout transactions in the United Kingdom. In 2000, only 5% of buyouts involved an offshore ultimate holding entity, compared to more than 25% of deals in 2022 (see Figure 2). It appears to be particularly common in larger buyout transactions and in buyouts involving PE firms who are headquartered overseas. Given that when the ultimate holding entity is registered offshore its financial accounts are not publicly accessible (unlike when the entity is registered in the United Kingdom), this highlights an important decline in the transparency of PE buyouts in the United Kingdom over the last two decades. Figure 2. Key Takeaways: Acquisition Vehicles as Essential Tools: Private equity buyouts commonly rely on tiered acquisition structures, with vehicles like Topco, Midco, and Bidco playing critical roles in managing investments and debts. Structural Subordination Benefits: The layered structure ensures that senior debt providers retain priority over junior lenders and equity holders, safeguarding their claims against the operating company’s assets. Jurisdictional Differences Matter: Variations in laws, such as Chapter 11 bankruptcy protections in the United States, influence the complexity of acquisition structures. Stronger bankruptcy laws may reduce the need for multiple vehicles. Offshore Flexibility: Registering acquisition vehicles in offshore jurisdictions like the Channel Islands or Luxembourg offers tax advantages and operational flexibility, particularly for dividend distributions. This has become an increasingly popular practice in the United Kingdom in recent years. Complexity Grows with Strategy: Buy-and-build deals and multi-jurisdictional transactions add layers of complexity, making structuring crucial for effective management and risk mitigation. By understanding these elements, stakeholders can navigate the intricate world of private equity buyouts with confidence and precision. In my next post, I will cover the consolidation of PE company portfolio accounts. [1] These acquisition vehicles can be called anything. Topco, Midco, and Bidco have traditionally been common in the United Kingdom and are used here for illustrative

The world economy stared into the abyss on 16 March 2020. COVID-19 had sent country after country into lockdown, disrupting manufacturing supply chains and service sectors. Global US dollar liquidity had dried up, and recession risks were soaring. In Europe, credit default swaps on corporates traded with a default probability of around 38%. As confirmed COVID-19 cases soared from fewer than 10 in January to nearly 165,000, scientists speculated desperately on fatality and transmission rates. Market participants, meanwhile, were on tenterhooks. As sentiment morphed from concern to panic, the crash began. The Dow Jones ended the day down nearly 3,000 points. The S&P 500 dropped 12%, and the NASDAQ fell 12.3%. It was the worst day for US equity markets since Black Monday in 1987. Reprising its global financial crisis (GFC) playbook, the US Federal Reserve sought to calm the markets and extended immediate liquidity to prevent a pandemic-induced cross-market domino effect. Before the market opened on 16 March 2020, the Fed agreed to swap-line arrangements with five other central banks in an effort to ease the strain on the global credit supply. A few days later, the Fed entered similar agreements with nine other central banks. But it wasn’t enough. Before the end of March, the Fed extended its provisions to even more central banks holding US Treasury securities, Saudi Arabia’s among them. These central banks could temporarily swap their securities held with the Fed to access immediate US dollar funding so they wouldn’t need to liquidate their Treasuries. Liquidity support for US dollar borrowers will always be an option for the Fed. Such interventions show the central bank is committed to alleviating economic instability concerns and protect the economy from financial wreckage. In the short term. But what about the long term? Does such swift — and often predictable — action heighten the vulnerability of the financial system? Does it create moral hazard for central banks and market participants? The state an economy is in when crisis strikes is important. Thanks to stricter regulation and the evolving Basel Accords, banks today are more resilient and better capitalized than they were in the lead-up to the GFC. They are not the main concern. But the economy is holding more debt and is even more vulnerable to shocks. In 2020, total global debt soared at a pace not seen since World War II amid massive monetary stimulus. By the end of 2021, global debt had reached a record US $303 trillion. This excess debt has created greater systemic risk, especially amid the recent surge in interest rates. Companies gorged on credit during the easy money era. Safe in the knowledge that policymakers would intervene during turbulent times, they failed to build a margin of safety. Recent market volatility — the brutal faceoffs between bulls and bears — has been driven by speculation about what the Fed will do next. The back and forth has repeated itself often this year: Bad economic news sets the bulls running in anticipation of a potential Fed pivot to smaller hikes, while strong GDP growth or employment numbers feed the bears, raising the odds that the Fed will sticks to its guns. Now, as the December Federal Open Market Committee (FOMC) meeting approaches, the equity markets have caught a bid again on high hopes of a pivot. The Fed first hiked rates this past March, so the current hiking cycle isn’t even a year old. Yet indebted firms are already showing strain. How many more hikes can they stomach, and for how long? Preventing runaway inflation is critical, but so is addressing the inevitable consequences through carefully crafted fiscal policies that take the whole economy into account. As investment professionals, we have to anticipate the long-term challenge. Today, the threat is clear: The higher interest rate environment will expose financially leveraged corporations. That means that risk management has to be among our top priorities and we have to hedge the interest rate hiking cycle. Active asset and liability management require we look beyond the accounting impact and focus on the economic value of equity, among other metrics. The bottom line is that amid economic turmoil, the solution to the imminent threat often creates more significant long-term dangers. We should avoid speculating as to when or whether central banks or regulators will intervene. We also need to remember that just as every economic downturn has unique causes, they also have unique cures. If you liked this post, don’t forget to subscribe to the Enterprising Investor All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image courtesy of the US Federal Reserve Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

With recession forecasted in many economies this year or next, distressed situations will be an important source of deals for prospective investors. But what will matter is whether the targets are permanently impaired or can be turned around. Two real-life scenarios from the debt bubble of the early aughts and the ensuing credit crunch provide helpful guidance. Cyclical Volatility, or Dislocation The UK investment firm Candover bought the hygienic products producer Ontex for €1 billion, or 8.1 times EBITDA, in 2002. The debt package, composed of bog-standard senior and mezzanine loans, totaled 6 times earnings. Despite strong economic growth, Ontex’s EBITDA margin dropped from 17% to 12% within three years due largely to rising oil prices. Oil is a key ingredient of the absorbent powder in Ontex’s diapers, and the company could not pass the costs onto customers because their products are distributed by Walmart, Tesco, and other price setters with oligopolistic positions. Unable to ship directly to consumers, and as a private-label manufacturer without a dominant brand, Ontex is a price-taker. But this wasn’t a new development. In the past, Ontex’s profitability had slumped whenever oil prices spiked. Still, excessive leverage didn’t make Ontex a bad investment. Rather, its debt package had a rigid structure with a set repayment schedule and strict interest margins when market cyclicality demanded more agile lending terms. When TPG and Goldman Sachs purchased Ontex from Candover in 2010, covenant-light — cov-lite — loans had become plain-vanilla instruments that gave borrowers the flexibility to adapt to such economic dislocation. That was what Ontex needed. As crude oil prices rose more than 160% between early 2016 and late 2018, its EBITDA margins slipped from 12.5% to 10.2%. Structural Change, or Disruption But there’s another kind of distress scenario where market shifts are more extensive. The private equity (PE) firm Terra Firma executed a leveraged buyout (LBO) of the storied record label EMI Music, valued at £4.2 billion, in 2007. Unlike Ontex’s debt structure, EMI’s featured all the tricks in the PE toolkit, including a gracious cov-lite package with unlimited rights to equity cures and abundant EBITDA adjustments. Yet the deal proved disastrous. The internet revolution had shaken up the recording industry, and for years EMI had struggled to adapt. To turn EMI’s fortunes around, Terra Firma planned to raise capital in the bond markets and secure it against the recurring cash flows of EMI’s music catalogs. It also hoped to restore margins by cutting the workforce, outsourcing some activities, renegotiating artist contracts, rationalizing the property portfolio, and shrinking expense accounts. Terra Firma likewise had its eye on new revenue streams — concerts, online services, merchandising, and artist management — and sought to onboard new tech talent to implement the digital transition. Yet despite multiple equity cures, EMI’s sole lender, Citi, took it over in 2011 and hastily sold it off piecemeal. EMI, it turned out, was not experiencing a brief dislocation but a permanent disruption. Due to online piracy, US compact disc (CD) shipments had collapsed by two-fifths between 1999 and 2007. In the fiscal quarter preceding the buyout, EMI CD sales had fallen by 20%. Paying over 18 times trailing EBITDA for such a business proved unwise. Adding leverage to a business facing such severe challenges wasn’t advisable. EMI’s net debt-to-EBITDA ratio remained above 8 throughout the LBO period. The turnaround strategy never improved profitability enough to keep up with the steepening debt commitments. The Risks Pyramid EMI’s experience shows how significant execution risk does not mix well with leverage amid a major restructuring. Cost cuts, asset disposals, contract renegotiations, refinancing, securitizations, and other conventional strategic and operating tools are no match for disruptive innovation. That’s why dislocation cannot be confused with disruption. The former is temporary and cyclical — it is manageable, even when it is recurrent by nature. Disruption, by contrast, is permanent and structural; for many businesses, it is a terminal threat. Whereas dislocation requires adaptation and can be tackled by progressively altering a firm’s strategy, disruption calls for reinvention, in which case a firm must reengineer its operations. In such a fundamental scenario, the extensive use of debt is a very bad idea. The Risks Pyramid below visualizes this dilemma: Leverage sits atop many other risk categories. Companies have little room for financial risk — i.e., debt — when facing market, operational, and strategic headwinds. Under the weight of so much uncertainty, additional leverage can crush any corporate borrower. Risks Pyramid Structure The Great Glut The unprecedented monetary stimulus in the aftermath of the global financial crisis (GFC) and during the pandemic ought to provide fertile ground for distress investing in the years ahead. Excess capital is frequently misallocated and leads to wasteful and ill-advised investments. It can kill returns. Debt-bloated buyouts and overcapitalized start-ups are plentiful, but thanks to capital accumulation — $12 trillion of assets, including $3 trillion in dry powder — private markets may take a long time to adjust. Following its March 2000 peak, the NASDAQ did not hit bottom until October 2002, and many dot-coms were still reeling when the GFC broke out. Today’s private market shakeout may entail a similarly extended wait. PE and venture capital (VC) firms would prefer to hold onto impaired assets and keep earning fees rather than acknowledge the true state of their portfolios. Yet with recent bank collapses, the bridge financing that start-ups need to postpone any down round may dry up. With their avid use of leverage, financial sponsors can still manage downside risks by negotiating looser loan agreements and massaging numbers. Too much debt, however, can leave borrowers in a zombie state and make it harder for distress investors to step in. They might have to wait it out like Citi did amid EMI’s inescapable disintegration in the wake of the GFC. Dealing with Market Fracture The financialization of the markets raises a broader question: Does the growing debt overhang represent temporary turbulence or a more radical discontinuity of modern economies? The cost of a stretched balance

One of the most persistent market anomalies is the post-earnings announcement drift (PEAD) — the tendency of stock prices to keep moving in the direction of an earnings surprise well after the news is public. But could the rise of generative artificial intelligence (AI), with its ability to parse and summarize information instantly, change that? PEAD contradicts the semi-strong form of the efficient market hypothesis, which suggests prices immediately reflect all publicly available information. Investors have long debated whether PEAD signals genuine inefficiency or simply reflects delays in information processing. Traditionally, PEAD has been attributed to factors like limited investor attention, behavioral biases, and informational asymmetry. Academic research has documented its persistence across markets and timeframe. Bernard and Thomas (1989), for instance, found that stocks continued to drift in the direction of earnings surprises for up to 60 days. More recently, technological advances in data processing and distribution have raised the question of whether such anomalies may disappear—or at least narrow. One of the most disruptive developments is generative AI, such as ChatGPT. Could these tools reshape how investors interpret earnings and act on new information? Can Generative AI Eliminate — or Evolve — PEAD? As generative AI models — specifically large language models (LLMs) like ChatGPT — redefine how quickly and broadly financial data is processed, they significantly enhance investors’ ability to analyze and interpret textual information. These tools can rapidly summarize earnings reports, assess sentiment, interpret nuanced managerial commentary, and generate concise, actionable insights — potentially reducing the informational lag that underpins PEAD. By substantially reducing the time and cognitive load required to parse complex financial disclosures, generative AI theoretically diminishes the informational lag that has historically contributed to PEAD. Several academic studies provide indirect support for this potential. For instance, Tetlock et al. (2008) and Loughran and McDonald (2011) demonstrated that sentiment extracted from corporate disclosures could predict stock returns, suggesting that timely and accurate text analysis can enhance investor decision-making. As generative AI further automates and refines sentiment analysis and information summarization, both institutional and retail investors gain unprecedented access to sophisticated analytical tools previously limited to expert analysts. Moreover, retail investor participation in markets has surged in recent years, driven by digital platforms and social media. Generative AI’s ease of use and broad accessibility could further empower these less-sophisticated investors by reducing informational disadvantages relative to institutional players. As retail investors become better informed and react more swiftly to earnings announcements, market reactions might accelerate, potentially compressing the timeframe over which PEAD has historically unfolded. Why Information Asymmetry Matters PEAD is often linked closely to informational asymmetry — the uneven distribution of financial information among market participants. Prior research highlights that firms with lower analyst coverage or higher volatility tend to exhibit stronger drift due to higher uncertainty and slower dissemination of information (Foster, Olsen, and Shevlin, 1984; Collins and Hribar, 2000). By significantly enhancing the speed and quality of information processing, generative AI tools could systematically reduce such asymmetries. Consider how quickly AI-driven tools can disseminate nuanced information from earnings calls compared to traditional human-driven analyses. The widespread adoption of these tools could equalize the informational playing field, ensuring more rapid and accurate market responses to new earnings data. This scenario aligns closely with Grossman and Stiglitz’s (1980) proposition, where improved information efficiency reduces arbitrage opportunities inherent in anomalies like PEAD. Implications for Investment Professionals As generative AI accelerates the interpretation and dissemination of financial information, its impact on market behavior could be profound. For investment professionals, this means traditional strategies that rely on delayed price reactions — such as those exploiting PEAD —  may lose their edge. Analysts and portfolio managers will need to recalibrate models and approaches to account for the faster flow of information and potentially compressed reaction windows. However, the widespread use of AI may also introduce new inefficiencies. If many market participants act on similar AI-generated summaries or sentiment signals, this could lead to overreactions, volatility spikes, or herding behaviors, replacing one form of inefficiency with another. Paradoxically, as AI tools become mainstream, the value of human judgment may increase. In situations involving ambiguity, qualitative nuance, or incomplete data, experienced professionals may be better equipped to interpret what the algorithms miss. Those who blend AI capabilities with human insight may gain a distinct competitive advantage. Key Takeaways Old strategies may fade: PEAD-based trades may lose effectiveness as markets become more information-efficient. New inefficiencies may emerge: Uniform AI-driven responses could trigger short-term distortions. Human insight still matters: In nuanced or uncertain scenarios, expert judgment remains critical. Future Directions Looking ahead, researchers have a vital role to play. Longitudinal studies that compare market behavior before and after the adoption of AI-driven tools will be key to understanding the technology’s lasting impact. Additionally, exploring pre-announcement drift — where investors anticipate earnings news — may reveal whether generative AI improves forecasting or simply shifts inefficiencies earlier in the timeline. While the long-term implications of generative AI remain uncertain, its ability to process and distribute information at scale is already transforming how markets react. Investment professionals must remain agile, continuously evolving their strategies to keep pace with a rapidly changing informational landscape. source

Handbook of Artificial Intelligence and Big Data Applications in Investments, edited by Larry Cao, CFA, is the big winner in 2023. The CFA Institute Research and Policy Center (RPC) focuses on four forward-looking research themes to drive content engagement, action, and outcomes. These themes are Capital Markets (Strengthening the Structural Resiliency of Capital Markets); Technology (Understanding the Latest Developments in Data Analytics, Technology, and Automation); Industry Future (Providing New Insights into the Future of the Profession); and Sustainability (Advancing the Industry’s Thinking on Sustainability Challenges). The most popular top three articles of 2023 from Understanding the Latest Developments in Data Analytics, Technology, and Automation are presented below. The theme tracks the evolving opportunity set for investment firms and professionals stemming from artificial intelligence (AI), big data, and new analytical tools and technologies. Our research recognizes that the future of the investment industry is one where smart machines and systems, data analysis, and inference will play a more central role in how the world of finance evolves. 1. Handbook of Artificial Intelligence and Big Data Applications in Investments Artificial intelligence (AI) and big data have their thumbprints all over the modern asset management firm. Like detectives investigating a crime, the practitioner contributors to this book, edited by Larry Cao, CFA, put the latest data science techniques under the microscope. And like any good detective story, much of what is unveiled is at the same time surprising and hiding in plain sight. 2. “Thematic Investing with Big Data: The Case of Private Equity” Using natural language processing (NLP) to score companies by the news frequency of terms related to private equity, Ludovic Phalippou creates an index weighted by theme exposure and liquidity, whose returns are highly correlated with non-traded indexes, in this research for the Financial Analysts Journal. 3. “CFA Institute and CFA Society Spain Briefing Paper on Fintech in the EU” Roberto Silvestri and Zaira Melero, CFA, gauge the opinions of CFA Institute members in the EU on the evolution of financial technologies, including the benefits and challenges for the investment industry. Their data is based on an informal survey of local CFA societies in the EU. If you liked this post, don’t forget to subscribe to Enterprising Investor and the CFA Institute Research and Policy Center. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / Yuichiro Chino Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

The essence of maximizing the internal rate of return (IRR) lies in the total amount of leverage contracted to finance a transaction. The less equity a buyout firm has to fork out, the better its potential gains. This mechanical process is shown in the following table using three hypothetical investments. The higher the leverage ratio, the higher the return on equity and the cash-on-cash multiple upon exit: Table 1: Leverage’s Effect on Private Equity Returns, in US $1,000s Understandably, private equity (PE) executives wouldn’t think of boosting their performance through other means without first negotiating the largest and cheapest debt package possible. Yet another factor, the time value of money (TVM), takes center stage. Leverage and TVM: A Powerful Combination So, why do PE investors operate the way they do? The following exercise will demonstrate the underlying rationale. The tables below delineate the range of returns that a leveraged buyout (LBO) might achieve. There are eight scenarios with three variables: Variable 1 is the amount of leverage — the net debt/equity or net debt/total capital — at inception. We use two different scenarios: 60% or 90% debt. Variable 2 is the timing of dividend recapitalizations during the life of the buyout. Again, we review two possibilities: achieving recaps in Year 2 and Year 3, or Year 3 and Year 4, while leaving all the other cash flows unchanged. Variable 3 is the timing of the exit. We assume a full disposal in Year 5 or Year 6. All of these scenarios assume that none of the debt is repaid during the life of the transaction. Assuming no repayment makes the scenarios easier to compare. The first scenarios in Table 2 include dividend recaps in Year 3 and Year 4 and an exit by the PE owner in Year 6. Both scenarios have the same entry and exit enterprise values (EVs). These two scenarios only differ in one way: Scenario A is structured with 90% debt, Scenario B with only 60%. Table 2: Year 6 Exit with Dividend Payouts in Years 3 and Year 4, in US $1,000s In the next two scenarios, in Table 3, the dividend payouts come in Year 2 and Year 3 and a realization by the buyout firm in Year 6. Again, the only difference in these two scenarios is the leverage: Scenario C uses 90% and Scenario D just 60%. Table 3: Year 6 Exit with Dividend Payouts in Year 2 and Year 3, in US $1,000s Table 4 shows dividend distributions in Years 3 and Year 4 and a sale by the financial sponsor in Year 5. Again, these two scenarios only differ on the debt: Scenario E is financed with 90% debt and Scenario F with only 60%. Table 4: Year 5 Exit with Dividend Payouts in Year 3 and Year 4, in US $1,000s The last set of scenarios in Table 5 looks at dividend recaps in Year 2 and Year 3 and an exit in Year 5. The only difference between them, again, is the amount of leverage. Table 5: Year 5 Exit with Dividend Payouts in Year 2 and Year 3, in US $1,000s We can draw several conclusions from these scenarios: It is better to leverage the balance sheet as much as possible since –assuming all other parameters remain constant — a capital structure with 90% debt yields significantly higher IRRs for the equity holders than a 60/40 debt-to-equity ratio: Scenario A beats B, C beats D, E beats F, and G beats H. Dividend distributions are best performed as early as possible in the life of the LBO. A payout in Year 2 generates higher average annual returns than one in Year 4: Scenario C beats A, D beats B, G beats E, and H beats F. The earlier the exit, the greater the profit — if we assume a constant EV between Year 5 and Year 6 and, therefore, no value creation during the extra year — which obviously does not reflect all real-life situations. Still, scenarios with earlier exits generate higher returns than those with later realizations, hence the popularity of “quick flips”: Scenario E beats A, F beats B, G beats C, and H beats D. Our first point underlines the mechanical effect of leverage shown in Table 1. But there are two other benefits related to debt financing: The second benefit relates to taxes. In most countries, debt interest repayments are tax-deductible, while dividend payouts are not. This preferential treatment was introduced in the United States in 1918 as a “temporary” measure to offset an excess profit tax instituted after World War I. The loophole was never closed and has since been adopted by many other jurisdictions. Borrowing helps a company reduce its tax liability. Instead of paying taxes to governments and seeing these taxes fund infrastructure, public schools, and hospitals, the borrower would rather repay creditors and improve its financial position. The PE fund manager’s sole duty is to their investors, not to other stakeholders, whether that’s society at large or the tax authorities. At least, that’s how financial sponsors see it. Earlier we referenced the concept of TVM. Despite their protestations to the contrary, PE fund managers prefer to get their money back as soon as possible. Conflicting interests abound between the financial sponsor — for whom an early exit means windfall gains thanks to a higher IRR — and the investee company’s ongoing management and employees who care about the business’s long-term viability. That said, financial sponsors can easily persuade senior corporate executives — and key employees — by incentivizing them with life-changing equity stakes in the leveraged business. Leverage’s Role in Value Creation To keep attracting capital, PE fund managers use many tools to highlight their performance. The value bridges developed by fund managers to demonstrate their capabilities as wealth producers are deeply flawed, as illustrated in Part 1, and only emphasize operational efficiency and strategic improvements in the fund manager’s profitable deals. That leverage is excluded entirely from

Hospitals are under pressure — from labor costs to ransomware, margin squeezes to misgovernance. This post explores the growing wave of financial distress among US healthcare providers in recent years. It unpacks what went wrong at several providers and draws from my own experience in the $7 billion restructuring of NMC Health. I share practical guidance for finance leaders and reveal how financial governance failures can quickly erode investor value. Labor inflation, payer pressure, digital disruption, and regulatory scrutiny have exposed structural vulnerabilities in the US healthcare system. In this environment, the role of finance professionals at healthcare companies becomes pivotal — not just in crisis containment but in institutional renewal. Financial missteps can ripple into service closures, job losses, and deteriorated patient outcomes. Done correctly, however, strategic financial leadership can stabilize operations, preserve access to care, and rebuild long-term value for stakeholders. These outcomes also carry direct implications for investors, as governance failures in healthcare can trigger portfolio losses, credit downgrades, and forced asset sales across institutional holdings. Restructuring healthcare systems requires a fundamentally different approach than traditional corporate turnarounds. Finance leaders must strike a unique balance: sustaining clinical service delivery, maintaining workforce and community trust, and complying with strict regulatory and funding requirements. A failure to do so not only erodes enterprise value but can directly compromise patient health outcomes. This dual mission, clinical and financial, demands a level of urgency, transparency, and coordination rarely seen in other industries. The reputational and societal stakes are simply higher. Lessons from the Field: Four Case Studies Steward Health Care (2023–2024) Steward Health Care grew rapidly to become the largest private for-profit hospital system in the United States, leveraging sale-leaseback transactions to unlock capital. Much of the freed-up cash, however, was redirected into expansion and operational shortfalls rather than infrastructure or care delivery. Without centralized treasury oversight, lease obligations ballooned, and financial control weakened. By 2024, burdened by more than $9 billion in liabilities and mounting vendor disputes, Steward filed for bankruptcy. [4] A more disciplined approach to capital investment like applying a minimum 12% ROI threshold might have filtered out underperforming expansion plans. Centralizing cash flow visibility could have flagged liquidity risks earlier, while stress testing for REIT exposure would have revealed unsustainable lease commitments. These tools are standard in many capital-intensive sectors but were underutilized here. Pipeline Health (2022–2023) Pipeline Health operated safety-net hospitals in underserved urban areas, heavily reliant on post-COVID funding. As elective volumes dropped and labor costs spiked, its financial model became unsustainable. A lack of rolling forecasts and flexible labor cost structures prevented the organization from adapting to the new reality. Eventually, delays in engaging turnaround advisors and the absence of an escalation protocol led to a Chapter 11 filing. [5] In Pipeline’s case, a centralized liquidity control tower with 13-week rolling forecasts could have identified cash shortfalls weeks in advance, buying time for vendor renegotiations. Had Pipeline implemented a dynamic labor model tied to volume shifts, it could have better aligned staffing with demand. Even a simple 10-day payment lag might have brought executive attention before the crisis deepened. Prospect Medical Holdings Prospect Medical was exposed by a US Senate report for prioritizing shareholder dividends while underinvesting in hospital infrastructure. Over several years, related-party transactions and opaque financial governance eroded internal trust and attracted regulatory scrutiny. In particular, behavioral health units saw declining care quality as capital projects were repeatedly deferred. [6] Strategic finance could have played a watchdog role. Requiring a capex-to-revenue ratio of 5% as a dividend precondition would have ensured reinvestment. A three-year rolling capital plan vetted by the board could have aligned strategic investments with operational needs. Transparent cash and reinvestment dashboards shared across departments might have empowered internal stakeholders to raise flags earlier. UnitedHealth Group (2024–2025) In a striking dual crisis, UnitedHealth Group first saw its Change Healthcare unit paralyzed by a ransomware attack, freezing pharmacy transactions and claims processing. Shortly after, the US Department of Justice opened a probe into Medicare Advantage fraud, alleging manipulation of patient risk scores for financial gain. These issues spotlighted the fragile operational core of even the most sophisticated payer-provider. [7] More proactive and risk-aware financial oversight could have helped identify vulnerabilities earlier and reduced the overall impact. Escrow reserves or redundant payment platforms could have protected provider payments during outages. Periodic audits of revenue risk scoring models might have flagged compliance gaps. Investment in cyber redundancy, while not a financial control per se, is increasingly a CFO mandate to mitigate operational risk. A Gameplan for Financial Leaders Here is how finance leaders can build muscle across liquidity, capital structure, and governance: Liquidity: Prioritize disbursement and daily dashboards and use 13-week rolling forecasts. Capital Structure: Incorporate sale-leaseback sensitivity analysis to determine the correct mix of fixed vs. floating debt. Governance: Implement real-time key performance indicators (KPIs) tied to decision rights, board-level crisis reporting, and whistleblower frameworks. These capabilities, when developed early and exercised often, become lifelines during distress. The Finance Toolkit in Action Here is how specific interventions could have changed the outcomes of healthcare companies in the case studies discussed earlier: In Steward’s case, real-time cash control could have exposed vendor bottlenecks before litigation risk materialized. At Pipeline, an early-warning signal tied to payroll risk might have launched executive action six weeks earlier. At Prospect, a quarterly dashboard could have exposed behavioral health underfunding trends, enabling board pushback. For UnitedHealth, regular audit of risk scoring logic could have ensured regulatory alignment before the DOJ’s intervention. When integrated into planning and operations, these tools empower finance teams to function as partners in care continuity. A Playbook for Financial Restructuring The following playbook summarizes seven financial levers that consistently surfaced across the case studies. These are not theoretical tools — they’re practical interventions that distinguish collapse from recovery when deployed with urgency and precision. Finance leaders can use this as a diagnostic checklist and guide for strategic action. The Cost of Inaction: Investor Impact These financial levers are not only operational lifelines; they’re also

Hookups just aren’t what they used to be. The worldwide value of mergers and acquisitions dropped to around US$1.22 trillion at the end of June 2023, down from US$2 trillion at the end of the second quarter last year. Higher interest rates are the primary reason. While they may be cooling inflation, they are also raising financing costs — and pinching the potential for strong returns via acquisitions. Formerly avid acquirers are sitting it out for now. In private equity, for example, the value of deals has decreased by more than 50%, to US$251 billion, while nearly US$2 trillion sits in cash. A less friendly regulatory environment, particularly for larger deals, also helps explain the falloff. In May, one of the United Kingdom’s key regulators, the Competition and Markets Authority (CMA), blocked Microsoft Corporation’s proposed acquisition of Activision Blizzard Inc., although it has since indicated a willingness to negotiate. Then the Federal Trade Commission (FTC) sued to block Amgen Inc.’s proposed acquisition of Horizon Therapeutics Public Ltd. Co. If successful, this would be the first FTC lawsuit to block a pharmaceutical deal since 2009. Despite the global drought in M&A, bright spots remain — if you know where to look. Health care deal value is up 40% year-over-year, boosted by Pfizer’s agreement to acquire Seagen and Eli Lilly’s agreement to purchase Dice Therapeutics. Deal values are also up over 200% in metals and mining, with Newmont’s proposed acquisition of Newcrest the largest potential transaction. Canada is another M&A hot spot. While there was a solid uptick in North American deal activity overall in May and June, Canada is experiencing a veritable M&A boom. Compared with the second quarter of 2022, transactions have risen 30% to more than US$90 billion. Why all the M&A activity? The usual reasons apply. These include trying to capture synergies, improving growth in a high-inflation/high-interest-rate environment, buying power from the US dollar, diversifying, acquiring talent and expertise, and eliminating a competitor. While regulators have been focused on large and mega merger deals, small- and mid-cap merger deals in Canada are not exposed to the same regulatory risk. And despite tighter financing conditions, in our core target universe of small- and mid-cap companies, the strength in equity markets this year is giving acquirers confidence to do deals. Matt Levine once suggested that “some large percentage of M&A activity might be driven by executives who want to avoid spending time with their children.” Family dynamics aside, M&A activity is likely to increase for several reasons. For the management of small-to-mid-cap companies, especially those that went public during the period of low interest rates, current lower valuations have been hard to stomach. Servicing debt and attracting financing is also more challenging at the same time that revenues are strained because customers are cutting back or postponing purchases. In certain cases, this has led to distressed situations. While some company founders are holding on tight in anticipation of a re-rating, others accept that one way to grow their business is to move it into stronger hands through acquisition. In Canada, there are several well-known serial acquirers, including Constellation Hardware, CCL Industries, Open Text, Enghouse, and Premium Brands, among others. For example, since 2005, Premium Brands has invested over US$3 billion in 79 transactions. It had a CAGR of 22.4% from 2010 to 2022. Despite pockets of softness, M&A appetite is expected to return in due course. Why? Because good capital allocation — buying the right company at the right price — creates incremental value over the long term. If you liked this post, don’t forget to subscribe to the Enterprising Investor. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images/ marrio31 Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

Public perception of gender equality issues runs in a repetitive cycle. We’ve all seen it. A scandal breaks out, or a study discovers yet another damaging disparity. Think pieces are written, hands are wrung, and companies promise to do better. Then the public’s attention moves on until another cycle starts. Actual change comes very slowly, if at all. This is especially true in the world of investing and investment funding. These are male-dominated fields where inequality grows more and more lopsided the higher up you go. These are well-known issues, and many firms have declared their intention to address various forms of inequality, both in their behavior as employers and in their influence as investors. But again, change comes slowly. So, what’s the best way to move forward? While hiring more women, especially in positions of real influence, is important, it isn’t enough. In finance and investment, the most powerful approach to achieving parity may be gender lens investing. There are many reasons different firms and businesses might adopt gender lens investing: For example, it can benefit people around the world, help develop new and neglected markets and sectors, and improve the overall quality of life. And then there’s the basic, foundational reason why any investor should support gender lens investing: It is a good investment. What Is Gender Lens Investing? Gender lens investing is a form of impact investing. Such investments are intended to create a beneficial social or environmental impact alongside the expected financial return. While green and other such funds and investments have been around for a while, what distinguishes gender lens investing is that it represents the difference between an investment that happens to benefit women and girls and an investment that, from inception, is intended to benefit women and girls. Gender lens investing is, therefore, a framework by which investors can create real impact and do so in a substantial way. Approaching equality and impact through gender lens investing means investing in: Enterprises that are owned or run by women Enterprises that encourage workplace equality Enterprises whose output improves the lives and economic prospects of women and girls Gender lens investing has a wide range of goals, and individual efforts can focus on specific aspects, regions, and opportunities. But closing the “gender gap” in both the investee firm and the investor’s firm is the primary mission. Gender lens investing approaches diversity from the ground up. It tries to avoid “genderwashing,” or bringing in women for appearances’ sake, and seeks to empower them on investment teams and place them in positions of real authority. The Benefits of Gender Lens Investing The business and investment world is discovering, however slowly, that diversity, gender parity, quality of life, and so on are not just buzzwords. They have a real impact on the bottom line. Studies have repeatedly shown that companies with diverse founders, especially when women are included from the beginning and have real influence as the business grows, perform better over the long term. In bare numbers, when these conditions are met, those businesses outpace the market, earn higher returns, and make things better for women in the future. Gender-balanced investment teams beat expectations by 10% to 20%. The International Finance Corporation found businesses with gender parity in their leadership teams had valuations up to 25% higher than teams with lower gender diversity. This is all quite logical. Business is all about innovation, the next great idea. And no company is going to be innovative, creative, and dynamic if company leaders have the same education, the same MBA, the same internships, and the same perspectives as their colleagues. It isn’t about abandoning that traditional route to success in business. It’s about having different ideas that can build on each other and lead to something new. This diversity of thought is central to innovation at the corporate and board levels as outlined in Blue Ocean Strategy and Governance Reimagined. Trends, Opportunities, and Challenges There are considerable efforts underway to “mainstream” gender lens investing, to move it from a niche investment opportunity to a strategy on par with any other. While it has a long way to go to achieve that, it is a growing field. Alternative investment strategies that emphasize the gender lens space account for almost $8 billion, up two-thirds from 2018. The G7 has committed to raising another $15 billion. Things are moving in the right direction, and opportunities abound. The gender lens investing mindset can find growth opportunities outside the scope of traditional investment firms. For example, women in Africa oversee just 6% of funds, often in the microfinance subsector. Women own 40% of African small and medium enterprises (SMEs), but only 20% have access to traditional funding paths. The gap here is more than $40 billion, and gender lens investing can help close it. India represents another opportunity where gender lens investing can mean the difference between lip service and actual change. Many business leaders in India have expressed interest in increasing gender equality. But the goal remains elusive, and in some ways ground is being lost. Between 2017 and 2019, the number of Indian start-ups with at least one female founder dropped from 17% to 12%. And of the start-up founders who receive early stage venture capital funding and beyond, fewer than 1% are women. Gender lens investing addresses such issues directly. This is especially important in the age of COVID-19. The pandemic has created something of a global rollback in the progress women have made in business and the workplace. Traditionalist gender roles have led to women once again shouldering a disproportionate share of domestic responsibilities. Systemic inequality has become more acute. GLI and GEM: A Case Study Gender lens investing isn’t superficial. It’s not a band-aid or public relations strategy. It can help businesses and investment firms have a beneficial impact. A brilliant example of this is Mennonite Economic Development Associates (MEDA), an international economic development organization that works to alleviate poverty. MEDA uses the Gender Equality Mainstreaming (GEM) Framework to

Crypto enthusiasts often claim that digital coins and tokens are uncorrelated with equities and can provide a safe haven amid stock market crashes. The assumption is that cryptoassets will act like “digital gold,” serving as a hedge against equity risk, and help investors ride out such downturns. Such bold claims beg for examination, especially amid what looks like a bear market for stocks. So, we explored how crypto has performed during previous crashes. In particular, we isolated the major panic events over crypto’s short history and studied the correlation between this new asset class and some of its more traditional peers. Five times over the last five years, the S&P 500 fell 7.5% or more. In each of these instances, we measured how correlations changed between gold and the S&P 500, bitcoin and the S&P 500, and bitcoin and gold. We examined the correlations between other cryptocurrencies and gold and the S&P 500 as well but found the results were qualitatively similar, so we used bitcoin as a proxy for crypto in general. The correlation between gold and the S&P 500 came in as expected. Outside of major downturns, gold and the S&P 500 have just a slight positive correlation of 0.060. Yet, when the S&P 500 plunges, so does its average correlation with gold, which drops to –0.134. The takeaway is clear: Gold does offer some protection in down markets and lives up to its status as a perennial hedge. Crash Correlations: Gold and the S&P 500 Correlation First Crash: 26 Jan. to 7 Feb. 2018 –0.073 Second Crash: 21 Sep. to 28 Dec. 2018 –0.077 Third Crash: 6 May to 6 June 2019 –0.407 Fourth Crash: 20 Feb. to 28 March 2020 0.241 Fifth Crash: 1 Jan. to 11 March 2022 –0.356 Average Correlation during Crashes –0.134 Average Correlation Outside of Crashes –0.060 The same cannot be said for bitcoin — or crypto in general. Outside of equity market downturns, bitcoin and the S&P 500 have had a slight positive correlation of 0.129. Amid the last five stock market contractions, however, the correlation between bitcoin and the S&P 500 jumped to 0.258. Indeed, in only two of the past five downturns did the correlation turn negative. On the other hand, true to its hedge-y reputation, gold exhibited a negative correlation with the benchmark index in four out of the last five crashes. Crash Correlations: Bitcoin and the S&P 500 Correlation First Crash: 26 Jan. to 7 Feb. 2018 0.814 Second Crash: 21 Sep. to 28 Dec. 2018 –0.025 Third Crash: 6 May to 6 June 2019 –0.583 Fourth Crash: 20 Feb. to 28 March 2020 0.588 Fifth Crash: 1 Jan. to 11 March 2022 0.493 Average Correlation during Crashes 0.258 Average Correlation Outside of Crashes 0.129 But what about bitcoin and gold? How has that relationship changed during recent panics and downturns? In rising equity markets, bitcoin and gold have a slight positive correlation of 0.057.  Amid stock market crashes, the correlation rises only slightly to 0.064. So, whatever the state of the equity markets, the correlation between gold and bitcoin is pretty close to zero. Crash Correlations: Bitcoin and Gold Correlation First Crash: 26 Jan. to 7 Feb. 2018 –0.194 Second Crash: 21 Sep. to 28 Dec. 2018 0.107 Third Crash: 6 May to 6 June 2019 0.277 Fourth Crash: 20 Feb. to 28 March 2020 0.275 Fifth Crash: 1 Jan. to 11 March 2022 –0.179 Average Correlation during Crashes 0.057 Average Correlation Outside of Crashes 0.064 Based on our data, crypto certainly does not act like digital gold. In times of panic, the correlation between crypto and the stock market actually increases. So, whatever its proponents may say about its utility as a hedge against market downturns, crypto has served as more of an anti-hedge, with its correlation with the S&P 500 rising as stocks plunge. That said, given the lack of correlation between gold and crypto, the latter may add some diversification benefits to a portfolio. Nevertheless, the overall verdict is undeniable: When it comes to hedging equity risk, bitcoin and cryptocurrencies are more fool’s gold than digital gold. If you liked this post, don’t forget to subscribe to the Enterprising Investor. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images/Moonstone Images Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source