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Critical analysis of Private Equity investments from the investors’ and the target companies’ point of view

Hausarbeit 2010 33 Seiten

BWL - Investition und Finanzierung


Table of Contents

Executive summary

List of Abbreviations

List of Figures

List of Tables


1 Introduction and problem definition

2 What is PE?
2.1 Definition
2.2 Short overview over the history of PE and its current situation in Germany ..

3 How does PE work?
3.1 Mayor players in the PE market
3.2 How is PE invested?
3.3 How is PE disinvested?

4 PE investments: The Perspective of PE investors
4.1 Returns
4.2 Risks of PE / VC investment
4.3 Lack of information

5 PE investments: The Perspective of PE issuers
5.1 Improved capital structure and room for expansion
5.2 PE investors as „Equity robbers“
5.3 Companies with succession problems
5.4 Management support & control
5.5 Loss of jobs in companies which are target of PE investments

6 Conclusion



ITM checklist

Executive summary

This assignment is part of the MBA studies at the University of Applied Science in Essen (FOM, Hochschule für Oekonomie, Essen) and covers the subject “International Finance and Controlling”.

The objective of this assignment was a critical analysis of Private Equity (PE) investments both from the perspectives of PE investors and of PE target companies. PE investors expect high returns, but it could be shown by taking independent data into account that it is highly questionable if the returns of PE investments are always higher compared to other forms of investments. Furthermore, there is the risk of a total loss, which is higher for PE investments than other forms of investments, especially due to the information asymmetry between PE investors and PE issuers.

Looking at it from the perspective of PE issuers, PE investments inject fresh capital into target companies with often a high percentage of debts. This capital can be used for expansion and innovation. However, PE investors expect high returns and may use assets of the target company to refinance debts which have been taken in order to finance the PE investment.

Furthermore, PE companies will gain managerial control within the target company through which decisions are aligned with the objectives of the PE investor. This can also include decisions regarding the future employment situation in the target company. There cannot be an overall statement if PE investments are “good” or “bad” for both sides, because the outcome of an evaluation strongly depends on the statistical method, the observed time span, the choice of statistical data and the personal viewpoint.

List of Abbreviations

illustration not visible in this excerpt

List of Figures

Fig. 1: Funds raised by type of investor

Fig. 2: Investment paths and involved players in the PE market

List of Tables

Table 1: Characteristics of Major Issuers in the PE Market

Table 2: Moving 5 year average in percent of the performance of VC, compared with S&P 500 and NASDAQ

Table 3: Capital structure of German companies in 2006

Table 4: Catalogue of transactions which are subjected to the authorization of an investing PE company


So Moses stretched out his rod over the land of Egypt, and the LORD brought an east wind on the land all that day and all that night. When it was morning, the east wind brought the locusts. And the locusts went up over all the land of Egypt and rested on all the territory of Egypt. They were very severe; previously there had been no such locusts as they, nor shall there be such after them. For they covered the face of the whole earth, so that the land was darkened; and they ate every herb of the land and all the fruit of the trees which the hail had left. So there remained nothing green on the trees or on the plants of the field throughout all the land of Egypt.

(Exodus 10:13-15, The Bible)

1 Introduction and problem definition

In 2005, the then chairman of SPD; Franz Müntefering made the following statement in „Bild am Sonntag“, a weekly German newspaper: „Manche Finanzinvestoren verschwenden keinen Gedanken an die Menschen, deren Arbeitsplätze sie vernichten - sie bleiben anonym, haben kein Gesicht, fallen wie Heuschreckenschwärme über Unternehmen her, grasen sie ab und ziehen weiter. Gegen diese Form von Kapitalismus kämpfen wir"1 (translation: „Some investment companies do not waste any thought about the people whose workplaces they destroy - they remain anonymous, have no face, descend like swarms of locust on companies, graze them and move ahead. We are fighting against this form of capitalism“).

This statement initiated an intense public debate in Germany addressing capitalism in general, but according to the German magazine „Stern“, which followed information from an internal SPD strategy paper, Müntefering mostly targeted U.S. Private Equity (PE) investment companies like Kohlberg Kravis Roberts & Co (KKR) with his statement.2

In this elaboration, there should be a critical examination regarding the effects of PE investments on PE investors and companies which receive PE (PE targets). Benefits and drawbacks for both sides should be examined and described.

2 What is PE?

2.1 Definition

The European Private Equity & Venture Capital Association (EVCA) defines PE as follows:

„Private equity provides Equity Capital to enterprises not quoted on a stock market. Private equity can be used to develop new products and technologies (also called Venture Capital), to expand working capital, to make acquisitions, or to strengthen a company’s balance sheet. It can also resolve ownership and management issues. A succession in family-owned companies, or the buyout and buy in of a business by experienced managers may be achieved by using PE funding“3.

There is a broader and a wider definition of PE. The broader definition uses the term „Private Equity“ as described above, while the narrow definition only uses this term to describe company financing in a later stage of a company’s lifecycle. For financing in an early stage, there exists the term „Venture Capital“(VC).4 In this elaboration, the term „Private Equity“ is understood and used in a broader sense, with VC as subtopic.

2.2 Short overview over the history of PE and its current situation in Germany

The PE market had its` origin in the U.S. during the last decades of the 19th century, when wealthy families like Rockefellers, Vanderbilts etc. invested their capital in companies. Some of these companies which have been supported were the predecessor entities of today world-known companies like AT&T, McDonald-Douglas etc. The first formal PE company was American Research and Development (ARD), which was founded in 1946 by MIT president Karl Compton, Harvard Business School Professor George F. Doriot and Boston business leaders. In the 1980s, VE was invested in many today world-known High-Tech companies, i.e. Microsoft.5

The PE industry had its origin in the U.S., but also gained ground in Europe. According to EVCA, investments by European PE investment companies reached €54 billion in 2008, which was a decrease of 27% compared to 2007, but still the third-highest annual investment rate ever undertaken by PE companies in Europe.6

Europe consists of many different countries, and therefore there are differences between the different countries regarding their PE market. When compared with other European countries such as the UK, Germany is said not to be very advanced in attracting PE investments.

For example, it is stated that the legal and fiscal framework in Germany does not favourably allow optimal PE capital investments when compared to other European countries. One of the reasons being, compulsory turnover taxation for all transactions between PE funds and the fund managing companies.7 According to a benchmarking of the European tax and legal environment for PE and VE investments published by EVCA, Germany is ranked in the lower part of the classification.8 In this benchmarking, it is also criticised that Germany "...does not provide any form of tax relief or incentives to encourage or stimulate investments in private equity and venture capital.9 In 2008, Germany accounted only for 16.3 % of total PE investments done in Europe (for comparison: United Kingdom 23.8%, France 16.1%, Italy 9.6%, Netherlands 4.7%),10 which is low when relating this figures to Germanys economic weight in comparison with other European countries.

From 2008 to 2009, the year of the financial crisis, Germany has seen a strong decrease of PE investments: The amount of PE invested in Germany dropped from 9.1 billion Euros in 2008 to 2.4 billion Euro in 2009.11 However, according to the German magazine Spiegel, Dörte Höppner, secretary of the German Private Equity and Venture Capital Association e.V. (BVK), said that PE investments in Germany increased again since the middle of 2009, and the PE industry is confident that the recovery will continue in 2010 except for the German Venture Capital market, which is stagnating since many years.12

3 How does PE work?

3.1 Mayor players in the PE market

The PE market consists of three major players, which are investors, intermediaries and PE issuers.13

Investors can be professional companies, wealthy persons or families which are looking for alternative investment opportunities: In Fig. 1, investor types which are investing into PE and their percentage of the total equity given in 2008 is shown for Europe.

illustration not visible in this excerpt

Fig. 1: Funds raised in Europe by type of investor14

Issuers of PE vary strongly in their size and in their motivation why they are looking for a financing through PE, but they share a common trait: In general, they are not able to raise capital from the Debt or Public Equity market, and therefore they have to look for PE financing which is the most expensive form of financing.15 Table 1 gives an overview over the six major types of PE issuers in the U.S. market, their characteristics and their motivation for seeking this kind of financing:

illustration not visible in this excerpt16 17 18

Furthermore, there are so-called intermediaries which manage PE investments. The PE investors are also called „limited partners“, while the intermediaries are called „general partners“.19

3.2 How is PE invested?

There can be a direct investment of PE into a company through a PE investor. This happens through the acquisition of parts of the company without involving intermediaries. This makes sense when the PE investor has professional and personal skills in the field of PE, because a PE investor who invests directly into another company must also provide resources in order to manage or control the company in which he invested. Another solution is an indirect investment in so-called funds which are managed by investment companies as intermediaries.20

Furthermore, there can be also an investment in Fund-of-Funds which invest in a couple of other PE funds. Through this, the investment funds are diversified, which leads to a portfolio mix of different industries and investment stages. It has to be considered that when investing into a Fund-of-Funds, there are two players (the fund-of-funds and the PE fund) which will require a management fee.21

In Fig. 2, the different investments paths and the involved investment stakeholders are shown.

illustration not visible in this excerpt

Fig. 2: Investment paths and involved players in the PE market22

When raising funds, it is profitable for a PE company to finance its investment with Debt Capital due to the so-called „leverage effect“.


1 Franz Müntefering in Bild am Sonntag from 17th April 2005, quoted in Hess (2007), p. 23

2 Stern from 25-10-2005, „Kapitalismusdebatte: Die Namen der "Heuschrecken"“, / 06-01-2010

3 / 05-01-2009

4 Cf. Thum et al. (2008), p. 11

5 Cf. Lerner et al. (2009), p. 2

6 / 05-01-2010

7 Cf. Kaserer et al. (2007), p. 86

8 Cf. EVCA (2006), p. 15

9 EVCA (2006), p. 56

10 / 27-01-2010

11 BVK (2010), p. 2

12 Spiegel-Online from 08-03-2010, „Gigantischer Geschäftseinbruch: Finanz-Heuschrecken erleben Horrorjahr“,,1518,682042,00.html / 08-03-2010

13 Cf. Prowse (1998) pp. 23

14 Source: PEREP_Analytics, data taken from g/YB09_Private_equity_funds_raised_by_type_of_investor.pdf / 12-03-2009

15 Cf. Prowse (1998), p. 25

16 Taken from Prowse (1998), p. 25

17 Turnaround means that a company which has undergone problems is given capital. This company and should then display a positive development again (cf. Hess 2007, p. 26)

18 LBO means that the purchasing of the target company is mostly financed through Debt Capital (cf. Eckstaller & Huber-Jahn 2006, p 25), see also chapter 3.2 regarding the „leverage effect“ / mezzanine partnerships are explained in chapter 4.2

19 Cf. Prowse (1998), p. 24

20 Cf. Thum et al. (2008), p. 15

21 Cf. Thum et al. (2008), p. 17

22 taken from THUM et al. (2008), p. 15, translated


ISBN (eBook)
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Institution / Hochschule
FOM Essen, Hochschule für Oekonomie & Management gemeinnützige GmbH, Hochschulleitung Essen früher Fachhochschule
critical private equity




Titel: Critical analysis of Private Equity investments from the investors’ and the target companies’ point of view