AbstractThis article serves as a comprehensive overview of the performance of private equity transactions. It gathers information from an analysis of 10,328 private equity deals, which include 3,296 pure buyout transactions. It introduces a new perspective for the analysis of the key drivers of value creation of private equity. It then isolates the impact of market timing, leverage, and operational improvements on transactions returns before focusing on the transactions in the financial institution industry. This article also provides indirect evidence that shows the possibility of operational improvements being the primary value drivers in other industries as well.

We investigate the impact of the reputation of a private equity group (PEG) on financing costs in leveraged buyouts (LBOs). PEGs with a strong reputation have superior selection abilities and may be able to obtain cheaper LBO loans due to their role in limiting moral hazard or their impact on lenders’ bargaining power in loan contract negotiations. We examine a sample of 4,111 credit facilities within 1,524 PEG-sponsored LBO loans in North America and Europe between 1993 and 2009. After controlling for other borrowers’ characteristics, the financing contract, and other factors, we find that PEGs’ reputation indeed lowers financing costs. The size of the effect depends crucially on the chosen syndicate structure. The effect on credit spreads is much stronger when the loan syndicate is highly concentrated. The literature reveals that concentrated syndicate structures are chosen by less transparent and more bank-dependent borrowers. We therefore conclude that well-reputed PEGs reduce financing costs because they are able to alleviate the effects of information monopolies that arise when asymmetric information limits the degree of competition between financing banks.

We analyze governance with a new dataset on investments of venture capitalists in 3848 portfolio firms in 39 countries from North and South America, Europe and Asia spanning 1971–2003. We provide evidence that cross-country differences in legality, including legal origin and accounting standards, have a significant impact on the governance structure of investments in the VC industry: better laws facilitate faster deal screening and deal origination, a higher probability of syndication and a lower probability of potentially harmful co-investment, and facilitate investor board representation of the investor. We also show that country-specific differences exist apart from legal and economic development.

Although buyout investments represent a considerable proportion of private equity volume, so far little research has been done on the exit strategies of buyout investments. This article takes a step in this direction by investigating buyouts in more detail focusing particularly on the divestment process. Since exiting enables the realization of returns and is thus the most important factor for private equity investors, it is important to understand the motivation behind and the determinants influencing this decision. The authors analyze three main exit routes for exiting buyout investments: initial public offerings (IPO), sales and write-offs, using a unique data set for U.S. and European buyout transactions. They examine the determinants influencing the choice of an exit channel by employing a multinomial logit model. The results strongly support the view that private equity investors write-off investments that turn out to be non-performing early, showing their ability to filter out bad investments. They also analyze how the internal rate of return (IRR) influences which exit route is chosen. The results show that only the most profitable ventures are taken public. The results have implications for exiting buyout investments during financial crises.

In this paper we introduce a framework to analyze the key drivers of value creation of private equity in financial institutions and the bank holding sub-segment. We estimate the influence of market-timing, take specifications of this highly regulated industry into account, and approximate the influence of leverage and operational improvement. We prove that market-timing has a positive but limited impact on value creation in financial institution and bank holding buyouts, and we find evidence that the value creation in the capital intense and highly regulated bank holding sub-segment is not diluted by financial leverage and depends to 87% on operational improvement. Moreover, we investigate the absolute and relative performance of these transactions and draw cross industry comparisons based on a unique data set of 3,296 completed buyout transactions. We show that leveraged buyouts of financial institutions generate a median gross IRR of 29% and a median PME of 1.9 compared to a public financial services benchmark index. The more capital intense bank holding sub-segment shows a median gross IRR of 23% and also outperforms the public benchmark with a median PME of 1.5. Results are controlled by DPI and Excess IRR figures, and are tested for significance. Both categories of companies are almost consistently in the upper half of our cross industry benchmarking with partially significant higher return figures than traditional buyout industries.

We analyze governance with a dataset on investments of venture capitalists in 3848 portfolio firms in 39 countries from North and South America, Europe and Asia spanning 1971-2003. We find that cross-country differences in Legality have a significant impact on the governance structure of investments in the VC industry: better laws facilitate faster deal screening and deal origination, a higher probability of syndication and a lower probability of potentially harmful co-investment, and facilitate board representation of the investor. We also show better laws reduce the probability that the investor requires periodic cash flows prior to exit, which is in conjunction with an increased probability of investment in high-tech companies. JEL Classification: G24, G31, G32

This paper investigates the market timing abilities of private equity fund managers using a unique set of detailed cash-flow data. We show that investment timing has an impact on the performance of venture capital funds. Surprisingly, divestment timing has no such impact on returns. For later-staged buyout funds our analysis reveals that fund performance is not driven by market timing but is significantly related to the experience of the individual fund manager. Thus, for successful investing into more mature portfolio companies, getting access to better deal flow and managing the investment affect the resulting success of these investments. Our results complement other recent findings on the performance of private equity funds.

In this article, we investigate risk return characteristics and diversification benefits when private equity is used as a portfolio component. We use a unique dataset describing 642 US-American portfolio companies with 3620 private equity investments. Information about precisely dated cash flows at the company level enables for the first time a cash flow equivalent and simultaneous investment simulation in stocks, as well as the construction of stock portfolios for benchmarking purposes. With respect to the methodology involved, we construct private equity, stock-benchmark and mixed-asset portfolios using bootstrap simulations. For the late 1990s we find a dramatic increase in the extent to which private equity outperforms stock investment. In earlier years private equity was underperforming its stock benchmarks. Within the overall class of private equity, returns on earlier private equity investment categories, like venture capital, show on average higher variations and even higher rates of failure. It is in this category in particular that high average portfolio returns are generated solely by the ability to select a few extremely well performing companies, thus compensating for lost investments. There is a high marginal diversifiable risk reduction of about 80% when the portfolio size is increased to include 15 investments. When the portfolio size is increased from 15 to 200 there are few marginal risk diversification effects on the one hand, but a large increase in managing expenditure on the other, so that an actual average portfolio size between 20 and 28 investments seems to be well balanced. We provide empirical evidence that the non-diversifiable risk that a constrained investor, who is exclusively investing in private equity, has to hold exceeds that of constrained stock investors and also the market risk. From the viewpoint of unconstrained investors with complete investment freedom, risk can be optimally reduced by constructing mixed asset portfolios. According to the various private equity subcategories analyzed, there are big differences in optimal allocations to this asset class for minimizing mixed-asset portfolio variance or maximizing performance ratios. We observe optimal portfolio weightings to be between 3% and 65%.

The paper explores factors that influence the design of financing contracts between venture capital investors and European venture capital funds. 122 Private Placement Memoranda and 46 Partnership Agreements are investigated in respect to the use of covenant restrictions and compensation schemes. The analysis focuses on the impact of two key factors: the reputation of VC-funds and changes in the overall demand for venture capital services. We find that established funds are more severely restricted by contractual covenants. This contradicts the conventional wisdom which assumes that established market participants care more about their reputation, have less incentive to behave opportunistically and therefore need less covenant restrictions. We also find that managers of established funds are more often obliged to invest own capital alongside with investors money. We interpret this as evidence that established funds have actually less reason to care about their reputation as compared to young funds. One reason for this surprising result could be that managers of established VC funds are older and closer to retirement and therefore put less weight on the effects of their actions on future business opportunities. We also explore the effects of venture capital supply on contract design. Gompers and Lerner (1996) show that VC-funds in the US are able to reduce the number of restrictive covenants in years with high supply of venture capital and interpret this as a result of increased bargaining power by VC-funds. We do not find similar evidence for Europe. Instead, we find that VCfunds receive less base compensation and higher performance related compensation in years with strong capital inflows into the VC industry. This may be interpreted as a signal of overconfidence: Strong investor demand seems to coincide with overoptimistic expectations by fund managers which make them willing to accept higher powered incentive schemes.

Die vorliegende empirische Studie analysiert die Vertragsgestaltung zwischen Investoren und europaischen Venture Capital-Fonds. Im Zentrum steht die Analyse der Vergutung des Fondsmanagements sowie der zum Einsatz kommenden Vertragsklauseln. Deren Ausgestaltung ist entscheidend fur die Uberwindung der Prinzipal-Agenten-Beziehung innewohnenden Agency-Probleme. Hierzu werden 122 Fondsprospekte sowie 46 Gesellschaftervertrage von europaischen Venture Capital-Fonds ausgewertet, die in den Jahren 1996 bis 2001, der ersten grosen Boomphase des europaischen Venture Capital- Marktes, aufgelegt wurden. Wahrend die jahrliche Vergutung des Fondsmanagements auf den ersten Blick sehr standardisiert erscheint, ergeben sich bei einer Barwertbetrachtung aller zu leistenden Management Fees uber die gesamte Fondslaufzeit deutliche Anzeichen fur Preisdifferenzierung. In Bezug auf den Einsatz von Vertragsklauseln kann eine Zunahme im Zeitablauf und mithin eine zunehmende Komplexitat des Vertragsdesigns festgestellt werden. Vor dem Hintergrund der Erfahrungen aus dem US-amerikanischen Venture Capital-Markt kann diese Entwicklung jedoch noch nicht als abgeschlossen gelten. Der europaische Markt bewegt sich in Bezug auf die Verwendung vertraglicher Restriktionen auf dem Niveau, das in den USA bereits Anfang der neunziger Jahre erreicht war.