Private Equity FINANCIAL MARKETS AND INVESTMENTS SERIES H Kent Baker and Greg Filbeck, Series Editors Portfolio Theory and Management Edited by H Kent Baker and Greg Filbeck Public Real Estate Markets and Investments Edited by H Kent Baker and Peter Chinloy Private Real Estate Markets and Investments Edited by H Kent Baker and Peter Chinloy Investment Risk Management Edited by H Kent Baker and Greg Filbeck Private Equity: Opportunities and Risks Edited by H Kent Baker, Greg Filbeck, and Halil Kiymaz Private Equity OPPORTU NI TI E S AND RIS KS EDITED BY H KENT BAKER GREG FILBECK and HALIL KIYMAZ 1 Oxford University Press is a department of the University of Oxford It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries Published in the United States of America by Oxford University Press 198 Madison Avenue, New York, NY 10016, United States of America © Oxford University Press 2015 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by license, or under terms agreed with the appropriate reproduction rights organization Inquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this work in any other form and you must impose this same condition on any acquirer Library of Congress Cataloging-in-Publication Data Private equity : opportunities and risks / edited by H Kent Baker, Greg Filbeck, and Halil Kiymaz p. cm — (Financial markets and investments series) Includes bibliographical references and index ISBN 978–0–19–937587–5 (alk paper) Private equity I Baker, H Kent (Harold Kent), 1944– II Filbeck, Greg, 1963 III Kiymaz, Halil, 1964– HG4751.P753 2015 332.63’2044—dc23 2014046431 9 8 7 6 5 4 3 2 1 Printed in the United States of America on acid free paper Contents List of Figures viii List of Tables xi Acknowledgments xv About the Co-Editors xvi About the Contributors xviii Abbreviations xxviii Part One INTRODUCTION Private Equity: An Overview h kent baker, greg filbeck, and halil kiymaz Economics of Private Equity 16 s h a n ta n u d u t ta , a r u p g a n g u ly , a n d l i n g e Private Equity in the United States and Europe: Market and Regulatory Developments 32 a l e x a n d r o s s e r e ta k i s Part Two MAJOR TYPES OF PRIVATE EQUITY Venture Capital in Europe: Myths and Reality jean-michel sahut and eric braune Leveraged Buyouts 66 christian rauch and marc p umber 49 Mezzanine Capital and Commercial Real Estate 84 j dean heller Distressed Debt Investments 100 stephen g moyer and john d martin Part Three HOW PRIVATE EQUITY WORKS Valuing Private Equity 123 h a r l a n p l at t a n d e m e r y a t r a h a n Cost of Capital for Private Equity 147 alain coën and aurélie desfleurs 10 Liquidity Issues in Private Equity: Lessons Learned in the Post–Financial Crisis 166 e l i f a k b e n s e l c u k a n d ay s e d i l a r a a l t i o k y i l m a z 11 Private Equity Portfolio Management: Challenges, Approaches, and Implementation 181 thomas meyer and tom weidig 12 The Role of Private Equity in Initial Public Offerings: The Case of Venture Capital Firms 200 s h a n ta n u d u t ta , a r u p g a n g u ly , a n d l i n g e 13 Exit Strategies in Private Equity 215 didier folus and emmanuel boutron Part Four PERFORMANCE AND MEASUREMENT 14 Private Equity Returns: Cross-Country Evidence 239 kenneth small and jeffrey s smith 15 Benchmark Biases in Private Equity Performance 257 robert spliid 16 Return Persistence: Finding Top Quartile Managers adrian oberli 17 Private Equity Due Diligence manu sharma and esha prashar 290 274 Part Five PRIVATE EQUITY: USES AND STRUCTURE 18 Institutional Investors and Private Equity 311 pa r v e z a h m e d 19 Private Equity and Value Creation 330 péter harbula 20 Compensation Structure 360 ji-woong chung 21 Global Regulatory and Ethical Framework 377 henry ordower Part Six TRENDS IN PRIVATE EQUITY 22 Private Investment in Public Equity 397 na dai 23 Listed Private Equity 419 douglas cumming, grant fleming, and sofia a johan 24 Private Equity Growth in International and Emerging Markets alexander peter groh 25 Diversification Benefits of Private Equity Funds-of-Funds axel buchner and markus kuffner 26 Publicly Traded Private Equity 483 henry lahr 27 The Future of Private Equity: A Global Perspective dianna c preece Discussion Questions and Answers Index 561 523 503 463 441 List of Figures 2.1 2.2 2.3 2.4 2.5 4.1 5.1 5.2 5.3 5.4 5.5 5.6 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 9.1 9.2 9.3 9.4 10.1 10.2 10.3 viii Number of Closed or Effective Leveraged Buyouts or Management Buyouts, 1970 to 2013 18 Firm Value 19 Poorly Performing Publicly Listed Companies in Different Financial Markets, January 2014 20 Mechanics of a Leveraged Buyout 21 Typical Structure of a Private Equity Fund 22 Fund Return and the J-Curve Effect 55 Fundraising Levels in 2013 by Fund Type 68 Median Leveraged Buyout Debt Levels and EBITDA Multiples over Time in the United States 72 Total Volume and Average Tranche Size of Syndicated Loans used in Leveraged Buyouts 73 The Value Creation Principle in Leveraged Buyouts 75 Choice of Exit Channels by Leveraged Buyouts, 1990 to 2013 79 Cash Multiples of Leveraged Buyouts by Exit Channel, 1990 to 2013 79 Size of the Early High Yield Market 102 Median Distressed Fund Return 103 Distressed Private Equity Funds Raised in North America 111 Merger and Acquisition Transaction Value, 1995 to 2009 112 Low Rated High Yield Issuance, 1995 to 2009 112 Acquisition Debt Multiples 113 Leveraged Finance Default Rates 113 European Leveraged Buyout Volume 114 Fundraising for European Distressed-Asset Private Equity 115 Beta: GRO Index vs the S&P 500 Index 152 Beta: MEZ Index vs the S&P 500 Index 153 Beta: Buyouts vs the S&P 500 Index 153 Beta: Private Equity Index vs the S&P 500 Index 154 Annual Median Net Internal Rates of Return by Vintage 170 Historical Private Equity Fundraising, 2008 to 2013 171 All Private Equity Annual Amount Called Up and Distributed, 2003 to 2013 172 l i s t o f f i g u r e s ix 11.1 11.2 12.1 12.2 12.3 13.1 13.2 13.3 13.4 13.5 13.6 13.7 13.8 14.1 14.2 14.3 14.4 14.5 14.6 16.1 16.2 17.1 17.2 18.1 18.2 19.1 20.1 22.1 22.2 22.3 22.4 22.5 The Risk Profile of Venture Capital: Direct, Funds, and Fund-of-Funds 193 Average Fund Performance per Vintage Year, 1990 to 2000 193 Number of Financial Buyer Exits via Public Offerings in Different Geographic Regions and Industries 201 Number of Venture-Capital-backed Initial Public Offerings in the United States, 1980 to 2013 202 Comparison of the Short- and Long-Term Returns of Venture-CapitalBacked and Non-Venture-Capital-Backed Initial Public Offerings in the United States, 1980 to 2013 202 Number of Global Buyout Exits, 2009 to 2013 216 Number of Global Buyout-Backed Exits by Region, 1995 to 2013 216 Number of Global Buyout-Backed Exits by Channel, 1995 to 2013 219 Private Equity-Backed Exits by Type, 2006 to 2013 219 Volume and Aggregate Value of PE-Backed IPOs: January 2005 to June 2014 225 PE-Backed IPOs (Volume) and Market Conditions: January 2005 to June 2014 225 Breakdown of the Aggregate Value of PE-Backed IPOs by the Region of Portfolio Company: January 2005 to June 2014 227 Breakdown of the Yearly Deal Value at the Completed Date per Industry Sector 229 Graph of the Top Three and Bottom Three Countries for PE Attractiveness 245 Global Private Equity Buyouts as a Proportion of Their 2006 Value 247 Proportion of Buyout Deals by Geographic Region, 2006 to 2013 247 Global Buyout Deals by Geographic Regions, 2006 vs 2013 248 Correlation Coefficient for Global Listed Private Equity Compared with Other Assets 252 Correlation Coefficient for PowerShares Global Listed Private Equity Compared with Other Assets 254 Top-to-Bottom Quartile Private Equity Internal Rate of Return Ranges by Vintage Year 277 Transition Matrix: Probability of Transition from One Quarter to Another 282 Types of Due Diligence 296 Summary of the Process of Due Diligence 304 Private Equity Deal Flows, 2004 to 2013 312 Model Investment Structure of Private Equity 315 An Overview of the Key Data Statistics of the Sample 336 Illustration of Profit-Sharing between Limited Partners and General Partners 365 Size of the Private Investment in Public Equity Market 399 The Distribution of Private Investments in Public Equity by Industry 400 Security Structure of Private Investments in Public Equity 402 Investors in the Private Investment in Public Equity Market 404 Alternative Financings for Small Firms: Unseasoned Issuers 414 576 i n d e x leveraged buyouts (LBOs) (continued) multiples in leveraged buyout deals, 348, 349t operating performance, impact on, 352 exit phase, 77–80 choice of exit channels by (1990–2013), 78–79 financial crisis of 2007-2008, 67, 72 post-financial crisis, 34–35 free cash flow (FCF), 330 free cash flows, 74 funds-of-funds, fee structure terms and characteristics, 465 generating returns, 66 H.J Heinz, 36, 71 holding period, 34 institutional investors, 313 investment phase categories, 74–77 cash multiples of leveraged buyouts (LBOs) by exit channel (1990–2013), 79 dividend recapitalization, 76–77, 81 governance intervention and management monitoring mechanisms, 76 operational engineering (operational excellence), 76–77 pre-investment phase, 74 restructuring strategies in leveraged buyouts (LBOs), 77, 78t value creation principle, 75 leveraged buyouts process, 21 low price, 74 mortgage effect, 67 one-time liquid private equity funds, 80 operating performance, impact on, 351–356 post-financial crisis, 34–35 pre-investment phase, 74 private equity market and regulatory developments, post-financial crisis, 34–35 regulatory guidance, crackdown on risky banking practices, 516 relationship banking, 71, 75 reversed leveraged buyout (RLBO) literary survey, 370 value creation, 335, 352, 354t, 355t special purpose acquisition companies (SPACs), 79–80, 491 3G (Brazilian private equity firm), 36, 80 transaction data, 334–345 data panel and descriptive key statistics, 335, 337, 338t–340t data panel key statistics, 337, 341t–344t key data statistics of sample, 336f–337f, 345 reversed leveraged buyout (RLBO), 335, 352, 354t, 355t value creation, 346–351 reversed leveraged buyout (RLBO), 335, 352, 354t, 355t value drivers, 73 Warner Music Group (case study), 80–81 leveraged dividend recapitalization, 222, 231, 233t limited liability corporations (LLCs), institutional investors, 316 limited partnership agreement (LPA) catch-up clause, 468, 469t, 470 fee structuring, 467, 468, 470, 478 limited partnerships capital assembly and income taxation, 378 challenges faced in conducting due diligence, 305 institutional investors, 316–317 listed private equity (LPE) and institutional investors, 419 on general partners, due diligence, 291–292 limited partners (LPs), 21–22 benefits of private equity firms, value creation, 24–25 capital assembly and income taxation, 378 challenges faced in conducting due diligence, 305 due diligence challenges, 305 on general partners, 291–292 economics of private equity business model structure, 21–22 institutional investors, 316–317 Institutional Limited Partners Association (ILPA), 374 limited partnership agreement (LPA), fee structuring and, 467, 468, 470, 478 catch-up clause, 468, 469t, 470 liquidity, generally, 168 liquidity issues during global financial crisis, 172 on general partners, due diligence, 291–292 private equity funds, structure, 21–22 profit-sharing between limited partners and general partners, illustration of, 365f liquidity, 9, 166–169 capital calls, 169 commonality-in-liquidity effect, 166 cost of capital for private equity illiquidity and the cost of equity in private equity, 162, 163t liquidity premium, 150, 155, 156, 158, 162 general partners, 168–169 global financial crisis See liquidity issues during global financial crisis institutional investors and listed private equity (LPE), 426–427 Kohlberg, Kravis, and Roberts (KKR), new liquidity sources, 507 limited partners, 168 liquidated funds-of-funds, 471, 473t, 478t, 479 listed private equity (LPE) and institutional investors, 426–427 i n d e x 577 portfolio management challenges, RRTTLU list, 187 private equity secondary markets, 168–169, 172, 173, 176 risk adjustments See liquidity and risk adjustments special purpose acquisition companies (SPACs), one-time liquid private equity funds, 80 standard definition of liquidity, 168 types of liquidity risk, 167–169 funding liquidity risk, 169 market liquidity risk, 168–169 liquidity and risk adjustments benchmark biases in private equity performance, 262–267 liquidity adjustments, 264–265 measuring gross or net of fees, 267 risk adjustments, 263–264 stale pricing problem, 265–266 valuation challenges, 266–267 liquidity issues during global financial crisis, 9, 167, 169–176 alternative investment fund (AIF), 175 Alternative Investment Fund Managers Directive (AIFMD), 174–175, 177 annual median net internal rates of return by vintage, 170 California Public Employees Retirement Systems (CalPERS), 173 capital asset pricing model (CAPM), 173–174 capital calls, 171, 172–173, 176–177 denominator effect (portfolio composition), 172 Dodd-Frank Act, 174–175 dot-com bubble (tech bubble), 169 empirical evidence, 175–176 endowment model (Yale model), 169, 171, 173–174, 177 European Private Equity and Venture Capital Association (EVCA), 173 exit activity, decline, 172–173 exiting private equity investments, examples, 173 general partners, affect on, 171, 172–173 general partners, exclusive right of to make capital calls, 172–173 Harvard Management Corporation (HMC), 173 historical private equity fundraising (2008–2013), 171–172 institutional investors exiting private equity investments, examples, 173 investors, affect on, 171 J-curve, 170 lessons learned, 173–175 limited partners, affect on, 172 Pastor-Stambaugh liquidity measure, 175 public market equivalents (PMEs), 176 regulatory changes, 174–175 W-curve, 170 Listed Private Equity Association (LPEQ), 423, 424, 426, 427, 438, 484, 495 listed private equity (LPE) See also publicly traded private equity (PTPE) defined, institutional investors See listed private equity (LPE) and institutional investors listed PE firms, 420 listed PE funds, 420 popularity of, statistics, 420 “private nature of private equity,” 419 synonyms for listed private equity, 483 types of, 420 listed private equity (LPE) and institutional investors, 13, 419–439 abnormal returns, 420, 424 beta of listed private equity funds, 420–421, 424 data and summary statistics, 427–436 comparisons of descriptive statistics between LPE as part and not part of investment mandate, 432–436 definitions and summary statistics, 427–432 fund-of-funds, 420, 424, 432 home bias, 420 limited partnerships, 419 liquidity-time preference, literature and hypotheses, 426–427 literature and hypotheses, 423–427 liquidity-time preference, 426–427 search costs, 423–425 specific human capital, 425–426 logit regressions, 436–437 market capitalization, 1993 to 2013, 420, 422f multivariate analyses, 436–438 logit regressions, 436–437 regression analyses of percentage allocations, 437–438 performance absolute return performance (2004 to 2014), 421, 422f statistics, 420–423 post initial public offering performance of Blackstone and Fortress (2007 to 2014), 420, 421f regression analyses of percentage allocations, 437–438 search costs, literature and hypotheses, 423–425 smaller institutional investors, 421, 423, 424, 438 specific human capital, literature and hypotheses, 425–426 578 i n d e x listed private equity (LPE) and institutional investors (continued) United Kingdom, institutional investors, 421f, 423, 424, 427, 438 unlisted funds, 420, 424, 425 venture capital trusts (VCTs), 424 worldwide distribution of LPE companies (December 2013), 420, 421f literature survey, 368–374 compensation structure in practice, 369–371 determinants of fee structure, 371–372 fees and incentive distortion, 373 relationship between fees and fund performance, 373 size of GP incentives, 372 summary statistics of fee terms, 370t reversed leveraged buyout (LBO) (RLBO), 370 time series dynamics and the future of fee structure, 373–374 Lithuania, private equity attractiveness, 449f, 451f, 452 loan default and pubic sale (under UCC definition), 95–96 loan-to-own investment strategy, 108 Longitudinal Business Database (LBD), 24 long-term orientation, 302 Madoff, Bernard, 297, 512 Malaysia, private equity attractiveness, 448, 449f, 451f, 452, 460 management buy-ins, 34 management buyouts (MBOs), 200, 230 due diligence, 293 of public companies, 18f, 23–24, 27, 34, 37 value creation, private equity and, 331, 351 management team, finding, 292 managers See also top-quartile managers carried interest, proposed tax change, 515, 519 compensation See Compensation structure of private equity funds; funds-of-funds, double layer of fees Marine Corps, Code Red, 239 market developments, post-financial crisis, 35–38, 43 Europe, 35, 37–38 Federal Reserve, 2013 monetary policy, 36 general trends, 36–37 golden age of private equity, 35 private equity mega deals, 36 recovery and statistics, U.S buyout market, 36 United States, 35, 36–37 marketing/advertising, new rules, 512–514 accredited investors, 512–513 Alternative Investment Fund Managers Directive (AIFMD), 515, 518 Basel III Accord, banking industry, 514–515 carried interest, proposed tax change, 515, 519 crowdfunding, 201, 513–514 Foreign Account Tax Compliance Act (FATCA), 515, 518 IPO On-Ramp provision ( JOBS Act), 201, 514 Jumpstart Our Business Startup Act ( JOBS Act), 200–201, 209, 513 leveraged buyouts (LBOs), risky banking practices, 516 retail investors, prohibitions, 512 market liquidity risk, 168–169 market timing, 193–194 Markowitz portfolio optimization, 184 masculinity vs femininity, 302 mature funds, 57, 266–267, 268, 271, 278, 473, 474t, 476, 477t, 478t, 479 benchmark biases in private equity performance, 266–268, 271 return persistence, 278 return persistence and quartile managers, 278 sample selection bias, 268 venture capital in Europe, 57 median distressed fund return, 103–104, 112 Mexico, private equity attractiveness, 441, 444, 449f, 451f, 452, 453–455, 456f, 460 mezzanine commercial real estate (CRE) financing, 8, 84–98 fundamentals, 84–86, 97–98 authorities, 86 consumers of mezzanine financing, 85 hallmark of mezzanine investments, 84–85 primary categories of mezzanine financing, 86 sources/providers of mezzanine capital, 85, 88–89, 97–98 history of, 86–88 commercial mortgage-backed securities (CMBS), 86–88, 90–91, 93–95, 97–98 debt securitization, 87 Financial Crisis Inquiry Commission (2011), 87–88 financial crisis of 2007–2008, 87–88, 89 legal factors, distinguishing forms of mezzanine financing, 94–97 enforceability, legal remedies, 95–96 fiduciary duty, 96–97 loan default and pubic sale (under UCC definition), 95–96 Revenue Procedure 2003–65, 94 standardization of documentation, 97 tax considerations, 94–95 mezzanine capital collateralized debt obligation (CDO), 88 cost of capital for private equity, mezzanine index (MEZ), 153, 158, 160t defined, 3, 84–85 demand for, 88 hedge funds, 88–89, 98 i n d e x 579 institutional investors, 313 pension plans, 88–89, 93, 94 sources/providers of, 85, 88–89, 97–98 users of, 88–89, 97–98 modes of investments, 89–94, 97–98 A-B loans, 93–94 debt obligations, 90–91 hybrid mezzanine investment, 93 preferred equity, comparison of mezzanine loan and, 92t preferred equity, distinction between mezzanine debt and, 91, 92t rating agencies, 86, 87, 90, 93, 94, 97, 98 structural subordination, 90 providers and users of mezzanine capital, 88–89, 97–98 real estate investment trust (REIT), 94–95 special purpose entity (SPE), 90, 92t types of mezzanine financing, 86 mezzanine index (MEZ) estimation of cost, decomposition of risk, 158, 160t S&P 500 index vs., 153 minority shareholders, eliminating, 386–387 modern portfolio theory (MPT), 181, 184–185, 189–190, 196–197 modified internal rate of return (MIRR), 148 “money-chasing deal” phenomenon, 59 monitoring investments VC-backed IPOs, 203, 209–210, 229 board of directors and management team, 210 endogeneity challenges, corporate governance and, 210 information asymmetry, reduction of, 203, 209 Moran v Household International, Inc., 388 Morocco, private equity attractiveness, 449f, 451f, 452, 460 mortgage effect, leveraged buyouts (LBOs), 67 MSCI Europe Index, 250, 251t, 252, 253t, 254 MSCI World Index, 250, 251t, 252, 253, 254 mutual funds, 402, 404t, 412 naïve investor hypothesis, 204 NASDAQ Composite Index, 265, 271 national culture, dimensions, 302 natural hedges, 194 net asset value (NAV), 262, 491–498 cash-on-cash multiples, 275 closed-end fund puzzle, 492, 493–494 fund managers, private benefits, 494 tax timing hypothesis, 494 compensation structure of private equity funds, 362, 367 hot issue markets, 496 internal rate of return (IRR), 277 J-curve, 494–495, 496 market timing and investor sentiment, 495–498 private equity, specific explanations, 494–495 qualitative behavior of premiums, 495–498 Netherlands, private equity attractiveness, 240, 244t net present value (NPV), 35, 261, 276, 478, 557 NewCo SPEs, 465 new firm creation and patents, 506 newly listed firms, 203, 206–207, 211 New Zealand private equity attractiveness, 449f, 451f, 452 return on capital (ROC) performance, 20 Nigeria, private equity attractiveness, 444, 450f North America, private equity attractiveness, 241, 246, 248 Obama, Barack, 513 Obama administration, 17, 200 Oman, private equity attractiveness, 451f, 452, 460 operating performance, impact of leveraged buyouts (LBOs), 351–356 operational due diligence, 297 operational efficiency benefits of private equity firms, 28, 518, 519 organizational culture, 301–302 organizational skills, due diligence, 292 outliers, sample selection bias, 270, 272 outsourcing, 519 overconfidence bias (Lake Wobegon fallacy), 197 Pakistan, private equity attractiveness, 444 Pan-European focus, private equity attractiveness, 241 partnership or limited liability corporation (LLC), Pastor-Stambaugh liquidity measure, 175 patents, 506 PE-backed IPOs See initial public offerings (IPOs) PEGCC See Private Equity Growth Capital Council (PEGCC) pension funds California Public Employees Retirement Systems (CalPERS), 173 defined contribution plans, 323–234 institutional investors, 311, 314, 323–325 largest retirement funds, 324 mezzanine capital, 88–89, 93, 94 performance evaluation, top quartile managers, 285–286 performance of funds venture capital in Europe, 54–58 J-curve effect, 54–55 mature funds, 57 580 i n d e x performance of funds (continued) performance comparisons, Europe and United States, 59–62 comparative performance of venture capital funds in Europe and United States, 59–61 IPO exit rates, 60 toward a convergence of venture capital practices in Europe and United States, 61–62 principal-agent problem, 55 smoothing bias, 57 Thomson Venture Economics (TVE), 57–58, 268–269, 281t performance of investments, venture capital in Europe, 53–54 Perlman v Feldman, 383 persistence in private equity fund returns transition matrix, probability of transition from one quarter to another, 282f persistence of funds in private equity fund returns venture capital in Europe, 58–59 Peru, private equity attractiveness, 449f, 451f, 452 philanthropy model, crowdfunding, 514 Philippines, private equity attractiveness, 441, 444, 450, 451f, 452, 453–455, 456f, 460 placement agents, role in PIPE market, 407–411, 417 agent compensation good faith retainer fee, 409 private placement agreement (engagement letter), 409 types of compensation, 409 contract knowledge gap, bridging, 410–411 private placement agreement (engagement letter), 408 relationship between issuer and placement agent, 407–408 reputation of agents, 409–410 Carter and Manaster (C&M) ranking, 409–410 SEC enforcement actions, effect of, 412–413 specific tasks and advising function, 408–409 poison pills, 387–389, 390–391 acquisition regulation, 387–389, 390–391 greenmail, 388 Grobow v Perot, 389 Moran v Household International, Inc., 388 Revlon v MacAndrews & Forbes Holdings, Inc., 388, 391 Smith v Van Gorkom, 388 Unocal Corporation v Mesa Petroleum Co., 388 pooled fund-of-funds fees, 468 portfolio composition (denominator effect), 172, 188 portfolio management See private equity portfolio management post-financial crisis liquidity issues See liquidity issues during global financial crisis market developments See market developments, post-financial crisis net present value (NPV), 35 Private Equity Growth Capital Council (PEGCC), 36 regulatory developments See regulatory developments, post-financial crisis potential private equity investment, valuing See valuing potential private equity investment (valuation example) power distance, 302 PowerShares Global Listed Private Equity Portfolio (PSP), 4, 248, 249–250 correlation coefficient compared with other assets, 254f correlation coefficients (2008–2013), 253t PrEQIn database, 101, 103, 246, 260, 274, 281t, 282, 322, 326, 369, 427, 471, 472t benchmark biases in private equity performance, 260 institutional investors, 322, 326 Principal Advisers Act, 511 principal-agent problem, 55, 204, 317, 356 defined, 463 institutional investors, 317 value creation, private equity and, 356 VC-backed IPOs, 204 venture capital in Europe, 55 private equity, generally, 5, 181–185 appraisal value effect, 182 as cash-flow assets, 184 buy-to-hold (buy-to-keep), 182, 183, 184 buy-to-sell, 182, 183, 184, 190 definition, 3, 182, 258 intermediation through fund investment, 183–184 portfolio management, 184–185 private equity intervention, 183 privately held companies and private equity, distinction between, 182 stale pricing, 182, 194 private equity associations, 504–505 Emerging Markets Private Equity Association (EMPEA), 504 European Private Equity and Venture Capital Association (EVCA), 50, 62, 173, 186, 465, 505 Latin American Private Equity and Venture Capital Association (LAVCA), 505, 509 Listed Private Equity Association (LPEQ), 423, 424, 426, 427, 438, 484, 495 Private Equity Growth Capital Council (PEGCC), 314, 504 i n d e x 581 private equity business model, ability of countries to support, 444–448, 459–460 “chicken and egg” problem, causality determinations, 447 depth of the capital market, bank centered and stock market centered, 445 economic activity, 445 entrepreneurial culture and deal opportunities, innovation, 447 human and social environment, 446–447 investor protection and corporate governance, quality of legal system, 446 key drivers of private equity maturity, determinants, 445–448, 459–460 tax regimes, impact of, 446 private equity deals first formal private equity deal, 16 largest buyout deals, 16, 17t mega deals, 36 top 10 largest private equity buyouts, ranked by inflation-adjusted deal value in 2014 dollars, 16, 17t private equity due diligence See due diligence private equity firms See also Kohlberg, Kravis, and Roberts (KKR) benefits of private equity firms, 22–28 bankruptcy rate, default and recovery, 26–27 corporate governance structure improvements, 25–26 dividends, misconceptions regarding, 28 endogeneity, corporate governance and, 26 fund performance, mixed evidence of, 23–24 innovation and operational efficiency, 28 job creation and unemployment, 27–28 value creation, 23–24 for limited partners, 24–25 buyout private equity firms, 116–117 compensation schemes, 18 criticisms of private equity firms, 16–18 firm value, 19–20 poorly performing publicly listed companies in different financial markets ( January 2014), 19–20 innovation at-the-market (ATM) offering, 414–415 benefits of private equity firms, 28 confidentially marketed public offerings (CMPOs), 415–416 entrepreneurial culture and deal opportunities, 447 new firm creation and patents, 506 small firms, alternative financing, 412, 412t 20 percent rule, 416 largest private equity firms, 505 operational efficiency benefits of, 28 private equity funds background, typical structure, 21–22 compensation See compensation structure of private equity funds debt-push-down mergers, 465 defined, 4, 465 general partners, 21–22 limited partners, 21–22 mixed evidence of fund performance, 23–24 NewCo SPE, 465 return persistence and quartile managers, 278–284 special purpose entity (SPE), management of fund, 465 structure of funds, 21–22 top 10 largest private equity funds, 22, 23t typical structure, 21–22 private equity funds-of-funds defined, 465–467 fund raising challenges, 465–466 fund raising statistics, 465 “make” or “buy” private equity access alternatives, 466–467 pooled funds-of-funds, 466–467 proprietary funds-of-funds, 466 Private Equity Growth Capital Council (PEGCC), 4, 36, 127, 314, 504, 512 private equity index estimation of cost, decomposition of risk, 158, 161t S&P 500 index vs., 154 private equity industry background, 18 globalization trends in private equity industry, 505–510 number of closed or effective leveraged buyouts (LBOs) or management buyouts (MBOs) (1970 to 2013), 18f top 10 largest private equity buyouts, ranked by inflation-adjusted deal value in 2014 dollars, 16, 17t top 10 largest private equity funds, 22, 23t worldwide private equity growth trend, 463 private equity intervention, 183 buy-to-hold (buy-to-keep), 182, 183, 184 buy-to-sell, 182, 183, 184, 190 private equity performance, benchmark biases in See Benchmark biases in private equity performance private equity portfolio management, 9, 181–198 active portfolio management, 196 asset allocation, 188–190 background risk, 189–190 naïve approaches, 189 buy-to-hold (buy-to-keep), 182, 183, 184 buy-to-sell, 182, 183, 184, 190 challenges asset liability management (ALM), 187 RRTTLU framework, 181, 185–188 582 i n d e x private equity portfolio management (continued) diversification management, 192–195 endowment model (Yale model), 189–190 generally, 184–185 institutional investors, 182, 183, 184, 186–187, 188, 190, 198 Markowitz portfolio optimization, 184 modern portfolio theory (MPT), 181, 184–185, 189–190, 196–197 monitoring and rebalancing, 196 outlook, 197 overconfidence bias (Lake Wobegon fallacy), 197 portfolio management frameworks, 190–192 adaptive market hypothesis (AMH), 181, 191 application to private equity portfolios, 191–192 behavioral finance, 190–191 core-satellite method, 181, 190–191 practical implementation, 195–196 private equity intervention, 183 privately held companies and private equity, distinction between, 182 return, risk, time horizon, taxes and fees, liquidity, legal, and unique circumstances (RRTTLLU) framework, 181, 185–188 satisficing rather than optimizing, 185 sovereign wealth funds, 183, 187 stale pricing, 182, 194 top-down and bottom-up approaches, 181, 195–196 university endowments, 189–190 private equity return measures, 275–278 asset class, characteristics of, 275 cash-on-cash multiples, 275–276 internal rate of return, 276–277 public market equivalent (PME), 275, 277–278 return persistence and quartile managers, 275–278 top-to-bottom quartile private equity internal rate of return ranges by vintage year, 277f private equity returns, cross-country evidence, 10, 239–254 aggregate value of private equity-backed buyout deals by region, 2006–2013, 246t BRIC (Brazil, Russia, India, and China), 241, 242, 245 buyouts, existing strategy for, 241 Companies Act of 1981, 240 comparison of private equity investments indexes, 250–251 FTSE EPRA/NAREIT Global Real Estate Index, 250–251, 252, 253, 254f MSCI Europe Index, 250, 251t, 252, 253t, 254 MSCI World Index, 250, 251t, 252, 253, 254 S&P 500 index, 242–243, 250, 251, 252, 253t, 254 S&P GSCI Commodity Total Return, 250, 251t, 252, 253 country-specific private equity attractiveness, 243–246 (See also Country Attractiveness Index) BRICs country attractiveness index values (2010–2014), 245t factors, 243–244 graph of the top three and bottom three countries for private equity attractiveness, 245f least attractive countries for private equity, 244–245, 450f most attractive countries for private equity, 244, 441 Venture Capital & Private Equity Country Attractiveness Index, 243–244 diversification benefits, 243 diversifying agent, global private equity as, 252–254 global interest in private equity, growth of, 240–241 Global Listed Private Equity (GLPE) return analysis, 251–252 annual returns by year for various assets, 2008-2013, 251t correlation coefficient for Global Listed Private Equity (GLPE) compared with other assets, 252f inverse coefficient of variation, 2008–2013, 252t global private equity activity, data on, 246–248 global buyout deals by geographic regions, 2006 vs 2013, 248f global private equity buyouts as a proportion of their 2006 value, 247f proportion of buyout deals by geographic region, 2006-2013, 247f global private equity as a diversifying agent, 252–254 Global Listed Private Equity (GLPE) correlation coefficients, 2008-2013, 253t PowerShares Global Listed Private Equity Portfolio (PSP), 4, 248, 249–250 correlation coefficient compared with other assets, 254f correlation coefficients (2008-2013), 253t historical performance of Global Listed Private Equity (GLPE), 248–249 initial public offerings (IPOs), 241 literature review on private equity returns, 241–243 performance of private equity, assessment issues, 242–243 i n d e x 583 PowerShares Global Listed Private Equity Portfolio (PSP), 248, 249–250, 253t, 254f Red Rocks Global Listed Private Equity Index, 249 venture capital, define, 240 private investment in public equity (PIPE), 13, 397–417 abnormal returns, 415 at-the-market (ATM) offering, 414–415 buyouts, 402, 404t confidentially marketed public offerings (CMPOs), 415–416 contractual structure of PIPE transactions, terms and provisions, 405–407 company-forced conversion options, 407 company put option, 407 investor protections, 405–406 issuer rights, 407 lock-up period to PIPE transaction, 406–407 optional redemption provisions, 407 placement agents, bridging contractual knowledge gap, 410–411 SEC enforcement actions, effect of, 412 structured PIPEs, 405, 411, 412 trading restrictions, 406–407 traditional PIPEs, 405, 412, 417 cumulative abnormal returns (CAR), 24, 403 death-spiral transactions and SEC enforcement, 411–413, 417 Form S-3 and Form F-3, 2008 amendments, 413, 414t hedge funds, 398, 402–403, 404 innovations, 414–416 issuance of PIPE securities under Regulation D (Rule 501), 397–398 major investors in PIPE market, 402–404 mutual funds, 402, 404t, 412 new regulations Form S-3 and Form F-3, 2008 amendments, 413, 414t SEC’s Securities Offering Reform, registration procedure reforms, 413 new regulations and innovations small firms, alternative financing, 412, 412t offerings, statistics, 397 overview of PIPE market, 397–402 development of market, 417 financial crisis of 2007-2008, impact on PIPE market, 402 growth of PIPE market, statistics, 398–399 industry distributions, statistics, 398, 400t popularity of PIPE market, 398 resale registration, SEC filing, 398 security structure, variations, 398, 401t, 402t security structure variations, 398, 401t, 402f size of PIPE market, 399t structured equity line, 400, 401t, 402f, 405 “toxic” PIPE, 400 placement agents See placement agents, role in PIPE market private equity (PE) funds, 398, 412, 417 Regulation D (Rule 501), 397–398 regulations, 413–414 seasoned equity offering (SEO), 398, 405, 407, 408, 409, 413, 414t, 415, 416, 417 SEC’s Securities Offering Reform, registration procedure reforms, 413 Securities and Exchange Commission (SEC) enforcement actions, 411–413 Amro International, S.A v Sedona Corp., 411 death-spiral transactions, hedge funds, 411–413 effect of enforcement actions, 412–413 lack of success, 412 post-action period compared with pre-action period, 413 SEC v Badian, 411 SEC v Berlacher, 412 SEC v Rhino Advisors, Inc and Thomas Badian, 411 Sedona Corp v Ladenburg Thalmann & Co., 411 Form S-3 and Form F-3, 2008 amendments, 413, 414t new regulations, 413 resale registration, 398, 407, 417 Securities Offering Reform, registration procedure reforms, 413 structured PIPEs, 405, 411, 412 traditional PIPEs, 405, 412, 417 20 percent rule, 416 venture capital funds, 398, 402–403, 404f, 412 private investment in public equity (PIPE), investors anti-dilution protection, 406 cumulative abnormal returns (CARs), 24, 403 dividend, interest, and warrants, 405 investor call options, 406 investor protections, 405–406 investor registration rights, 405–406 major investors in PIPE market, 402–404 private investment statistics, 403t financial sector investments (1995–2012), 403t total amount (USD) invested, investor type (1995–2012), 404t redemption rights, 406 right of first refusal, 406 strategic investors, 403 privately held companies and private equity, distinction between, 182 private placement memoranda (PPM), 286, 288 584 i n d e x private placement memoranda (continued) international and emerging markets, private equity growth, 457–458 private equity country maturity and historic private equity returns, 457–458 return persistence and quartile managers, 286, 288 professionalization of European venture capital practices, 50–53, 62–63 increasing professionalism, 61–62 negative aspects of investors’ stability, 51 positive aspects of investors’ stability, 50–51 professionalizing investors’ practices, 52–53 serial entrepreneurship in Europe, 51–52 ProShares Global Listed Private Equity ETF, PR providers, due diligence, 293 pubic sale (under UCC definition), 95–96 public companies, management buyouts (MBOs), 331, 351 due diligence, 293 publicly traded corporation acquisition, hostile takeovers, 383–384 publicly traded private equity (PTPE), 14, 483–500 See also listed private equity (LPE) advantages, 483, 490 alternative investment market (AIM), 486, 490 current and historical market trends, 484–485 indexes, 484–485 disadvantages, 483–484 dot-com boom, 484 financial crisis of 2007-2008, 484, 499 institutional investors and See listed private equity (LPE) and institutional investors listed private equity firms, 420 listed private equity funds, 420 location of vehicles, statistics, 484 market risk, 498–499 net asset value (NAV) discounts, 491–498 closed-end fund puzzle, 492, 493–494 fund managers, private benefits, 494 tax timing hypothesis, 494 hot issue markets, 496 J-curve, 494–495, 496 market timing and investor sentiment, 495–498 private equity, specific explanations, 494–495 qualitative behavior of premiums, 495–498 organizational forms, vehicles, 486–491 classification of, dimensions, 486 funds, 486–487 funds-of-funds, 487–488 investment companies, 488–489 lock-up periods, 489 management companies, 488, 489t special legal forms for public investments in private equity, 490–491 business development companies (BDCs), 490 investment trusts, 490 small business investment companies (SBICs), 490 special purpose acquisition companies (SPACs), 79–80, 491 split capital trusts, 491 venture capital trusts (VCTs), 484, 490–491 popularity of, statistics, 420 portfolio companies, 483 “private nature of private equity,” 419 publicly traded private equity, defined, 483 synonyms for publicly traded private equity, 483 types of, 420 public market equivalents (PMEs), 56, 258, 260, 261–262, 275 cost of capital for private equity, 148 liquidity issues during global financial crisis, 176 private equity return measures, 277–278 survivorship bias, 267 quartile managers See return persistence and quartile managers rational discounting hypothesis, 204 real estate investment trust (REIT), 94–95 rebranding private equity firms, 503 recommitment, institutional investors, 321 Red Rocks Global Listed Private Equity Index, 249 registration advisers, requirements, 511–512 seasoned issuers, SEC’s Securities Offering Reform, 413 Regulation D (Rule 501), 380, 397–398 regulatory developments, post-financial crisis, 38–42, 43 European Union, 38, 41–42 Investment Advisers Act (“Advisers Act”), 39 Volcker Rule (Section 619 of Dodd-Frank Act), 38, 39, 40 regulatory framework See global regulatory framework relationship banking, 71, 75 relative compounded return (RCR), 262 renminbi (RMB) funds, China, 508 restructuring the acquired companies, 391 retail investors, 416, 419 prohibitions, new marketing rules, 512 retirement funds See pension funds return, risk, time horizon, taxes and fees, liquidity, legal, and unique circumstances (RRTTLLU) framework, 181, 185–188 i n d e x 585 asset liability management (ALM), 187 denominator effect (portfolio composition), 188 environment, social, and governance (ESG), 188 European Private Equity and Venture Capital Association (EVCA), 186 legal issues, regulations and perceptions of regulations, 187–188 liquidity, 187 return, 185–186 risk, 186 Risk Measurement Guidelines (EVCA ), 186 tax and regulatory requirements, 187 time horizon, 186–187 unique circumstances, 188 return persistence and quartile managers, 11, 274–288 distribution to paid-in-capital (DPI), 275 evidence of quartile persistence reasons why returns or not persist, 283–284 return persistence post-2000, 282–283 ex-ante performance evaluation, 285–286 mature funds, 278 net present value (NPV), 276 PrEQIn database, 274, 281t, 282 private equity fund returns, persistence in, 278–284 empirical evidence on private equity return persistence, 281t evidence of quartile persistence, 279–283 initial empirical evidence on return persistence, 279–281 top-quartile fund, defined, 279 transition matrix: probability of transition from one quarter to another, 282f private equity return measures, 275–278 cash-on-cash multiples, 275–276 characteristics of asset class, 275 internal rate of return, 276–277 public market equivalent (PME), 277–278 top-to-bottom quartile private equity internal rate of return ranges by vintage year, 277f top-quartile managers, 284–287 due diligence, role of, 286–287 ex-ante performance evaluation, 285–286 limitations in implementing a top-quartile approach, 284–286 private placement memoranda (PPM), 286, 288 top-quartile classification, 285 Revenue Procedure 2003-65, 94 reverse causality explanation, 505 reversed leveraged buyout (LBO) (RLBO) literary survey, 370 value creation, 335, 352, 354t, 355t Revlon v MacAndrews & Forbes Holdings, Inc., 388, 391 reward-based model, crowdfunding, 514 Risk Measurement Guidelines (EVCA ), 186 RJR Nabisco, 16, 17t, 32 Romney, Mitt, 16, 515, 519 Russia globalization trends in private equity industry, 509 private equity attractiveness, 245, 441, 443, 444f, 449f, 451f, 452–456, 460 private equity returns, cross-country evidence, 241, 242, 245 sales, exit strategies, post-financial crisis, 33, 36 Santa Fe Industries v Green, 386 seasoned equity offering (SEO), 398, 405, 407, 408, 409, 413, 414t, 415, 416, 417 seasoned issuers SEC’s Securities Offering Reform, registration procedure reforms, 413 secondary buyouts (SBOs) (sponsor-to-sponsor buyout) exit strategies, post-financial crisis, 37 leveraged buyout (LBO) funds, 70 post-financial crisis, 34, 37 exit strategies, 37 SEC's Securities Offering Reform, registration procedure reforms, 413 sector, identification of; due diligence, 295 Securities Act of 1933 (SA), 379 Securities and Exchange Commission (SEC) private investment in public equity (PIPE) enforcement actions, 411–413 Amro International, S.A v Sedona Corp., 411 death-spiral transactions, hedge funds, 411–413 effect of enforcement actions, 412–413 lack of success, 412 post-action period compared with pre-action period, 413 SEC v Badian, 411 SEC v Berlacher, 412 SEC v Rhino Advisors, Inc and Thomas Badian, 411 Sedona Corp v Ladenburg Thalmann & Co., 411 Form S-3 and Form F-3, 2008 amendments, 413, 414t new regulations, 413 resale registration, 398, 407, 417 Securities Offering Reform, registration procedure reforms, 413 Regulation D (Rule 501), 380, 397–398 Securities Exchange Act of 1934 (SEA), 379 586 i n d e x SEC v Badian, 411 SEC v Berlacher, 412 SEC v Rhino Advisors, Inc and Thomas Badian, 411 Sedona Corp v Ladenburg Thalmann & Co., 411 selection bias, 267–270 outliers and weighting, 270, 272 sample, 267–270 size bias, 269 skill bias, 269–272 survivorship bias, 267–268 update bias, 269 venture capital in Europe, 53–54 vintage bias, 268–269 serial entrepreneurship in Europe, 51–52 Silver Lake Management, LLC, 36, 312 Singapore, private equity attractiveness, 244, 245f, 250, 449f Singer v Magnavox, 386 size bias, 269 skill selection bias, 269–272 Small Business Act of 1956, 325 small business investment companies (SBICs), 490 small firms, alternative financing, 412, 412t Smith v Van Gorkom, 388 smoothing bias, 57 Société Générale Private Equity Index (PRIVEX), 485 sourcing the deal, 292 Southeast Asia, emerging markets, 509–510 sovereign debt crisis, 33, 35, 36, 37, 38, 43 sovereign wealth funds, 507–508, 519 private equity portfolio management, 183, 187 S&P 500 index, 242–243, 250, 251, 252, 253t, 254 special due diligence, 303–304, 304t special purpose acquisition companies (SPACs), 79–80, 491 special purpose entity (SPE) debt obligations, 90, 92t NewCo SPEs, 465 S&P GSCI Commodity Total Return, 250, 251t, 252, 253 S&P index vs buyout (BO) index, 153 growth index (GRO), 152–153 mezzanine index (MEZ), 153 private equity index, 154 split capital trusts, 491 sponsorship, defined under Volcker Rule, 40 sponsor-to-sponsor buyout See secondary buyouts (SBOs) (sponsor-to-sponsor buyout) S&P’s Listed Private Equity Index, 485 stale pricing problem cost of capital for private equity, 149, 150, 162 private equity portfolio management, 182, 194 risk and liquidity adjustments, 265–266 state antitakeover laws, 388–391 acquisition regulation, 389–391 CTS Corp v Dynamics Corp of Am., 389 Edgar v Mite Corp., 389 STOXX Europe Private Equity 20 index, 485 strategic due diligence, 299–300 Sub-Saharan Africa (East Africa) globalization trends in private equity industry, 509–510 sub-sector, due diligence in finding, 295 Sun Capital Partners III, LP v New England Teamsters & Trucking Indus., 379 survivorship bias, 267–268 “swarm of locusts” analogy, 392 Sweden, private equity attractiveness, 242, 244t, 250 Switzerland, private equity attractiveness, 242, 244t, 250 syndicated loans, total volume and average tranche size of, 71, 73f syndicating investments, institutional investors, 319 systemic risk, 33, 38, 39, 40, 42 Taiwan, private equity attractiveness, 448, 449f TargetCo, debt capital structure of, 105–106, 107, 108, 109, 110, 116 taxation carried interest, 515, 519 Country Attractiveness Index, impact of tax regimes, 446 debt tax shield, 17, 19 due diligence, 303 Foreign Account Tax Compliance Act (FATCA), 515, 518 global regulatory and ethical framework, 378–379 Key Elements of Legal and Tax Regimes Optimal for the Development of Private Equity (EMPEA), 504 limited partners and partnerships, capital assembly and income taxation, 378 mezzanine commercial real estate (CRE) financing, 94–95 private equity portfolio management, RRTTLU list, 187 publicly traded private equity (PTPE), tax timing hypothesis, 494 valuing private equity earnings before interest, tax, depreciation, and amortization (EBITDA), 123, 131–132 enterprise-value-to-EBITDA (EV/ EBITDA), 131, 133, 134t, 140 VC-backed IPOs, underpricing issued securities; tax advantages, 207 tax due diligence, 303 tax timing hypothesis, 494 i n d e x 587 tech bubble See dot-com bubble technology improvements, 518, 519 tender offers and regulatory balancing, 384–385, 391 EU Takeover Directive, 42, 385, 387, 389–391 Williams Act, 383, 384–385, 389, 390–391 Thomson Reuters VentureXpert (TVEX), 24, 25 Thomson Venture Economics (TVE), 57–58, 268–269, 281t 3G (Brazilian private equity firm), 36, 80 time series dynamics and the future of fee structure, 373–374 top-quartile fund, defined, 279 top-quartile managers, 284–287 See also return persistence and quartile managers due diligence, role of, 286–287 ex-ante performance evaluation, 285–286 limitations in implementing a top-quartile approach, 284–286 private placement memoranda (PPM), 286, 288 top-quartile classification, 285 “top quartile” performance, 68–69 total value to paid-in capital (TVPI), 258, 261 “toxic” PIPE, 400 trends in private equity diversification benefits, private equity funds-of-funds, 14, 463–481 future of private equity, global perspective, 14, 503–519 listed private equity, 13, 419–439 private equity growth in international and emerging markets, 13, 441–460 private investment in public equity, 13, 397–417 publicly traded private equity (PTPE), 14, 483–500 Turkey, private equity attractiveness, 441, 444, 451f, 452, 453–455, 456f, 460 turnaround investing, 109–110 20 percent rule, 416 2-and-20 standard compensation structure, 360, 467, 468 UCITS Directive (Article of Directive 2009/65/EC), 41 uncalled committed capital See dry powder (uncalled committed capital) uncertainty avoidance, 302 underpricing issued securities VC-backed IPOs, 203, 206–209, 229 behavioral aspects, 207 dot-com bubble, 208 Ernst & Young survey institutional investors, perceptions regarding value of private equity and VC-backed IPOs, 209 generation of excess demand, 208 greater underpricing, top-tier investment bankers and underwriters, 208 hostile takeovers, reduction of threat, 208 hot issue markets, 207–208 information asymmetry, 206, 208 information cascades argument, 207 lawsuits from shareholders, reduction of likelihood, 207 newly listed firms, 203, 206–207, 211 price stabilization, 207 tax advantages, 207 top-tier investment bankers and greater underpricing, 208 underpricing, defined, 203 VC-backed vs non-VC-backed IPOs, 208–209, 229 winner’s curse, 206 unemployment and job creation benefits of private equity firms, 27–28 Hiring Incentives to Restore Employment Act (HIRE Act), 515 leveraged buyouts (LBOs), Europe, 506 United Kingdom institutional investors, financial assets held by, 323t leveraged buyouts (LBOs) in, history of, 331–332 listed private equity (LPE) and institutional investors, 421f, 423, 424, 427, 438 private equity attractiveness, 240–242, 244 United States institutional investors, financial assets held by, 323t market developments, post-financial crisis, 35, 36–37, 43 Federal Reserve, 2013 monetary policy, 36 general trends, 36–37 mega deals, 36 recovery and statistics, U.S buyout market, 36 private equity attractiveness, 244 regulatory developments, post-financial crisis, 38, 39–40, 43 Dodd-Frank Act, 38, 39, 40 Investment Advisers Act (“Advisers Act”), 39 Volcker Rule (Section 619 of Dodd-Frank Act), 38, 39, 40 U.S Census Bureau, 24, 27 U.S Steel Corporation, 16 university endowments, 189–190 Harvard Management Corporation (HMC), 173 unlisted funds, 420, 424, 425 Unocal Corporation v Mesa Petroleum Co., 388 unseasoned issuers SEC’s Securities Offering Reform, registration procedure reforms, 413 588 i n d e x update bias, 269 upward bias, 458 valuation, risk and liquidity adjustment, 266–267 value creation leveraged buyouts (LBOs), 346–351 private equity firms, benefits of, 23–24 for limited partners, 24–25 reversed leveraged buyout (LBO) (RLBO), 335, 352, 354t, 355t value creation, private equity and, 12, 330–357 data panel and descriptive key statistics, 335, 337, 338t–340t data panel key statistics, 337, 341t–344t dot-com bubble, 331 Europe, history of leveraged buyouts (LBOs) in, 331–332 key data statistics of sample, 336f–337f, 345 leveraged buyout (LBO) funds, operation of, 332–333 leveraged buyout (LBO) transaction data, observations data panel and descriptive key statistics, 335, 337, 338t–340t data panel key statistics, 337, 341t–344t key data statistics of sample, 336f–337f, 345 leveraged buyouts (LBOs) and value creation, generally, 333–334 impact on operating performance, 351–356 value creation, and leverage, 346–351 management buyouts (MBOs) of public companies, 331, 351 principal-agent problem, 356 reversed leveraged buyout (LBO) (RLBO), 335, 352, 354t–355t transaction multiples (EV/.EBITDA), 336f–337f transaction value leverage in continental European leveraged buyouts (LBOs), 345 valuing potential private equity investment (valuation example), 133–145 adjusted present value (APV) valuation method generally, 133, 134t private equity ownership assumptions, 140, 143t–144t discounted cash flow (DCF) valuation method generally, 133, 134t private equity ownership assumptions, 138t– 139t, 140 multiples-based valuation method, 133–135, 141t–142t, 145 current structure and management assumptions, 135, 136t–137t generally, 133, 134t private equity ownership assumptions, 138t– 139t, 140 valuing private equity, 8–9, 123–145 See also valuing potential private equity investment (valuation example) adjusted present value (APV) method cash flows to estimate value, 130–131 generally, 133, 134t capital asset pricing model (CAPM), 133, 135 capital expenditures (CAPEX), 125, 136t–138t cash flow complex whole-firm cash flow measure, 125, 133 difficulties of valuation process, 124–126 estimating value, 126–131 major cash-flow definitions, components, 126 measures of cash flow, 124–126 net cash flow, 124 net income, 124–126 simple cash flow (SCF), 124, 125, 126 discounted cash flow (DCF) valuation method, 133, 134t alternative, multiples-based valuation method, 131–132 cash flows to estimate value, 127–129 earnings before interest, tax, depreciation, and amortization (EBITDA), 123, 131–132 enterprise-value-to-EBITDA (EV/EBITDA), 131, 133 trading multiples, 133, 134t, 140 transactions multiples, 133 enterprise value, 133, 134t, 135 estimation of value, use of cash flows, 126–131 adjusted present value (APV), 130–131 capital cash flow (CCF) method, 131 cost of capital, 129–130 discounted cash flow (DCF) valuation method, 127–129 steps involved, 126–127 increasing value of acquisition, private equity firms turnaround actions, 132 measures of cash flow, 124–126 multiples-based valuation method, 133, 134t, 140 as alternative to discounted cash flow (DCF) valuation method, 131–132 earnings multiple method (relative value method), 132 generally, 133, 134t valuation methods, generally, 133, 134t weighted average cost of capital (WACC), 129–130, 133, 135 VC-backed IPOs, 10, 200–211, 229 American depository receipt (ADR), 202 certification hypothesis, 203, 205–206, 229 grandstanding hypothesis, 205–206, 229 reputable and less reputable VC firms, 205–206 i n d e x 589 conflicts of interest, 203–205 economic agents with conflicting interests, 203 naïve investor hypothesis, 204 principal-agent problem, 204 rational discounting hypothesis, 204 conflicts of interest, VC-backed IPOs Kohlberg, Kravis, and Roberts (KKR), creation of, 204 crowdfunding, 201 institutional investors, 203, 204, 209 IPO On-Ramp provision ( JOBS Act), 201 Jumpstart Our Business Startup Act ( JOBS Act), 200–201, 209 monitoring investments, 203, 209–210, 229 board of directors and management team, 210 endogeneity challenges, corporate governance and, 210 information asymmetry, reduction of, 203, 209 Obama administration, 200 performance comparisons, Europe and United States IPO exit rates, 60 reasons to exit, 229 statistics, 200–203 comparison of short and long term returns of VC-backed and non-VC-backed IPOs in United States (1980–2013), 202 financial buyer exits, different geographic regions and industries, 201 number of VC-backed IPOs in United States (1980–2013), 201, 202f time, average time to exit IPO, 229 unanswered research questions, 211 underpricing issued securities, 203, 206–209, 229 behavioral aspects, 207 dot-com bubble, 208 Ernst & Young survey institutional investors, perceptions regarding value of PE and VC-backed IPOs, 209 generation of excess demand, 208 greater underpricing, top-tier investment bankers and underwriters, 208 hostile takeovers, reduction of threat, 208 hot issue markets, 207–208 information asymmetry, 206, 208 information cascades argument, 207 lawsuits from shareholders, reduction of likelihood, 207 newly listed firms, 203, 206–207, 211 price stabilization, 207 tax advantages, 207 top-tier investment bankers and greater underpricing, 208 underpricing, defined, 203 VC-backed vs non-VC-backed IPOs, 208–209, 229 winner’s curse, 206 venture capital funding, 53–59 venture capital funds, 242–243 Venture Capital & Private Equity Country Attractiveness Index, 243–244 venture capital trusts (VCTs), 424, 484, 490–491 venture capital (VC) See also Europe, venture capital; VC-backed IPOs benchmark biases in private equity performance, 258 China, private equity industry, 507–508 defined, 3, 464 performance comparisons, Europe and United States, 59–62 comparative performance of venture capital funds in Europe and United States, 59–61 IPO exit rates, 60 toward a convergence of venture capital practices in Europe and United States, 61–62 venture capital (VC) equity, 313 Venture Economics, 243 Vietnam, private equity attractiveness, 444, 450f vintage bias, 268–269 Volcker Rule (Section 619 of Dodd-Frank Act), 38, 39, 40, 381, 510–511, 519 vulture funds, 18 vulture investors, 116 Warner Music Group (case study), 80–81 waterfall provisions American-style waterfall provisions, 365–367 automation technologies, operational improvement opportunities, 518 European-style waterfall provisions, 366, 367 fees and expenses, 367 fees and incentives, distortion, 373 regulation of, 80 waterfall provisions, 363, 365–367, 374 W-curve, 170 Weavering Macro Fixed Income Fund Limited, 297 weighted average cost of capital (WACC), 129–130, 133, 135 weighting, sample selection bias, 270, 272 Weinberger v UOP, 386 well-known seasoned issuers (WKSI), 413 Williams Act, 383, 384–385, 389, 390–391 winner’s curse, 206 Yale model (endowment model), 169, 171, 173–174, 177 ... 160 Private Equity Index 161 Illiquidity and the Cost of Equity of Private Equity: GLM Adjustment 163 Distinction between Privately Held and Private Equity? ?? 182 Private -Equity- Backed IPOs and. .. Edited by H Kent Baker and Greg Filbeck Private Equity: Opportunities and Risks Edited by H Kent Baker, Greg Filbeck, and Halil Kiymaz Private Equity OPPORTU NI TI E S AND RIS KS EDITED BY H... esha prashar 290 274 Part Five PRIVATE EQUITY: USES AND STRUCTURE 18 Institutional Investors and Private Equity? ?? 311 pa r v e z a h m e d 19 Private Equity and Value Creation 330 péter harbula