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Alternative Investments

Christian Deger

Behind the Curve: An Analysis of the Investment Behavior of Private Equity Funds

ISBN: 978-3-8428-8910-1

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Produktart: Buch
Verlag: Diplomica Verlag
Erscheinungsdatum: 01.2013
AuflagenNr.: 1
Seiten: 80
Abb.: 34
Sprache: Englisch
Einband: Paperback


In the domain of corporate acquisitions, leveraged buyouts (LBO) have gained tremendous importance since their first appearance in the late 1970’s. After having suffered from different economic downturns throughout the years, buyouts have become a major force in the worldwide economy, and reached a record accumulated transaction value of 8bn in 2007. LBOs are generally conducted by a private equity (PE) firm through a buyout fund. The fund manager raises a certain amount of equity from outside investors, and invests it into later-stage companies for an average holding period of around five years. An important characteristic of an LBO is that investments are not only financed by equity capital from the fund but, also with a significant amount of debt which is raised individually on a deal-by-deal basis. Moreover, the compensation of both fund managers, and equity investors is not based on the individual investment itself but, on the success of the whole fund. As a result, the particular conditions of buyout investments in a fund setting, as well as the distinct incentive structure of buyout funds, facilitate an increased sensitivity of fund managers with regard to the current state of their fund. This may also influence their leverage and pricing decisions on the transaction level. Corresponding research on buyout structuring is still in its infancy. While there is an increasing amount of empirical literature on the various determinants of leverage and pricing in buyout transactions, little is known about how the investment behavior of buyout funds drives these structuring decisions. A notable exception is the work by Axelson, et al. (2009), who developed a theoretical model that is based on a principal agent conflict between fund managers and outside investors. The model provides a number of predictions on how the investment behavior of fund managers impacts leverage, and decisions about prices at investment entry. The main goal of this study is to identify the forces behind these decisions, and to verify empirically the predictions of the Axelson, et al. (2009) model. Therefore, the work of Axelson, et al. (2009), supplemented with additional literature on LBO leverage and pricing, as well as the investment behavior of buyout funds, forms the theoretical part of the study. Based on the findings of this theoretical part, three hypotheses are formulated, and tested through the use of comprehensive investment pressure variables that were developed on the basis of a representative dataset of 1,190 buyout transactions which were completed between 1985 and 2009.


Textprobe: Chapter 4, Fund State and Investment Pressure: As previously discussed, it is especially principal agent driven factors, which play an important role in the fund manager’s transaction structuring decisions. However, in order to have a certain decision-making basis, there is a necessity for different measures, supporting the GP in assessing the fund’s current state. In that context, this chapter introduces commonly used measures and discusses potential dynamics in a fund manager’s investment behavior. In the last part of the chapter, three hypotheses are formulated, which are empirically tested in chapter 6. 4.1, Fund Performance: Throughout relevant literature, internal rate of return (IRR) is the predominant measure for PE fund performance. In contrast to a standard NPV calculation, which finds the NPV of an investment given a specified discount rate, the IRR method finds the respective discount rate given a NPV of zero. Consequently, an investment or a buyout transaction is value enhancing for investors, if the actual cost of capital are below the calculated IRR. In contrast, if the investment’s cost of capital are higher, it is value destroying. Fund level performance is measured similarly by using fund cash flows across all investments conducted. Poor fund performance can have various sources and may be caused by both internal and external factors. A GP, who selects bad targets and does a poor job in increasing operational efficiency in his portfolio companies, is possibly facing lower fund performance than fund managers with better skills. Externally, fund performance may be also negatively influenced by bad capital market conditions or a limited availability of good investment opportunities, e.g. through increased competition among PE companies. Kaplan / Schoar (2005) find that fund performance increases with both the GP’s skills and size of the fund for buyouts between 1980 and 2001. They further find that fund performance is lower in boom markets characterized by a high number of new funds raised and limited availability of good investment opportunities. These findings remain to be persistent, yet weaker, when the time horizon is extended until 2010 and thus includes buyouts, which were conducted during the competitive buyout period in the mid 2000’s. While IRR strongly depends on the timing of cash flows and is thus harder to predict, fund managers often use money multiples (also: cash-on-cash multiple) in order to approximate an investment’s performance. The money multiple is defined as the amount of cash a GP receives from an investment divided by the amount initially invested into the target company. As it can be calculated quickly and represents an investor’s success more directly, money multiple is a very common measure in the private equity space. Since throughout the analysis in chapter 6, the GP is assumed to have a certain understanding of the overall fund performance rather than to predict monthly cash flows, this study relies on money multiples as performance measure. 4.2, Capital Invested: Another important measure is the capital invested (CI) ratio of a private equity fund. Total capital invested represents the amount of capital which was drawn down from equity investors and directly invested into portfolio companies. The CI ratio, as the amount of capital invested in relation to total committed capital, thus indicates how heavily a buyout fund has been investing. In their analysis, Ljungqvist, et al. (2008) find three major factors determining the amount of capital invested in buyout funds. First, higher overall quality of investment opportunities has a positive effect on capital invested. Second, if bargaining power increases and buyout funds find themselves in situations with only little competition, they invest more heavily. Third, capital invested increases under favorable credit conditions. Thus, consistently with the findings of Axelson, et al. (2010), if debt is cheap, PE firms invest more often.

Über den Autor

Dipl. Kfm. Christian Deger was born in Karlsruhe, in 1986. The author graduated in Technology and Management Oriented Business Administration at the Technical University of Munich where his main focus was on Controlling and Entrepreneurial Finance. He was a scholar, and was supported by the German National Merit foundation. Further, he holds an Honors Degree in Technology Management from the Center for Digital Technology and Management, a joint institution of the two Munich universities and the elite network of Bavaria. After graduating in 2011, in his role as Venture Manager at Barikuta Partners, Christian Deger became responsible for building the South East Asian business unit of PAYRETO, a leading BPO company for payment providers. In the beginning of 2012, he co-founded the mobile payment company payworks where he currently serves as the Managing Director for Sales and Business Development.

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