“Private equity is more economically significant than ever, as institutions hunt for high returns in a risky world. Private Equity 4.0 examines the role, workings and contribution of this important industry in a straightforward yet revealing manner.”
Dr. Josh Lerner
Jacob H. Schiff Professor of Investment Banking
Chair, Entrepreneurial Management Unit
Harvard Business School
A multi-perspective look at private equity's inner workings
Private Equity 4.0 provides an insider perspective on the private equity industry, and analyzes the fundamental evolution of the private equity asset class over the past 30 years, from alternative to mainstream. The book provides insightful interviews of key industry figures, and case studies of some of the success stories in the industry. It also answers key questions related to strategy, fund manager selection, incentive mechanisms, performance comparison, red flags in prospectuses, and more.
Private Equity 4.0 offers guidance for the many stakeholders that could benefit from a more complete understanding of this special area of finance.
- Understand the industry's dominant business models
- Discover how value is created and performance measured
- Perform a deep dive into the ecosystem of professionals that make the industry hum, including the different incentive systems that support the industry's players
- Elaborate a clear set of guidelines to invest in the industry and deliver better performance
Written by a team of authors that combine academic and industry expertise to produce a well-rounded perspective, this book details the inner workings of private equity and gives readers the background they need to feel confident about committing to this asset class. Coverage includes a historical perspective on the business models of the three major waves of private equity leading to today's 4.0 model, a detailed analysis of the industry today, as well as reflections on the future of private equity and prospective futures. It also provides readers with the analytical and financial tools to analyze a fund's performance, with clear explanations of the mechanisms, organizations, and individuals that make the system work.
The authors demystify private equity by providing a balanced, but critical, review of its contributions and shortcomings and moving beyond the simplistic journalistic descriptions. Its ecosystem is complex and not recognizing that complexity leads to inappropriate judgments. Because of its assumed opacity and some historical deviant (and generally transient) practices, it has often been accused of evil intents, making it an ideal scapegoat in times of economic crisis, prodding leading politicians and regulators to intervene and demand changes in practices. Unfortunately, such actors were often responding to public calls for action rather than a thorough understanding of the factors at play in this complex interdependent system, doing often more harm than good in the process and depriving economies of one of their most dynamic and creative forces. Self-regulation has clearly shown its limits, but righteous political interventions even more so.
Private equity investment can be a valuable addition to many portfolios, but investors need a clear understanding of the forces at work before committing to this asset class. With detailed explanations and expert insights, Private Equity 4.0 is a comprehensive guide to the industry ways and means that enables the reader to capture its richness and sustainability.
Table of Contents
List of case studies ix
About the authors xi
Professional acknowledgments xiii
Personal acknowledgments xv
Foreword xvii
Introduction xxi
Private equity at the crossroads xxi
An historical perspective to gain insights for the future xxi
Private equity: all about people xxiii
The best capitalism has to offer? The conceptual groundings xxiv
Empowering and incentivizing: partnering for mutual success xxiv
Focus, focus, focus xxv
Strategy is cheap; operationalizing is key xxv
Alignment brings cohesion xxvi
Flexibility as strategic value xxvi
Carrots and sticks: the value of discipline xxvi
Leverage… at all levels xxvii
The cash flow paradox xxvii
The buy-and-sell approach: capitalism on speed xxviii
Believers, sceptics and cynics xxviii
1 Private equity: from “alternative” to “mainstream” asset class? 1
Moving into mainstream 3
A brief history 6
An increasingly global industry 8
Private equity in North America 10
Private equity in Europe 11
Private equity in Asia 12
Emerging private equity players 13
An industry in the limelight 18
2 Private equity as a business system 25
Setting the stage 27
The raison d’être of private equity funds 27
Private equity’s market segments 29
The fuel behind private equity: investors 37
Portfolio allocations by investors 39
The (apparent) madness of private equity fees 42
Management fee 43
Carried interest 43
General partner interest 46
Commitments versus investments 50
Distributions in cash, please! 51
Due diligence, leverage, focus and… incentives 53
Superior information 54
Active ownership 54
Financial leverage 55
Alignment of interests 55
Mitigating possible confl icts of interest 56
Illiquidity… and new ways to cope with it 58
Secondaries market 58
Publicly listed private equity vehicles 60
3 Value creation in private equity 69
The art of private equity 71
Sourcing deals 74
Creating value in private equity 78
Operational value 79
Exiting investments 95
The economic impact of private equity 96
4 Private equity performance 103
Performance metrics 106
Valuing realized and unrealized investments 108
Reporting fund performance 109
Membership and self-reporting biases 109
Performance by segments 112
Performance by fund size 113
The persistence effect 114
The timing effect 116
Comparison against benchmarks 117
Correlation to other asset classes 121
5 The main characters in private equity 125
Size matters: fund sizes, deal sizes and other dimension issues! 127
Global alternative asset managers 132
Example: The Carlyle Group 133
Example: Bain Capital 138
Regional, domestic and multi-country funds 142
Example: EQT Partners 143
Mid-market funds 146
Example: H.I.G. Capital 148
Venture capital funds 152
Example: TVM Capital 154
Distressed private equity 157
Example: Cerberus Capital Management LP 159
Secondary funds 162
Example: Coller Capital 163
Funds-of-funds 165
Example: Pantheon 166
Example: AlpInvest Partners 169
Institutional limited partners 171
Example: CalPERS (California Public Employees Retirement System) 171
6 The supporting cast 173
London as European centre of gravity 176
The private equity ecosystem: follow the fees 177
Investment banks 178
M&A advisory fees 179
Arrangement fees 180
Securitization fees, or the price of turning frogs into princes 180
Fund management fees, or how to compete with your best clients 182
Lending banks 183
Accountancy firms 184
Law firms 185
Due diligence specialist providers 186
Strategy consultants 187
Placement agents 189
Fund administrators 190
Recruitment consultants 191
Public relations agencies 192
7 Investing in a fund 195
The private equity game 197
The decision to invest 198
Choice of investment vehicle 203
Direct fund investments 204
Indirect fund investments 204
Diversification in a rich marketplace 209
Stages of investment 210
Geographic focus 210
Sector and size of investments 210
Strategic approach 210
Types of private equity firms 211
Timing 211
The pitch 212
Manager selection 214
Due diligence 216
Terms, conditions and fee structures 221
Subscription to a fund 228
Capital calls 228
Monitoring 229
Distributions 230
Reporting 232
Fund liquidation 233
8 The future of private equity 235
Reports of private equity’s death were highly premature 237
Private equity in a changing world 239
Conclusion 244
Index 247
