Investing in Private Equity Partnerships - The Role of Monitoring and Reporting

2 Investing in Private Equity Partnerships (S. 11-13)

2.1 Fundamentals of Private Equity

2.1.1 Definition of Private Equity Investments

Private equity investments comprise all equity investments in non-public, closely held companies that face a transformational situation in their corporate development.28 Apart from providing financial resources, private equity investors offer additional management support mainly by advising the management teams of the portfolio companies. 29 The objective of the investors is to generate an optimal risk-adjusted rate of return of their investments. The primary reward of the investors is typically a capital gain which is only rarely supplemented by dividend yields. In order to realize that capital gain, the investors typically plan for an exit of the company investment already at the time of the initial investment.

The holding period of the investments lasts usually five to seven years. According to the stage of the companies that receive the financing, private equity investments are typically split into different sub-segments.31 Broadly defined, these subsegments are venture capital, i.e. early stage investments, on the one hand, and buy- outs, i.e. late stage investments, on the other.32 Venture capital encompasses all equity investments in start-up companies intended to finance the launch, early development or expansion of a business.33 The financing may be required for developing business plans, product development, initial marketing activities, or the commercialization of products and their production.

The portfolio companies typically belong to high growth industries, e.g. technology or biotech. Due to their inherent risks, these firms have very limited financing alternatives other than equity financing provided by venture capitalists. The source of the return to the equity provider typically comes from revenue and profit stream growth. Buyouts or late stage investments comprise investments in established companies. These companies are considered to have stable business or to face matured growth.35 As these companies normally have positive and predictable cash flows, the financing structure of the transactions allows for additional leverage of the investments through debt.

The potentially high returns to equity providers are mainly sourced from financial structuring, cost reductions and improving efficiencies.36 The purposes for financing companies with private equity can be distinguished as follows. On the one hand, private equity is used to finance growth, e.g. by providing capital to develop new products, to expand operations, or to make acquisitions. This is typical for venture capital investments, but could be also relevant for later stage companies.

Private equity can further resolve ownership and management issues. A succession in family-owned companies or the buyout or the buyin of a company by ex- perienced managers may be achieved by using private equity. In some cases, private equity capital is used to strengthen a company’s balance sheet, e.g. in turnarounds. In the subsequent analysis, the term private equity refers to private equity investment as asset class in general. This term comprises all respective sub-segments of the asset class such as venture capital or buyout investments. Where it is appropriate and necessary to emphasize further distinctions, these sub-segments of private equity are explicitly mentioned.