Private equity can be described as investing in a company through a negotiated process. Investment entails transformational, value-added and active management strategy. Private Equity investments can be undertaken following three categories. These are venture capital, Buy-out and special situation investment. Venture capital can be described as an investment to create a new company or expand a smaller company that is presently undeveloped.
Buy-out investment involves acquisition of a significant portion of investment in a mature company so as to gain control or ownership of the company. Special situation investment involves changing government regulations or industry trends on investment due to availability of opportunity (Robinson and Cottrell, 2007). This paper will broadly analyze buy out investment in detail, discussing its history, growth, merits and failures.
Private equity firms accrue interest on investment through any of the three ways. These include an IPO, sale or merger and recapitalisation. Private equity firms sell unlisted securities directly to investors through private offering or private equity fund which attracts different sources of contributions from small investors who prefer to invest directly to investors due to the risks associated with private equity funds.
Private equity fund require a large amount of money to allow entry which cannot be afforded by most private equity firms. Moreover Private equity firms prefer to invest in firms or investors where the firm can accrue returns after a short duration unlike private equity funds which can take up to twelve years to accrue interests. Private equity firms evaluate availability of opportunity to avoid investing in a failing company which, led to heavy capital losses by the firm. The risk has been noted to be higher in venture capital funds (Lasen, 2006).
Private equity industry was begun in 1946 by the American Research and Development Corporation (ARD) to encourage private institutions provides funding to soldiers who returned from World War II. ARD aimed to provide skills and funding to the management and this would stimulate success of the companies accrue profits. The success of the industry led to permeation of few wealthy families into the industry in 1970s. The industry focussed more on debt financed leveraged buy-outs (LBOs)
A Leveraged buy-out (LBO) occurs when a financial sponsor gains control of a majority of a target company’s stock ownership through the use of borrowed money or debt (Lasen, 2006). A Leveraged buy-out is a widely used strategy where a company acquires another company through significant amount of borrowed money. In most cases, the assets of the acquiring company and the company being acquired are used as security for the loans. Leveraged buyouts allow companies to make acquisitions without committing a lot of capital.
In an LBO 70% debt to 30% equity ration is allowed though the debt can amount 90% top 95% of target Company total capitalisation. Private equity firm prefer to sue leveraged buyouts for two reasons. Use of debt that is widely used in US increased financial return to the private equity sponsor. Debts are exempted from taxation and hence the returns from debt are greater that from cash (Lasen, 2006; Robinson and Cottrell, 2007).
Many countries for example Germany have introduced new tax laws with an aim of discouraging leveraged buyouts through reduction of tax shield effectiveness. The performance of private equity firms that used LBO as their main source of financing went into bankruptcy in 1980s and 1980s. The insolvency was largely contributed by excessive debt financing amounting up to 97%. This led to higher interest payment that exceeded the company’s operating cash flow. Most companies were taken over by other companies and government.
In the recent past private equity industry has experienced a boom as noted in Great Britain as well as USA. Most pension scheme companies have invested in private equity firms and in particular LBOs. The size of private equity pool increased by 37% in 1994 in Great Britain. There is great disparity between foreign private equity pool and United States which present possibility of future growth. The rapid growth in the private equity industry has led to poor returns on capital invested. The returns from public equity deals are higher and this challenges the stability of private equity industry in using LBOs as way of financing (Clark and Whiteside, 2003).
PED projects were initially known to have positive impact in paediatrics industry. The PED projects however are on the decline. This can be attributed to poor management and appointment of nationals who have worked in public service to oversee them yet they have little experience or knowledge that is needed. The PED has encountered pressure from fear of disappointing former and future employees and this has in most cases resulted in failure or problem in implementation of the projects (Saylor, Swenson, Reynolds and Taylor, 1999).
Clark, G. L., Whiteside, N. (2003) Pension Security in the 21st Century: Redrawing the Public-Private Debate. Oxford: Oxford University Press.
Robinson, M. J., Cottrell, T. J “Investment Patterns of Informal Investors in the Alberta Private Equity Market” Journal of Small Business Management, 45, (2007):11-89.
Larsen, D. L. “Challenges to the Private Equity Industry” Journal of Accountancy, 202, (2006):112-156.
Saylor, C. F., Swenson, C., Reynolds, S., and Taylor, M “The Paediatric Emotional Distress Scale: a Brief Screening Measure for Young Children Exposed to Traumatic Events.” Journal of Clinical Child Psychology. 28.1. (1999): 34-70.