Editor

Several structural changes are impacting financial markets globally and providing opportunities and risks to private equity investors. The U.S. Federal Reserve Board of Governors is close to raising interest rates for the first time since the Great Recession hit in 2008. This means that interest rates may once again become a market indicator of financial and economic risk. Higher interest rates will also redirect the flow of funds in favor of financial instruments and private equity may find it more difficult to attract funds unless firms can boost returns—which may not be easy.

There is also a growing retirement problem, which is substantial not only in the United States but also overseas. The growing gap between rich and poor will aggravate this problem with the government threatening to step in and initiate a wealth transfer from rich to poor via wealth taxes. This could have an adverse impact on investment funding. Funds to support private equity activity may become less accessible and more expensive.

As a consequence, private equity activity may become more challenging, unless such companies are able to find new ways of doing business that achieve higher returns for investors. In this issue of The Journal of Private Equity, we begin to explore some of the actions private equity firms can initiate to once again make their returns more attractive to investors.

For example, in “The Venture Capital Premium: A New Approach,” Luis Pereiro analyzes a new method for estimating the risk premium that investors should demand on top of public equity’s return in order to be properly compensated for the peculiar hazards of investing in venture capital. His method is an empirically grounded alternative to the rules of thumb employed by institutional investors and fund managers when defining target returns on venture capital.

In “Failed Integrations are the Seed Bed for Turnaround Work: The Pitfalls of Corporate M&A Strategy,” authors Harry Gray, Randy Besosa, and Lance Wimmer consider more mature private equity transactions. The authors describe how the process of developing strategy must account for critical resource constraints such as capital, talent, and time while implementation of the strategy must take into consideration execution leadership, communication skills, and slippage. The authors identify five necessary ingredients for M&A success.

In “An Investor’s Guide to Search Funds,” Stephen G. Morrissette and Shamus Hines explain that search fund investing is not investment in a fund; it is a near-direct investment in a single operating company. This article provides insights into the evaluation of search funds and their relevance within an investment portfolio from an investor’s perspective. The authors find that the three processes to find a target company are more complex for a search fund investment than for a typical investment in marketable securities or an institutional-style private equity fund.

Continuing with the performance enhancement theme, Andrej Gill and Nikolai Visnjic explore the “Performance Benefits of Tight Control.” The authors investigate the transition from being a listed company with a dispersed ownership structure to being a privately held company with a concentrated ownership structure. Their analysis shows significant positive abnormal growth in several performance ratios for the private period of their sample companies relative to comparable public companies. These differences come from the increase in ownership concentration after the leveraged buyout transaction.

M.B. Raghupathy and A. Thillairajan, in their article “Financial Value Creation: A Comparative Study of VC-Backed IPOs and Non-VC-Backed IPOs in India” is a pioneering effort in exploring VC value creation in the Indian context. The authors examine how VC firms, as financial investors in portfolio companies, are expected to add value through continuous monitoring and sustained involvement. Such an effort is expected to give VC-backed IPO firms (VC IPOs) an edge over those IPO firms not backed by VCs. A comparative analysis was undertaken of operating and stock performance data of VC IPOs against three groups of non-VC IPOs. A set of 92 VC IPOs and 182 non-VC IPOs were compared; the 182 non-VC IPOs were subdivided into industry and size groups. The authors found that the medians of VC IPOs on most operating performance parameters are better than those of non-VC IPO groups, although relational tests could not attribute the better performance to VC influence. The authors concluded that this could be because of the VC’s superior ability to identify promising ventures and push them to achieve their maximum potential.

In “The Effect of Private Equity on the BFSI Sector in India: A Logistic Panel Data Analysis” authors Raj. S. Dhankar and Kunjana Malik find that return on assets, after-tax profit margins, and total assets of a company benefit more from private equity investment. However, the returns on capital employed and the ratio of equity to total assets are not affected much by private equity inflows. Furthermore, asset growth in banking companies are found to be unaffected by private equity inflows.

Eymen Errais and Sarra Ben Miled analyze “Investing in Microfinance: The Case of Tunisia.” A sudden change in conditions can present opportunities to private equity. For example, after the Tunisian revolution, people were hit with the bitter reality of an unemployment rate of 20% and a poverty rate reaching 25%. With no access to loans, low-income people found themselves in a vicious cycle of poverty leading them to either begging or criminal activity. Consequently, the government made changes that led to more liberalization of the microfinance sector, in order to alleviate poverty and enhance financial inclusion. The decision was unexpected, as the microfinance sector in Tunisia has historically operated solely within the nonprofit sector, far from the reach of private equity.

F. John Mathis

Editor

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