Can Private Equity Firms Pay Fair Value for Acquisitions?

Abstract

Private equity firms market to limited partners by claiming to be able to earn returns on equity of the order of 18% for their investors. Because this rate of return is typically higher than the cost of equity capital for target firms, a question arises as to how private equity firms can pay competitive prices for acquisitions. The author examines that question from a variety of perspectives, and identifies the conditions under which private equity firms are likely to be able to pay fair market value as well as the conditions under which potential targets should say no.

TOPICS: Private equity, fundamental equity analysis, portfolio construction, legal/regulatory/public policy