I

Executive summary

This assignment is part of the MBA studies at the University of Applied Science in Essen (FOM, Hochschule für Oekonomie, Essen) and covers the subject “International Finance and Controlling”.

The objective of this assignment was a critical analysis of Private Equity (PE) investments both from the perspectives of PE investors and of PE target companies. PE investors expect high returns, but it could be shown by taking independent data into account that it is highly questionable if the returns of PE investments are always higher compared to other forms of investments. Furthermore, there is the risk of a total loss, which is higher for PE investments than other forms of investments, especially due to the information asymmetry between PE investors and PE issuers.

Looking at it from the perspective of PE issuers, PE investments inject fresh capital into target companies with often a high percentage of debts. This capital can be used for expansion and innovation. However, PE investors expect high returns and may use assets of the target company to refinance debts which have been taken in order to finance the PE investment.

Furthermore, PE companies will gain managerial control within the target company through which decisions are aligned with the objectives of the PE investor. This can also include decisions regarding the future employment situation in the target company. There cannot be an overall statement if PE investments are “good” or “bad” for both sides, because the outcome of an evaluation strongly depends on the statistical method, the observed time span, the choice of statistical data and the personal viewpoint.

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Table of Contents

Executive  summary.  I

Table of  Contents  II

List  of Abbreviations.  IV

List  of Figures  V

List  of Tables.  VI

Prologue   VII

1  Introduction and problem definition  1

2  What is PE?  1

2.1  Definition  1

2.2  Short overview over the history of PE and its current situation in Germany  2

3  How does PE work?  3

3.1  Mayor players in the PE market.  3

3.2  How is PE invested?  5

3.3  How is PE disinvested?  7

4  PE investments: The Perspective of PE investors.  8

4.1  Returns  8

4.2  Risks of PE / VC investment.  9

4.3  Lack of information.  10

5  PE investments: The Perspective of PE issuers  11

5.1  Improved capital structure and room for expansion  11

5.2  PE investors as „Equity robbers“  12

5.3  Companies with succession problems.  14

5.4  Management support control  14

5.5  Loss of jobs in companies which are target of PE investments  16

6  Conclusion  17

References   VIII

III

Declaration ......................................................................................................................XI

ITM checklist ................................................................................................................ XII

IV

List of Abbreviations

BVK German Private Equity and Venture Capital Association

etc. et cetera EVCA Private Equity & Venture Capital Association GmbH Gesellschaft mit beschränkter Haftung KKR Kohlberg Kravis Roberts & Co LBO Leverage Buy-Out NASDAQ Association of Securities Dealers Automated Quotations NVCA National Venture Capital Association p. page pp. pages PE Private Equity R&D Research and development S&P 500 Standard & Poor's 500 SPD Sozialdemokratische Partei Deutschlands VC Venture capital www world wide web

V

List  of Figures  

Fig.  1: Funds raised by type of investor.  

Fig  2: Investment paths and involved players in the PE market  

VI

List of Tables

Table 1: Characteristics of Major Issuers in the PE Market .............................................4 Table 2: Moving 5 year average in percent of the performance of VC, compared with

S&P 500 and NASDAQ............................................................................................9 Table 3: Capital structure of German companies in 2006...............................................11 Table 4: Catalogue of transactions which are subjected to the authorization of an

investing PE company.............................................................................................15

VII

Prologue

So Moses stretched out his rod over the land of Egypt, and the LORD brought an east wind on the land all that day and all that night. When it was morning, the east wind brought the locusts. And the locusts went up over all the land of Egypt and rested on all the territory of Egypt. They were very severe; previously there had been no such locusts as they, nor shall there be such after them. For they covered the face of the whole earth, so that the land was darkened; and they ate every herb of the land and all the fruit of the trees which the hail had left. So there remained nothing green on the trees or on the plants of the field throughout all the land of Egypt.

(Exodus 10:13-15, The Bible)

1 Introduction and problem definition

In 2005, the then chairman of SPD; Franz Müntefering made the following statement in „Bild am Sonntag“, a weekly German newspaper: „Manche Finanzinvestoren verschwenden keinen Gedanken an die Menschen, deren Arbeitsplätze sie vernichtensie bleiben anonym, haben kein Gesicht, fallen wie Heuschreckenschwärme über Unternehmen her, grasen sie ab und ziehen weiter. Gegen diese Form von Kapitalismus

kämpfen wir" ¹ (translation: „Some investment companies do not waste any thought about the people whose workplaces they destroy - they remain anonymous, have no face, descend like swarms of locust on companies, graze them and move ahead. We are fighting against this form of capitalism“).

This statement initiated an intense public debate in Germany addressing capitalism in general, but according to the German magazine „Stern“, which followed information from an internal SPD strategy paper, Müntefering mostly targeted U.S. Private Equity (PE) investment companies like Kohlberg Kravis Roberts & Co (KKR) with his

statement. 2

In this elaboration, there should be a critical examination regarding the effects of PE investments on PE investors and companies which receive PE (PE targets). Benefits and drawbacks for both sides should be examined and described.

2 What is PE?

2.1 Definition

The European Private Equity & Venture Capital Association (EVCA) defines PE as follows:

„Private equity provides Equity Capital to enterprises not quoted on a stock market. Private equity can be used to develop new products and technologies (also called Venture Capital), to expand working capital, to make acquisitions, or to strengthen a company’s balance sheet. It can also resolve ownership and management issues. A

¹ Franz Müntefering in Bild am Sonntag from 17th April 2005, quoted in Hess (2007), p. 23

² Stern from 25-10-2005, „Kapitalismusdebatte: Die Namen der "Heuschrecken"“, http://www.stern.de/politik/deutschland/kapitalismusdebatte-die-namen-der-heuschrecken-539759.html /

06-01-2010