Abstract

This paper gives an overview of private equity. Functionality of investing firms, possible applications of private equity, and its influence on portfolio-companies is in the focus of interest. The topic is investigated by analysing the German market and describing private equity as a controversial financial instrument. Thereby also reservations are portrayed that exist in the German society as well as in the German “Mittelstand” (small and medium sized businesses). The paper concludes with presenting the author’s individual view on private equity and a positive outlook on development of private equity in Germany.

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Contents

  Abstract  2

  Contents  3

Tables and  Graphics  4

Tables 4   

  Graphics  4

1  ) Introduction and background  5

2  ) Methodology  5

3  ) Particularities of the German market  6

3.1  ) Facts and numbers  6

3.2  ) Economic and social causes  7

4  ) Structure and refinancing of the market participants  8

5  ) Characteristics of investment  10

5.1  ) Share of participation  11

5.2  ) Form of capital  11

5.3  ) Life cycle of the target company  12

5.4  ) Exit  13

6  ) Intents and actions of private equity firms and their investors  14

7  ) Decision-relevant factors for target companies  15

8  ) Discussion: the impact of private equity on target-companies  16

9  ) Limitations  20

9.1  Restrictions of words and time  20

9.2  Methodical Limitations  21

10  ) Conclusion  21

  References  23

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Tables and  Graphics  

  Tables  

Table 3 1  Private equity investment and GNP in Europe and the USA  7

Table 3 2  Private equity portfolios in Europe  7

Table 4 1  Foreign and domestic investments in Germany  9

Table 4 2  Fundraising in Europe and Germany ( billion)  10

Investments  2006 according to company life cycles  12

  Development of sales according to company life cycles  18

  Graphics  

  Graphic 5 1 Risk and return of mezzanine capital  11

  Graphic 5 2 Investments according to company life cycles over time  13

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1) Introduction and background

Object of this study is private equity (PE): the allocation of capital to enterprises by investment firms with the objective of a profitable future sale of the interest. This sounds rather dry and does not give consideration to connotations that are raised when talking about PE to “normal” not especially financial interested Germans. I have done so a lot during the course of this work and was confronted with stereotype predications like “brood cell of capitalism” or “fine suits and fat wallets”. The aim of this paper is to fractionise this myth of PE by answering the following questions: How do PE firms work? Which investment policy and which management policy do they pursue? How do PE firms generate above average returns for their investors? Finally, what is the impact on capital recipients (in the course of the paper: target-companies or portfolio-companies)? My motivation to do so is my simple interest in the topic and the PE industry. This interest enlarged to the extent that I am looking for an internship in the industry whilst doing this study (alas, in Germany only a few more than 1,000 professionals are employed [BVK, 2007c]).

Rather too early than too late I want to inform the reader at this stage that I am member of the liberal party of Germany (Freie Demokratische Partei Deutschlands, FDP). This organisation can be characterised as a capitalistic one. I tried to ensure an appropriate degree of objectivity is applied. However, my political attitude might constrict this to some extent.

2) Methodology

One of my German lecturers, Prof Dr Balz who is a former corporate finance consultant at McKinsey, told me that papers on PE would fill a small lorry. Having done research for this report I can state he is obviously right. Nonetheless, I have found only a few books specialised on PE. Thus I decided to structure my paper in form of a handbook: I look forward to provide the reader with an overview of a dynamic and relatively young sector.

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Building the structure of this paper I found myself adding one bullet to another. Due to space and time restrictions I had to cut out several points that are listed in the limitations (chapter 9). At last I decided to forego the claim of completeness in favour of a presentation of the main characteristics of PE in Germany in reasonable argument and depth.

In doing so, focus lies on the impact of PE on the target companies. The dedicated chapter 8 does not aim at presentation and analysis of studies in the main. It rather tries to inaugurate the controversial aspects of the topic in a discussing way in order that the reader can experience reservations regarding PE and judge them on his own.

I tried to give a fair view of all aspects but the awakening of reader’s interest instead of objectivity was my highest priority in doing this paper. Thus original statements from questionnaires filled by two PE professional are incorporated and some paragraphs tend to exaggerate and provoke on purpose. Thereby my intent is not to close down discussion but rather initiate it. Nevertheless, my individual point of view is given in the conclusion (chapter 10).

3) Particularities of the German market

3.1) Facts and numbers

The German PE market differs in size and importance from mature markets such as Great Britain or the United States of America. Table 3.1 compares the size of PE investment with the size of the Gross National Product (GNP) in Europe and the USA. It shows that In relation to the GNP the share of PE in Great Britain is six times as high as in Germany.

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Table 3.1 Private equity investment and GNP in Europe and the USA

Source: BVK, 2007b

Indeed, one has to regard that the German market is still young. Private owned PE Firms exist in Germany only since 1983, when venture capital euphoria came from the USA to the country (see BVK, 2007b).

However, instead of catching up with high rates Germany’s market growth is still under average as shown in the following table.

Table 3.2 Private equity portfolios in Europe

*CAGR = compound annual growth rate

Source: BVK, 2006a

3.2) Economic and social causes

The low spread of PE in Germany has manifold reasons. Klaus-Joerg Schneider, investment manager at DZ Equity Partners, reckons the cause in the structure of the German economy: “There are many small and medium sized enterprises in Germany. These owner-managed companies work traditionally in a tight relationship with a single bank and avoid the complexities of the capital markets.” He adds that

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