of the interests and incentives of management with that of the owners’ 1 , this is ultimately achieved by encouraging all parties involved in the takeover to invest a portion of their private capital into the business. The added benefit of private equity ownership is that there are no conflicting goals that have to be dealt with or compromises that have to be made to add value to the target business. A normal publicly listed or family owned business would have to worry about quarterly profit statements, investor speculation, media engagements and large advertising bills in an attempt to compensate for a lack of efficiency. A PE owned company however focuses more on long-term goals given the view that long term stability and structural efficiency add more value to a company than short term bubbles. A PE acquisition would normally last between 3 and 7 years in which time they would hope to encourage investment to increase the productivity of the firm. At the same time, the GPs would sell underused assets belonging to the target firm to rid them of any unnecessary interest/rent payments which yield less benefit than costs would seemingly suggest (Campbell & Campbell, 2008). Many more incentivizing mechanisms are found though when it comes to the sale of a target company. The general structure of payments for GPs follows that of Hedge Funds and other investment institutions, the ‘2 and 20’ rule. This basically states that LPs pay a 2% management fee (that is, 2% of the LP’s investment) to GPs and then they pay 20% of the profits, otherwise known as carried interest (given the profit exceeds a hurdle, normally around 8%-10% of the initial investment), to the GPs. If the target company is sold for a loss though, the GPs receive no carried interest and they also lose their personal stake in the acquisition, they may also be forced to use previous carried interest payments to satisfy the unquestionably very annoyed LPs. What’s worse though is the tarnish left on the reputation of the PE firm, not only have they lost the faith of potential investors – reducing account liquidity – but as mentioned before, they lose the respect of the public since the media often use a one-off failure of a leveraged buyout to criminalize the PE industry as a whole. The following arguments do include the use of data from recent research into this field, and I feel it’s appropriate to comment on the validity of such data for the purposes of my investigation. Research into the effects of PE firms on target businesses does exist however my only criticism of it is a lack of timescale, as regardless of how many target businesses a study may investigate over, say, a 5 year period, the structural bias due to economic conditions (for example interest and tax rates) will restrict any long term patterns from emerging. This is problematic as PE firms aim to increase the long term prospects of target companies and as there is not much data for the long run performance, it is harder to judge PE firm’s success. However, I hasten to add that this is not entirely the fault of researchers, the PE ‘boom’ picked up pace in the mid 1980’s and thus many acquisitions have taken place after this time, furthermore it would be unreasonable to expect meticulous data books to have been created at the birth of this new industry, so the only accessible data is from the last 20 or so years. Even with this in mind though, the lack of long term data shouldn’t provide too much of a hurdle as my investigation focuses on the effects of PE firms in the UK today and the medium term data is satisfactory for this purpose. In any case, I intend to use data sets covering the largest period of time possible to increase the validity of my investigation. I should also say that statistical analyses have been carried out on all pieces of data (by Popov & Roosenboom) which confirms that the relationship between PE activity and innovation is due to causation, not correlation. In other words, the increase in number of patents and productivity is a result of PE investment; we should not interpret the results in such a way that we assume they show cases where PE companies invest in companies that already possess vast patent orientated wealth or highly productive capital. Past Research and Validity of Data
1 http://www.pegcc.org/education/how-does-private-equity-work/
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