Risk Aspects in Private Equity Investments

89 Pages Posted: 17 Oct 2007

Date Written: August 30, 2007


The motivation of this paper was to support a prospective Private Equity investor in his selection of LBO (leveraged buyout) funds and to give practical insights into the buyout market's recent transactions. More precisely, the hypothesis was that the combination of both high-level operating risks and financial leverage risks would be disadvantageous for investors.

In general, buyout funds from the US with investment focus on the media industry and the consumer-related industry as well as EU buyout funds focusing on the industrial/energy industry and the consumer-related industry achieved strong excess returns from the mid-1980s to the early 2000s. These findings confirm this paper's hypothesis that the combination of both high-level operating risks and financial leverage risks - mainly present in funds investing in the high-technology sector - would be disadvantageous for investors. By regressing the vintage-specific funds' IRR on the corresponding S&P 500's CAGR (compound average growth rate) as of end-2006, one can note with statistical significance (at the 5 percent significance level) that most buyout fund segments are positively depending on the stock market's long-term returns. For buyout investors, a conservative approach may be to choose LBO funds and corresponding management companies which have (or aim to have) a major part of their portfolio companies within the consumer-related industry and which are at least partly geographically diversified. Concerning the buyout cases, low-valued target companies - measured by EBITDA multiples - with extensive cash available tend to be top-ranked regarding the potential IRR. Future - including those which are still pending - LBO transactions may create substantial shareholder value provided that these are carried out by adhering to reasonable market multiples and focusing on stable industries. Contrarily, the deals majorly completed for the reason of the attractive debt financing environment may potentially prove to be unsuccessful. Future LBOs of publicly-listed companies could increasingly take place in the energy industry and the refining industry which - positively affected from low EBITDA multiples and strong free cash flows making early debt redemptions possible - both reveal the highest potential IRRs on median average with 27 percent and 21.3 percent, respectively.

Keywords: Private Equity, Buyout, LBO, Investments, Funds

JEL Classification: G12, G24, G30

Suggested Citation

Lustenberger, Marc, Risk Aspects in Private Equity Investments (August 30, 2007). Available at SSRN: https://ssrn.com/abstract=1022280 or http://dx.doi.org/10.2139/ssrn.1022280

Marc Lustenberger (Contact Author)

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006

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