Motivation to Invest in Private Equity, Research Paper Example
Words: 2596Research Paper
For this review, a framework was selected, as indicated in Figure 1 above. The framework was based on five phases: private equities, associated risk, motivations for each investor, investors, and motivation for undertaking investments. The results are established based on the findings from each of the five secondary resources obtained previously. The discussed themes varied and were categorized according to the report’s framework.
Schickinger et al. (2018) revealed the current relationship between private equity firms and private businesses. The review revealed the number of equity investments in private firms in European companies by private equity firms and established that the investments increased from 34.4 to 46.2 billion between 2012 to 2016. Schickinger et al. (2018) also revealed that private equity firms or investors tend to focus on a shorter time perspective than the private company owners, hence creating an impression that owners of the private firms accept collaborating with PE firms as a last resort. As established by Schickinger et al. (2018), the findings for investments are summarized in the table below.
The established motivation for undertaking investment in private firms by the private equity firms, as established by Schickinger et al. (2018), includes the characteristics of the private firms being large and attractive deal portion. Additionally, the uniqueness in the human capital is classified by loyalty and commitment and the presence of the non-family managers in the case of firms that families own. Lastly, the firms’ growth potential also motivated investors to undertake investments in the firms.
As established by Schickinger et al. (2018), the associated risks for undertaking investments in private firms include owner-to-agency problems, especially in the scenario whereby the family-owned enterprises have problems with the management. An additional problem is the non-economic interests of the private managers may reduce the attractiveness of the firm hence impacting profits too significantly. The last risk established in the research study includes variables identified as deal-killers, including the absence of an exit strategy for the investors.
The vital theories used by Schickinger et al. (2018) in the research to support the findings were classified as primary and mirror focus. The primary focus theory classification identified the agency theory, while the mirror focus identified resource-based perception, stewardship theory, and pecking order theory to support motivations and risks associated with undertaking investments in private firms.
A research study conducted by Cumming (2009) revealed the type of investors in the private equities and their motivations. Cumming (2009) defines private capital markets as comprising a significant part of financing which provides a linkage between financing of the private firms. The research study reveals the investor category who invests in PE firms in the US and Europe, obtained from funding sources.
The types of investors revealed by Cumming (2009) include pension funds, financial institutions, and family offices. Additionally, the study revealed environmental endowments and foundations, funds of funds, and the rest categorized as others. The private equity investors were classified based on percentages whereby the pension funds, financial institutions, family offices and individuals, endowment foundations, funds of funds, and others were 57%, 12%, 12%, 9%, 5%, and 5% in the US (Cumming, 2009). Additionally, the statistics for the PE in Europe were also established to comprise 18%, 23%, 6%, 2%, and 36% for the pension funds, financial institutions, family offices and individuals, endowment foundations, funds of funds, and others respectively (Cumming, 2009). Comparison analysis reveals that there were more PE managers in the US than in Europe for each category of investor.
The research study by Cumming (2009) established motivations for each investor. For instance, institutional investors were motivated by the financial returns, including returns on investments and the internal rates of returns. The banks and other financial institution stockholders are inspired to undertake PE investments for tactical objectives, including accessing enterprises to sell their items, including modern technologies and additional new launched products from the institutions (Cumming, 2009). Additional motivation for the banks and other financial institutions includes eliminating the competitive threats and financial returns (Cumming, 2009). The government in the national and regional investors are motivated to acquire PE investments by the public policy developed and intended goals for the policies (Cumming, 2009). The goals may include the development of local ventures and the capital industry. Additional motivation includes the need to accelerate economic growth and employment and the need to commercialize available technology presented by the firms.
The sources of financing for individual investments were also established in the report established by Cumming (2009). For instance, the financial sources for the institutional investors were pension financing, endowments, and funds of funds (Cumming, 2009). Additionally, the source of financing for the institutional investors was revealed as insurance company balance sheets (Cumming, 2009). For investments made by the banks and other institutional investors in private equities, the funding sources were revealed as balance sheets, business development or the budgets from R&D (Cumming, 2009). The finance sources for the governments in PE investments were established as government finances and, in some instances, matching private sector finances from other investors classified as third party.
The study by Cumming (2009) revealed different risks associated with the investment types. The risks associated with the institutional investors include restricted life, several fund-raisings, and contract agreements. The risks associated with investments inside the banks and other financial enterprises include unlimited life and formal administrative control (Cumming, 2009). Additional risks were identified as informal control by the companies they are investing in through corporate culture (Cumming, 2009). Government investments in private equities at the national and regional levels also have risks, as identified by Cumming (2009). The risks identified include limited life, single fund raising, and the difficulties associated with the contract’s covenants (Cumming, 2009). The covenants in the contracts are often linked to the geographic distribution of the companies and restrictions based on the investment stages.
A research study by Gondi and Song (2019) revealed that the private equities value in health sector were $42.6 billion globally. Private equity investments on a global scale increased by 17% from 2016 (Gondi and Song, 2019). The research study revealed that the value of deals improved to 265 from 206 in the healthcare system (Gondi and Song, 2019). The total deals associated with investments in private equities in healthcare summed up to 18% globally (Gondi and Song, 2019). Physicians and hospitals accounted for most of the buyouts, with 139 out of 265 private healthcare deals being announced globally.
The motivation for the private equity firms to undertake investments in the private healthcare firms was established as the fragmentation of the healthcare based on geographical locations, which makes the private equity investors exploit economies of scale through consolidation of the market (Gondi and Song, 2019). Additional motivation for investing in private equities, especially in healthcare, as established by Gondi and Song (2019), is that the healthcare demand is resistant to recession, with the valuations in the healthcare remaining high despite the economic turbulence. An additional finding is that the delivery system possesses a significant number of inefficiencies, attracting private equities that possess competency to reduce or minimize possible wastes (Gondi and Song, 2019). Additionally, an aging population that suffers from many chronic illnesses also contributes to the increasing demand for healthcare services, prompting private equities to undertake investments in the fields.
A research study conducted by Gondi and Song (2019) also establishes potential barriers to investments by private equities in the medical field. The risks associated with investing in private equity firms include the need to achieve high returns on investment within a first-time zone (Gondi and Song, 2019). The need to generate more income within a fast time frame causes an impact on the nature that a business is undertaking its activities (Gondi and Song, 2019). For instance, in the medical field, the impact includes compromising quality and safety (Gondi and Song, 2019). An additional need to increase returns creates pressure on the operation of the businesses (Gondi and Song, 2019). For instance, the need to maximize utilization of products in the private companies, create direct referrals in the company for more revenue, and deliver unsupervised care by allied clinicians.
A research study conducted by Harris et al. (2012) reveals the performance of PE through the use of research quality presented by the Burgiss dataset. The outperformance of the firms verse the S&P 500 averaged 20% and 27%, indicating value addition to the firms. A study by Harris et al. (2012) indicates that the US buyouts and VC raised $148billion between 1980 and 1995. The total amount raised by the venture capitals and the buyouts between 1996 to 2004 was $668 billion. The increase in the capital raised by the VC and the buyouts is significant for determining the increase in the private equity ventures. The buyout funds outperformed the public markets established by the 27% and 20% averages above S&P.
A research study conducted by Sean Field (2022) reveals that private equity investors in the oil and gas industries in the US have a significant amount of risk associated with their investments in the business (Sean Field, 2022). The study establishes that PE equity investors have a primary role in the oil industry in the US as they undertake to finance the small private companies since the foundation of the industry (Sean Field, 2022). The study established that the associated risks of investing in the companies include the risk of establishing the amount of earnings that can potentially be obtained from the enterprises (Sean Field, 2022). Additional risks include establishing the total income from the investment when the company is not sure of the potential income they are likely to obtain from the oil wells. Like in most companies, the associated risks of investing in private companies are due to the uncertainty of returns on investments.
Discussion of Results
Motivation for Investment
The private firms usually have a significant and striking deal for the PE investors with prospects of profit return since the private firms are considered as the supporting entrepreneurs of the economy (Schickinger et al., 2018). The motivation and investment attractiveness posed by the private companies are also supported by a research study conducted by Gondi and Song (2019). According to a research study conducted by Gondi and Song (2019), private equity investors are motivated to undertake investments in private equities in the healthcare system because of the fragmented market based on the geographical distribution, which allows the investors to be able to undertake market consolidation. Additional findings in the research study conducted by Gondi and Song (2019) reveal that the demand for medical items continues to increase, making investments in the private equities in the sectors profitable. Therefore, it can be argued that positive prospects in an industry are also an additional factor that motivates investments in that particular field. Investors are motivated to invest in a market sector with better future returns. Therefore, as established by a research study by Gondi and Song (2019), the returns of equity investments in healthcare totaled $42.6billion, indicating an increase of 17%. The motivation for the private equity investments is that the field has continued to remain profitable despite an economic impact on the other fields of investments. The factors that motivate the investors to undertake investments in different private equities are based on the advantages possessed in the particular industry. Most private companies providing an opportunity for investors to undertake investments in their firms usually do not have enough resources to compete effectively in the economy (Schickinger et al., 2018). Therefore, when such resources are made available in the companies, the firm and the private investors usually have the potential to unlock great potential for earning from the ventures (Schickinger et al., 2018). Investors usually value investments and the initial commitments of the owners of businesses in a firm. Therefore, private equity investors are motivated to invest in private equities because the firms pose significant growth opportunities.
Private equity investors are also motivated to undertake investments in private firms because of the human capital (Schickinger et al., 2018). According to a research study conducted by Schickinger et al. (2018), private equity investors assess private firms and establish employers’ characteristics. During the assessment, the investors attempt to establish employee loyalty to know those committed to the firm for the long-term benefit (Schickinger et al., 2018). The motivating factor of the human capital at a particular private firm has been established to be dependent on several issues. Some of the issues established include the employees prefer that the management be comprised of the people who are not classified as the business owners (Schickinger et al., 2018). The ability of the management to be comprised of people who are not owners of an enterprise was established to signify the business owner’s ability to be willing to delegate the management of the business to other people (Schickinger et al., 2018). The management’s ability to be delegated to people who are not regarded as the owners of a business is a factor that investors in the private equity consider as it forms the exit strategy for the business. Investors are usually concerned about the ability to have an exit strategy that is appropriate for a business (Schickinger et al., 2018). Private equity investors also easily relate with people at a similar professional level. The investors also like managers in private firms who have external experience and can display professionalism to add value to the firm. Professionalism is a motivation for investing in private business.
The growth potential that the private firms depict is a motivation for the investors in the private equities to undertake investments because of possible financial returns. A research study by Gondi and Song (2019) established that the potential returns on investments are usually realized if the PE firms succeed in value addition. The addition of value is for the private companies invested in with a subsequent sale of the stake that the investors possess in the company at an increased price than the initial one they were purchased. A study by Gondi and Song (2019) reveals that the stocks are usually sold within 3 to 7 years of the initial investment. A study conducted by Schickinger et al. (2018) reveals that private firms are usually tempted to pursue non-economic goals. Therefore, an investment in the firms is usually aimed at making them have the required infrastructure, enabling them to turn their activities into profit-generating ventures. A research study conducted by Gondi and Song (2019) revealed that investors usually provide significant additional capital for undertaking investments that will ensure that an enterprise provides profits. The additional investments are also significant for the re-vitalization of a company’s operations. Schickinger et al. (2018) state that private firms have the potential to re-organize themselves and re-consider operations that can ensure that the profitability of a firm is enhanced hence motivating private equity investors.
Gondi, S., & Song, Z. (2019). Potential implications of private equity investments in health care delivery. Jama, 321(11), 1047-1048. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6682417/
Harris, R. S., Jenkinson, T., & Kaplan, S. N. (2014). Private equity performance: What do we know?. The Journal of Finance, 69(5), 1851-1882. https://www.nber.org/system/files/working_papers/w17874/w17874.pdf
Schickinger, A., Leitterstorf, M. P., & Kammerlander, N. (2018). Private equity and family firms: A systematic review and categorization of the field. Journal of Family Business Strategy, 9(4), 268-292.https://www.sciencedirect.com/science/article/pii/S1877858518300263
Cumming, D. (Ed.). (2009). Private equity: Fund types, risks and returns, and regulation. John Wiley and Sons.https://sites.baylor.edu/peter_klein/files/2015/11/chapman-klein_2010-12dhl5u.pdf
Field, S. (2022). Risk and responsibility: Private equity financiers and the US shale revolution. Economic Anthropology, 9(1), 47-59.
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