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Private equity (PE) has emerged as one of the fastest growing asset classes in the past decade, with an increasingly large amount of capital being deployed into the private space. Because of the recent macroeconomic uncertainties, credit market turmoil, and volatile equity markets, however, growth in the PE industry has slowed down. Overall global PE deal values nevertheless remained considerably stable at about $184 billion in 2011.
Private equity is a type of alternative investment pertaining to infusion of private capital into both private companies at the growth stage and public companies for M&A financing, buyouts, turnaround, and so on. Generally, however, PE investing refers only to investments in nonpublic companies either at the early-growth (venture capital) or lategrowth (PE) stage.
Considering the fact that the investee companies are generally at an earlier stage of firm maturity, the risk associated with these investments is much higher than with traditional investments such as equities, commodities, and fixed income. PE investment decisions are thus more complex than traditional investment decisions. In particular, risk- return measurement is a subjective matter for PE investment candidates because they are privately held and are not revalued/ benchmarked on an ongoing basis. This subjectivity makes devising a robust model that considers all the relevant factors that can aid in effective decision making for a successful PE investment all the more important.
EVALUATION FACTORS
For any PE investor, a trade-off exists between risk and return (just as for any other investment). Several factors need to be accounted for when one decides to make an investment. The factors more often than not tend to be qualitative in nature, and therein lies the primary difficulty in making PE investments. Apart from generating a maximum incremental rate of return (IRR) for limited partners (LPs), general partners (GPs) or active investors also need to satisfy several constraints simultaneously (such as time frame/horizon of the investment, associated riskiness, etc.). Thus, PE investing is an art without, as of yet, a clear-cut, objective approach to guide the decision-making process.
Broadly speaking, six major factors need to be given due consideration when making any investment: management; operations and profitability; strategy; transaction and horizon; cost; and exit routes. Within these categories are several other indicators/subfactors that compose that particular primary...