On average, private equity has produced very high returns with low correlations to public stocks and bonds and real estate. In other words, private equity offers the prospect of both high returns and increased portfolio diversification. In some cases, private equity may also provide collateral benefits, e.g., a vehicle to make economically targeted investments or to create or preserve union jobs. Finally, there is also the undeniable appeal of seeking innovative investments (Gompers, 2003).
1. Until the investments go public or are liquidated, investments are carried either at cost or at prices set by later rounds of financing. Except in this latter case, private equity is even harder to accurately value than real estate (Bray,1997).
2. Ultimate returns have varied (and are likely to continue to vary) widely by "vintage year," i.e., the year of initial investment, because of wide fluctuations in the business cycle. For example, the median 1986 private equity fund returned only 8.4% per year through 1997, whereas the median 1990 private equity fund returned more than 17% per year through 1997.
(In statistical terms, the mean return is much higher than the median.) For example, for venture funds formed in 1988, an upper quartile manager returned almost 18% more per year than a lower quartile one from 1988 through 1997 (21.6% vs. 3.9%).
4. Reputation is very important: The best deals and the largest investment flows tend to go to firms with the best track records. Consequently (and quite unlike public equity markets), success tends to persist. The result, however, is that it is often difficult, if not impossible, for new investors to get into the best partnerships or deals. Here, the services of an established fund-of-funds manager can be of real value (Gompers, 2003).
AIM OF THE PAPER
Private equity (PE) buy-out deals have profound influence on domestic economies. Since the beginning of this year, they have accounted for more than one third of all deals that have been done on the New York stock Exchange1, and have raised $240 billion of cash for their acquisition plans2. The purpose of this report is to discuss the consequences of this type of buy-out on public markets, jobs, and tax revenues. Nevertheless, The effects of high leverage, which is used by PE firms to finance this class of acquisition, are beyond the scope of this report.
Private Equity investment used to be defined as "an equity investment in a company which is not quoted on a stock exchange". However, currently this definition has many limitations because it does not include investments that are structured as convertible debt and investments in public companies that are taken private3. For the purposes of this paper, Private Equity Buy-Out deal is a subset of