Private Equity businesses have surged into the corporate finance market since 1946. The majority of private equity capital is formed by pension funds, financial and investment institutions and the rich. Private equity investments are managed by professionals for private and public companies. It is often provided by specialized intermediaries and, to a limited extent, by institutional investors. The main business of private equity company is the sale of the company including listed or non-listed and then restructuring or split or IPO. Eventually, private equity funds cash in sold for huge price difference between companies. Managers in the private equity firms acquire large ownership stakes and play a crucial role in monitoring and advising portfolio companies. Although dramatic growth and outstanding performance in corporate finance, private equity market received little attention. However, in the past two decades, it has increased by an order of magnitude over the public equity and public and private bond market (Fenn, 1997). Today, private equity has taken roughly 25% the size of both markets for commercial and industrial bank loans and the market for commercial papers in outstanding. The explosive growth is due to favorable regulatory and tax charges, which incurred the flow of venture capital to private equity market. It became a vital source of funds especially for start-up firms, private middle-market firms, firms in financial crisis and public firms demanding buyout financing.
In this paper, we will review the development of private equity market in the twenty years and highlight the turning points between the boom and bust. The factors brought about the growth contains the occurrence of emerging industries, economy globalization, the innovation of investment tools and the government support in the developing countries. Those factors accelerate the development of private equity. We also provide data of buyouts in main private equity markets all over the world. In the end, we have a good outlook about the future of private equity market including both developed market and emerging market.
Development of Emerging industries
In recent twenty years, emerging industries have grown gradually, such as electronic industry, education, network game, biotechnology. At the early stage of these emerging industries' growth, private equity played a significant role in raising funds.
It is obvious that companies require a large amount of capital to operate and begin their own business at the early stage of any industry, especially for emerging industries. However, not all the emerging industries have sufficient funds to take their first step. That is to say, for those companies who cannot raise the capital from interior, funds collected from exterior has positive effect on firms’ development and expansion. Private equity is just an opportunity to solve their urgent problems. As Praveen K Singh (2009) pointed out, avoiding uncertainty and contingency in a volatile market, private equity is a relatively safer financing method to assist developers to start with and complete ongoing projects.
Actually, among numerous emerging industries, most of which are high -technology industries. These companies possess superior recourses of manpower, materials and technology, in spite of shortage of enough capital. Consequently, private equity firms or investors offer them financial assistance and help those corporations being giants in their own field.
Owing to early consciousness of private equity and rapid progress in emerging industries, private equity in the western countries has reached the advanced stage. Reviewing the history of past two decades, plenty of large-scale organizations and corporations, like Blackstone, KKP, The Carlyle Group, Bain & Company, Goldman Sachs and Merrill Lynch, invested in the form of private equity, such as merger and acquisition, which flourished world economy. Take network as an example, during the eightieth and ninetieth of the twentieth century, large amount of funds was injected into Intel Corporation, Microsoft Corporation, Yahoo!, which played a critical role in financing and initiate business. The facts warrant that most of them have become the prestigious leader at present.
The same situation existed in China during the last decade. Since the high return of private equity and the potential Chinese market, foreign private equity firms or investors made substantial investment in the small and medium enterprises. Consequently, a plenty of enterprises were listed in the overseas market because of the success of raising capital. For instance, three venture investment firms provided five millions to Mengniu in 2002. Thus, Mengniu gained a return of 2.6 billion after releasing. The Government of Singapore Investment Corporation invested 18.50 million to LINING Company in 2003. It has gained over 10 times return on investment when it was listed in 2004. Moreover, firms like CTRP, JOBS were invested in form o private equity several times and collecting capitals before listed in foreign markets.
To sum up, a large quantity of small and medium-sized emerging industries initiated and expanded between the eightieth and ninetieth of the twentieth century. They are under conditions of high technology but few capitals. It has been proved that private equity provides a platform for those firms and makes a worthwhile contribution on financing. This method promotes emerging industries enlarge and activate business, eventually attain high market value and return after companies listed in stock exchange.
Strategy changes
The development of leveraged buyouts is closely related with private equity business, because it is the dominant strategy of private equity. Leveraged buyouts were comparatively rare in the 1990s and early 2000s. However, when America and other nations in the world raised another leveraged buyouts surge in mid-2000s, private equity business experienced an enormous growth.(Steven N. Kaplan and Per Stromberg, 2008) Leveraged buyouts achieved an unprecedented scale between the year 2003 and 2007, especially in the US in 2005 (Table 1). During this period, the private equity firms were growing quickly by applying leveraged buyouts. The leading private equity firm in the world-Blackstone Group has proved this. On seventh February of 2007, Blackstone Group successfully acquired the American largest commercial property group- Equity Investment Trust Office, with the price of $3.95 million. This transaction has become the largest leveraged buyouts trading ever since before, which promoted the progress of private equity business. From then on, private equity industry plays a significant role in the global economy.
Table 1
Another primary way of private equity is raising funds by venture capital. The development of venture capital, to large extent, enhances the private equity business in the past two decades. During the 1990s, venture capital has experienced a rapid expansion stage. Especially in the United States, the venture capital market was thriving owing to high-tech industry in the "Silicon Valley". However, the internet stocks crashed from 2000, which directly caused the high-tech venture capital bubble burst in the areas of network and bio-engineering. This situation did not change until early 2003, with the U.S. economy and stock market turning better, venture capital industry gradually recovered. According to the released data by European Venture Capital Association, in 2000, the world's total amount of venture capital investment created record levels, reaching 206 billion U.S. dollars. But in 2002, the world’s total amount of venture capital reduced by half, only 102 billion U.S. dollars. It can be seen from the data that even if the amount of venture capital fluctuated, it still produced great value as the big absolute figure shown. Thus, venture capital is a crucial factor that contributes to the growth of private equity.
Mezzanine finance, as a financial innovation of private equity, began to emerge in the late 1970s. It develops rapidly in Europe and America. According to Alt Asset, mezzanine investments in Europe have ascended from 4.7 billion U.S. dollars in 2002 up to 8.5 billion U.S. dollars in 2006. In recent years, it has become the main financing instrument of infrastructure construction and expansion for small and medium enterprises. Take an IT network security systems provider - Serve Gate Technologies as an example. This company obtained mezzanine capital of 18 million U.S. dollars with the assistance of investment companies such as Com Ventures on twenty-third April 2004. The fund offered expense for expansion sales and marketing inputs in the high-growth stage of the business, and effectively improved the company's asset-liability structure. As a result, the innovation and development of mezzanine finance has made private equity appeared in multi-stage development of the company, which brings about the growth of private equity business.
Private Equity in developing countries
Private equity in developed countries as the US has been developing for many years. Its growth is relatively slowing down in recent two decade years. However, in those developing countries, private equity is expanding rapidly. The reason of its great growth is that the economics in developing countries has flourished during the recent years. Large quantity of money is accumulated and those who are rich have the will to reinvest the money. Simultaneously, many firms which cannot or do not want to raise money from bank starves for the money. As a result, a new form of investment has fulfilled the desirability of both sides, which is private equity. Besides, the government has a serious of policies to encourage this kind of investment. As Lerner and Schoar said the capital market is underdeveloped and private equity has an opportunity. In the following discussion, take China as the representative developing country.
It is a common phenomenon that the government-led investment in new business in China during these years. Government may give the money directly. What is more, policy support and tax preferential are also significant. Thus, the Chinese style industrial investment capital is very different from the internationally accepted operation of private equity. The State Development and Reform Commission of China indicate that private equity should be combined with investing straightly on corporations by government, managing by fund manager and fund custodian. In a world, the government support promotes the development of private equity.
Another favorable element for development of private equity in developing countries is the less restrain in laws and regulations. Although the private equity in developing countries has not been developing well due to it remains at the inception of its growth, the laws and regulations have not been developing soundly either. The deficient laws and regulations offer great opportunity for the improvement of investing private equity. For instance, the only restraint of establishing private equity in China is Corporation Law. Private equity exist under all kinds of finance and legal release clauses. There are only a few years that private equity is paid attention to, the laws and regulations are not maturity. As a result, private equity has an opportunity to grow rapidly under this situation. What is more, the main capital in China is focused on commercial bank, insurance, social insurance fund and etc which are the main sources of private equity in developed countries. The Chief Executive Officers of commercial banks has realized the high retunes of private equity and invest more in it. This is another reason that the high rate of growth in private equity in developing countries.
The future of private equity business
Since the 1990s, private equity businesses have developed dramatically in the developed countries, particularly in the USA. They have set up a mature and ordered private equity market. Howeverï¼Å’private equity markets in developing countries have emerged rapidly in recent years. Thus, private equity businesses can be divided into developed markets and emerging markets.
Developed markets leading by the USA, the UK and some other European countries will come into a stage of bottleneck in the future. Firstly, the private equity business goes up in a good and healthy economic environment. However, financial crisis is still affecting the equity market now. Perkowski (2008) stated that majority think it needs a long recovery. Secondly, the foundation of private equity is not strong. It can be seen that private equity business lives in a continuous circles: prepare money, invest company, sugar it up and then sell it at a higher price. It cannot work if anywhere goes wrong. However, due to credit crisis and economic downturn, private equity firms are not responsible for their customers. Fewer banks are content to lend them money (Margaret Doyle, 2009). Furthermore, some relative administrations will strengthen risk assessment. Under economic recession and Ponzi scheme of the 2008, U.S. Securities and Exchange Commission attempts to take more emphasis on the control process of private equity market. Finally, private equity firms must change their structure under the crisis. Some corporations turn into global, diversified and extensive firms. The trend of other firms will become indigenous, single and small-scale. These adverse factors will retard the speed of the development of private business.
Emerging private equity markets leading by Asia countries such as China will be more attractive for the investors. Firstly, those countries unveiled favorable policies for the investor. They will enter the market as the investments that can stimulate economic growth and industry development. On the other hand, the investor will gain more returns due to government supports. Secondly, it is much easier to raise money in the banks of emerging markets. With the strong support of government, more and more banks will provide the service to supply the private equity businesses. Raising money is the first step of private equity continuous life cycle. Thus, large quantities of investors have capabilities to enter the private equity market. Thirdly, new emerging companies in private equity market need more suggestions in growing and enlarging companies from the experienced investors. Those companies which do not have strong background and excellent managements always need more developing space from the rich investors with prosperous developing prospects. Meanwhile, the investor will earn more if they participate in the management of companies. Lastly, financial specialists such as the agencies, consultants are favorable to come into the private equity markets to occupy the market. It will also accelerate rapidly the development of private equity businesses. Not only the individuals but also many funds which are famous in the developed market also set up their businesses in Asia.
With the economy globalization, although private equity businesses in developed markets struggle to survive in financial crisis, emerging markets still show an optimistic environment for the investors. The private business will have a prosperous prospect, however, it seems that there needs much more urgent changes to improve it in the future.
In a word, the rapid development of private equity in the twenty years has a beneficial influence in the economy spread all over the world. First, it stimulates the increase of private equity in the emerging industries, which needs to raise funds to start-up and extend the companies. Second, the innovation of strategy, for example, leveraged buyout and venture capital brought new opportunities to attract more concentrations and money from the institutional investors. Third, the developing countries especially in Asia had an upward trend due to favorable policy and economic development. In the end, economic globalization also did a significant effect in facilitating the private equity development, which accelerates the extending of private equity market. However, it should be seen that the financial crisis happened twice in these two decades, which had a heavy blow for global economy. It will be a warning for both government and economic market. The excessive growth of fortune would easily transform the economy from prosperity to foam.
