The Capital Structure of PE‐Funded Companies (and How New Debt Instruments and Investors Are Expanding Their Debt Capacity)

The capital structures and financial policies of companies controlled by private equity firms are notably different from those of public companies. The concentration of ownership and intense monitoring of leveraged buyouts by their largest investors (that is, the partners of the PE firms who sit on their boards), along with the contractual requirement of PE funds to return their capital within seven to ten years, have resulted in capital structures that are far more leveraged than those of their publicly traded counterparts, but also considerably more provisional and “opportunistic.” Whereas the average U.S. public company has long operated with roughly 30% debt and 70% equity, today's typical private‐equity sponsored company is initially capitalized with an “upside‐down” structure of 70% debt and just 30% equity, and then often charged with working down its debt as quickly as possible. Although banks supplied most of the debt for the first wave of LBOs in the 1980s, the remarkable growth of the private equity industry in the past 25 years has been supported by the parallel development of a new leveraged acquisition finance market. This financing innovation has led to a general movement away from a bankcentered funding base to one comprising a relatively new set of institutional investors, including business development corporations and hedge funds. Such investors have shown a strong appetite for new debt instruments and risks that banks have been unwilling or, thanks to increased capital requirements and other regulatory burdens, prohibited from taking on. Notable among these new instruments are second‐lien loans and uni‐tranche debt—instruments that, by shifting the allocation of claims on the debtor's cash flow and assets in ways consistent with the preferences of these new investors, have had the effect of increasing the debt capacity of their portfolio companies. And such increases in debt capacity have in turn enabled private equity funds—now sitting on near‐record amounts of capital from their limited partners—to bid higher prices and compete more effectively in today's intensely competitive M&A market, in which high target acquisition purchase prices are being fueled by a strong stock market and increased competition from corporate acquirers.     

Morgan Stanley Roundtable on The State of Global Private Equity

In this discussion led by Alan Jones, Morgan Stanley's head of Global Private Equity, the University of Chicago's Steve Kaplan begins by surveying 25 years of academic research on private equity. Starting with Kaplan's own Ph.D. dissertation on leveraged buyouts during the 1980s, finance academics have provided a large and growing body of studies documenting the ability of private equity firms to make “sustainable” (that is, maintained over a three‐ or four‐year period) improvements in the operating performance of their portfolio companies, whether operating abroad or in the U.S. Even more impressive, the findings of Kaplan's new study (with Tim Jenkinson of Oxford and Bob Harris of the University of Virginia) suggest that these improvements have been large enough to enable PE funds raised between 1990 and 2008 to deliver returns to their limited partners that have averaged 300 to 400 basis points higher per year than the returns to the S&P 500. And given the “persistence” of PE fund returns—the tendency of the funds of the same PE firms to show up in the top quartile of performers year after year—that Kaplan has documented in earlier work, the performance of private equity seems notably different from that of mutual funds and hedge funds, where there has been little if any consistency in the returns provided by the top performers. Following Kaplan's overview of the research, four representatives of today's leading private equity firms explore questions like the following:

• ? How do the best PE firms, after paying premiums to acquire their portfolio companies and collecting large management fees, provide such consistently high returns to their limited partners?
• ? How did PE portfolio companies perform during the last recession, when many popular business publications were predicting the death of private equity—and what, if anything, does that tell us about how private equity adds value?
• ? What can PE firms do to avoid, or at least limit the damage from, the overpricing and overleveraging that tend to occur near the end of the boom‐and‐bust cycle that appears to be a permanent feature of private equity?

As Jones notes in his opening comments, the practitioners' answers to such questions “should help investors distinguish between the alpha that the firms represented at this table have generated through active management from the ‘closet beta’ that critics say results when private equity firms simply create what amounts to a levered bet on the public equity markets.”     

Leveraged Buyouts in the U.K. and Continental Europe: Retrospect and Prospect

The markets for management buyouts in the U.K. and continental Europe have experienced dramatic growth in the past ten years. In the U.K., buyouts accounted for half of the total M&A activity (measured by value) in 2005. And as in the U.S. during the‘80s, the greatest number of U.K. buyouts in recent years have been management‐ and investor‐led acquisitions of divisions of large corporations. In continental Europe, by contrast, the largest fraction of deals has involved the purchase of family‐owned private businesses. But in recent years, increased pressure for shareholder value in countries like France, Netherlands, and even Germany has led to a growing number of buyouts of divisions of listed companies. Like the U.K., continental Europe has also seen a small but growing number of purchases of entire public companies (known as private‐to‐public transactions, or PTPs), including the largest ever buyout in Europe, the €13 billion purchase this year of the Danish corporation TDC. In view of the record levels of capital raised by European private equity funds in recent years‐which, until 2005, exceeded the amounts invested in any given year‐we can expect more growth in private equity investment in the near future. In continental Europe, the prospects for buyouts remain especially strong, given both the pressure from investors to restructure larger corporations and the possibilities for adding value in family‐owned firms. But, as the authors note, today's private equity firms face a number of challenges in earning adequate returns for their investors. One is increased competition. In addition to the increased activity of U.S. private equity firms, local private equity investors are also facing competition from hedge funds and new entrants such as government‐sponsored operators, family offices, and wealthy entrepreneurs. Another major challenge is finding value‐preserving exit vehicles. Although an IPO is an option for the largest buyouts with growth prospects, most buyout investments are harvested either through sales to other companies or, increasingly, other private equity firms. The latter transactions, known as “secondary” buyouts, now account for a significant share of new funds invested by private equity firms across Europe.     

Private Equity,the Rise of Unicorns,and the Reincarnation of Control‐based Accounting

This article discusses the rise of intangibles‐intensive companies and private equity (PE) since the late 1970s, and the role of both in bringing about the creation of a streamlined, more flexible set of accounting rules that, since their approval by the IASB and FASB in 2009, have been used by private companies and their investors. The PE industry comprises both venture capital (VC) firms that fund high‐growth enterprises and leveraged buyout (LBO) firms that fund more traditional, cash‐generating operations. Mainly because of the greater risks associated with both VC‐backed firms and LBOs—risks that make them ill‐suited for most public investors—such companies tend to require the more direct and active oversight provided by PE investors. And as the author goes on to argue, the more direct and active ownership of PE investors, as compared to the governance provided by most public‐company boards, suggests that financial accounting and reporting play a fundamentally different role in private than in public companies. Whereas the primary role of public‐company GAAP has increasingly (since the creation of the SEC in 1933) been to provide information for outside investors when valuing companies, the most important function of accounting reports in private companies is internal control—more specifically, ensuring that the interests of the managers of their portfolio companies are aligned with those of all the providers of capital. And recognizing this difference in the role of accounting, both the IASB and FASB responded to the requests of various parties (including private companies) by approving in 2009 the use by private companies of a streamlined and more flexible set of accounting standards. To the extent that the workings of PE markets continue to reduce the numbers of U.S. public companies, the author predicts that the resulting increase in the use of private‐company GAAP will continue to shift the primary role of accounting away from valuation and back toward its traditional roots in internal control and corporate governance.     

CARE Conference Hong Kong Polytechnic University,June 9, 2014: Equity Financing for Early‐Stage Companies in China

Many of the smaller private‐sector Chinese companies in their entrepreneurial growth stage are now being funded by Chinese venture capital (VC) and private equity (PE) firms. In contrast to western VC markets, where institutional investors such as pension funds and endowments have been the main providers of capital, in China most capital for domestic funds has come from private business owners and high net worth individuals. As relatively new players in the market who are less accustomed to entrusting their capital to fund managers for a lengthy period of time, Chinese VCs and their investors have shown a shorter investment horizon and demanded a faster return of capital and profits. In an attempt to explain this behavior, Paul Gompers and Josh Lerner of Harvard Business School have offered a “grandstanding hypothesis” that focuses on the incentives of younger, less established VCs to push their portfolio companies out into the IPO market as early as they can—and thus possibly prematurely—to establish a track record and facilitate future fundraising. This explanation is supported by the under‐performance of Chinese VC‐backed IPOs that has been documented by the author's recent research. Although they continue to offer significant opportunities for global investors, China's VC and PE markets still face many challenges. The supervisory system and legal environment need further improvement, and Chinese funds need to find a way to attract more institutional investors—a goal that can and likely will be promoted through government inducements.     

Private Equity and Portfolio Companies: Lessons from the Global Financial Crisis

Critics of private equity have warned that the high leverage often used in PE‐backed companies could contribute to the fragility of the financial system during economic crises. The proliferation of poorly structured transactions during booms could increase the vulnerability of the economy to downturns. The alternative hypothesis is that PE, with its operating capabilities, expertise in financial restructuring, and massive capital raised but not invested (“dry powder”), could increase the resilience of PE‐backed companies. In their study of PE‐backed buyouts in the U.K.—which requires and thereby makes accessible more information about private companies than, say, in the U.S.—the authors report finding that, during the 2008 global financial crisis, PE‐backed companies decreased their overall investments significantly less than comparable, non‐PE firms. Moreover, such PE‐backed firms also experienced greater equity and debt inflows, higher asset growth, and increased market share. These effects were especially notable among smaller, riskier PE‐backed firms with less access to capital, and also for those firms backed by PE firms with more dry powder at the crisis onset. In a survey of the partners and staff of some 750 PE firms, the authors also present compelling evidence that PEs firms play active financial and operating roles in preserving or restoring the profitability and value of their portfolio companies.     

Private Equity: Accomplishments and Challenges

The authors provide an overview of the main accomplishments of private equity since the emergence of leveraged buyouts in the 1980s, and of the challenges now facing the industry—challenges that have been encountered before during three major growth waves and two full boom‐and‐bust cycles. In so doing, the authors review a large and growing body of academic studies responding to questions like these:

• (1) How have PE buyout companies performed relative to their public counterparts? And to the extent there have been improvements in operating performance and productivity gains, how have such gains been achieved? What role have PE firms played in this process?
• (2) Especially in light of the large fees and profit shares paid to the PE firms, or GPs, and the significant “control” premiums over market paid to the selling companies, how have the returns to the LPs that provide the bulk of the funding for PE funds compared to the returns earned by the shareholders of comparable public companies?
• (3) Apart from the high fees earned by its GPs, why is PE so controversial? Beyond their effects on productivity and benefits for investors, what are the employment and other social effects of buyouts and PE?
• (4) What are the prospects for future PE returns to their LPs, especially in light of the volume of capital commitments and high purchase multiples that were being paid, at least until the onset of the COVID pandemic? And what role, if any, should PE activity be expected to play in the recovery from the pandemic?

     

Morgan Stanley Roundtable on Private Equity and Its Import for Public Companies

The role of private equity in global capital markets appears to be expanding at an extraordinary rate. Morgan Stanley estimates that there are now some 2,700 private equity funds that either have raised, or are in the process of raising, a total of $500 billion. With this abundance of available equity capital, the willingness of private equity firms to participate in “club” deals, and the leverage that can be put on top of the equity, private equity buyers now appear able and willing to pay higher prices for assets than ever before. And thanks in part to this new purchasing power, private equity transactions reportedly account for a quarter of all global M&A activity as well as a third of the high yield and IPO markets. The stock of capital now devoted to private equity reflects the demonstrated ability of at least the most reputable buyout firms to produce consistently high rates of returns for their limited partners. Although a talent for identifying and purchasing undervalued assets may be part of the story, the ability to produce such returns on a consistent basis implies an ability to add value, to improve the performance of the operating companies they invest in and control. And in this round‐table, a small group of academics and practitioners address two main questions: How does private equity add value? And are there lessons for public companies in the success of private companies? According to the panelists, the answer to the first question appears to have changed somewhat over time. The consensus was that most of the value added by the LBO firms of the‘80s was created during the initial structuring of the deals, a process described by Steve Kaplan as “financial and governance engineering,” which includes not only aggressive use of leverage and powerful equity incentives for operating managements, but active oversight by a small, intensely interested board of directors. In the past ten years, however, these standard LBO features have been complemented by increased attention to “operational engineering,” to the point where today's buyout firms feel obligated, like classic venture capitalists, to acquire and tout their own operating expertise. In response to the second of the two questions, Michael Jensen argues that much of the approach and benefits of private equity‐particularly the adjustments of financial policies and stronger managerial incentives‐can be replicated by public companies. And although some of these benefits have already been realized, much more remains to be done. Perhaps the biggest challenge, however, is finding a way to transfer to public companies the board‐level expertise, incentives, and degree of engagement that characterize companies run by private equity investors.     

Private equity and Covid-19

We survey more than 200 private equity (PE) managers from firms with $1.9 trillion of assets under management (AUM) about their portfolio performance, decision-making and activities during the Covid-19 pandemic. Given that PE managers have significant incentives to maximize value, their actions during the pandemic should indicate what they perceive as being important for both the preservation and creation of value. PE managers believe that 40% of their portfolio companies are moderately negatively affected and 10% are very negatively affected by the pandemic. The private equity managers—both investment and operating partners—are actively engaged in the operations, governance, and financing in all of their current portfolio companies. These activities are more intensively pursued in those companies that have been more severely affected by the Covid-19 pandemic. As a result of the pandemic, they expect the performance of their existing funds to decline. They are more pessimistic about that decline than the venture capitalists (VCs) surveyed in Gompers et al. (2021). Despite the pandemic, private equity managers are seeking new investments. Rather than focusing on cost cutting, PE investors place a much greater weight on revenue growth for value creation. Relative to the 2012 survey results reported in Gompers, Kaplan, and Mukharlyamov (2016), they appear to give a larger equity stake to management teams and target somewhat lower returns.     

The Future of Private Equity

A distinguished University of Chicago financial economist and longtime observer of private equity markets responds to questions like the following:

• ? With a track record that now stretches in some cases almost 30 years, what have private equity firms accomplished? What effects have they had on the performance of the companies they invest in, and have they been good for the economy?
• ? How will highly leveraged PE portfolio companies fare during the current downturn, especially with over $400 billion of loans coming due in the next three to five years?
• ? With PE firms now sitting on an estimated $500 billion in capital and leveraged loan markets shut down, are the firms now contemplating new kinds of investment that require less debt?
• ? If and when the industry makes a comeback, do you expect any major changes that might allow us to avoid another boom‐and‐bust cycle? Have the PE firms or their investors made any obvious mistakes that contribute to such cycles, and are they now showing any signs of having learned from those mistakes?

Despite the current problems, the operating capabilities of the best PE firms, together with their ability to manage high leverage and the increased receptiveness of public company CEOs and boards to PE investments, have all helped establish private equity as “a permanent asset class.” Although many of the deals done in 2006 and 2007 were probably overpriced, the “cov‐lite” deal structures, deferred repayments of principal, and larger coverage ratios have afforded more room for reworking troubled deals. As a result of that flexibility, and of the kinds of companies that get taken private in leveraged deals in the first place, most troubled PE portfolio companies should end up being restructured efficiently, thereby limiting the damage to the overall economy. Part of the restructuring process involves the use of the PE industry's huge stockpile of capital to purchase distressed debt and inject new equity into troubled deals (in many cases, their own). At the same time the PE firms have been working hard to rescue their own deals, some have been taking significant minority positions in public companies, while gaining some measure of control. Finally, to limit overpriced and overlev‐eraged deals in the future, and so avoid the boom‐and‐bust cycle that appears to have become a predictable part of the industry, the discussion explores the possibility that the limited partners and debt providers that supply most of the capital for PE investments will insist on larger commitments of equity by sponsors to their own funds and individual deals.     

How Much Do Private Equity Funds Benefit From Debt‐related Tax Shields?

In 2008 the German government enacted a measure designed to curb excessive leverage in LBOs by limiting tax‐deductible interest to 30% of EBITDA. And in the U.S., legislators are currently reviewing several regulatory measures, including limits on tax‐deductible interest, that are intended to reduce the leverage of portfolio companies in U.S. LBO funds. In their recent study of 56 German LBOs transacted after the tax law change in 2008, the authors analyze the importance of debt‐related tax savings and the economic consequences of their reduction for the PE business model. The study begins by confirming that LBO debt tax shields are a material component of LBO purchase prices, contributing as much as 20% of the average estimated total enterprise value. At the same time, however, the study finds that the effects on LBO fund returns of limits to the taxdeductibility of LBO interest payments are likely to be modest, in part because a large portion of the value from expected tax savings is effectively paid for upfront by the private equity firm in the form of higher LBO purchase prices. Moreover, the authors do not expect to see LBO funds change their business model in response to this change in taxdeductibility. Based on their findings, the authors expect neither a significant decline in LBO leverage nor a notable change in the pricing of PE deals. As finance scholars have suggested, there are significant benefits associated with the use of debt that have nothing to do with the tax shield provided by the deductibility of interest. The authors' results provide yet another piece of evidence suggesting that taxes have at most a second‐order effect on corporate financing decisions—and that the gains to private equity come mainly from improvements in operating performance.     

The Case for Secondary Buyouts as Exit Channel

Do private equity firms have a clear pecking order when deciding on exit channels for their portfolio companies? Are secondary buyouts—that is, sales to other PE firms—always an exit of last resort? And are there company‐ or market‐related factors that have a clear and predictable influence on decisions to pursue secondary buyouts? Using a proprietary dataset of over 1,100 leveraged buyouts that exited in North America or Europe between 1995 and 2008, the authors attempt to answer these questions by analyzing the returns associated with public, private, and secondary (or “financial”) exits. Based on their analysis of the realized returns, there is no clear pecking order of exit types. Secondary buyouts deliver rates of return that are the equal of those achieved through public exits. In addition, the authors assess the relationship between the likelihood of choosing a financial exit and certain company‐related as well as market‐related factors. Portfolio companies with greater debt capacity are more likely to be sold in secondary buyouts. Furthermore, increases in both the liquidity of debt markets and the amount of undrawn capital commitments to the private equity industry increase the probability of exit through secondary buyouts.     

U.S. Corporate Governance: Accomplishments and Failings A Discussion with Michael Jensen and Robert Monks

Two of America's most prominent shareholder activists discuss three major issues surrounding the U.S. corporate governance system: (1) the case for increasing shareholder “democracy” by expanding investor access to the corporate proxy; (2) lessons for public companies in the success of private equity; and (3) the current level and design of CEO pay. On the first of the three subjects, Robert Monks suggests that the U.S. should adopt the British convention of the “extraordinary general meeting,” or “EGM,” which gives a majority of shareholders who attend the meeting the right to remove any or all of a company's directors “with or without cause.” Such shareholder meetings are permitted in virtually all developed economies outside the U.S. because, as Monks goes on to say, they represent “a far more efficient and effective solution than the idea of having shareholders nominate people for the simple reason that even very involved, financially sophisticated fiduciaries are not the best people to nominate directors.” Moreover, according to both Jensen and Monks, corporate boards in the U.K. do a better job than their U.S. counterparts of monitoring top management on behalf of shareholders. In contrast to the U.S., where the majority of companies continue to be run by CEO/Chairmen, over 90% of English companies are now chaired by outside directors, contributing to “a culture of independent‐minded chairmen capable of providing a high level of oversight.” In the U.S., by contrast, most corporate directors continue to view themselves as “employees of the CEO.” And, as a result, U.S. boards generally fail to exercise effective oversight and control until outside forces—often in the form of activist investors such as hedge funds and private equity—bring about a “crisis.” In companies owned and run by private equity firms, by contrast, top management is vigorously monitored and controlled by a board made up of the firm's largest investors. And the fact that the rewards to the operating heads of successful private equity‐controlled firms are typically multiples of those received by comparably effective public company CEOs suggests that the problem with U.S. CEO pay is not its level, but its lack of correlation with performance.     

The Return to Direct Investment in Private Firms: New Evidence on the Private Equity Premium Puzzle*

This paper uses a novel dataset to analyze the return to direct investments in private firms by pension funds. We have two key findings. First, direct investments in private firms have underperformed public equity by 392 basis points per annum under conservative risk adjustments. Second, initial mispricing, due to over‐optimism or misperceived risk, and subsequent low capital gains seem to explain the gap in returns to private firms. Overall, these findings complement the finding of Moskowitz and Vissing‐Jørgensen (2002) of low returns on entrepreneurial investments and provide new insight into the existence of what they call the private equity premium puzzle: Even professional investors with well‐diversified portfolios like pension funds seem to get a poor risk‐return tradeoff from investing directly in private firms.     

Private Equity in the U.S.: Building a New Future

Despite the recent downturn, private equity firms still have an important role to play in the global economy. At the same time, many PE firms may need to rethink their strategies. Practices that have been worked in the past may not produce acceptable returns in a future, particularly given the current constraints on financing and leverage. One source of PE's comparative advantage, as demonstrated during the recent crisis, has been the ability of the best and most experienced firms to reorganize their portfolio companies when they get into financial trouble. But in addition to their financial management skills, specialized operating expertise has become more critical to success, and those PE firms that have not acquired it are especially likely to find that past success in raising capital is no guarantee of success in the future. The authors begin by providing a brief overview of the past three decades of global private equity to identify how the market arrived at its current position. Using the findings of academic research together with case studies and interviews with PE practitioners in the U.K., the authors suggest a number of building blocks for the future that reflect the considerable success of the most reputable and experienced PE firms in increasing the value of their portfolio companies.     

Capital Deployment Roundtable: A Discussion of Corporate Investment and Payout Policy

U.S. companies are now reportedly earning record‐high operating returns on capital while at the same time continuing to set new records both for corporate cash holdings and distributions to investors in the form of dividends and stock repurchases. But are most of these companies really maximizing value? And what role, if any, do these large distributions play in creating value? These are the two main questions that are addressed by a small group that includes two senior corporate executives and two representatives of well‐known activist investors. A number of panelists suggest that many companies, in misguided efforts to maximize returns on capital, have been using hurdle rates that are too high and so sacrificing value‐adding investment opportunities. As evidence for this claim, they cite evidence that, in recent years, the companies that have achieved the highest stock market returns appear to have made conscious decisions to reduce their returns on capital to pursue higher growth. Another increasingly common charge against U.S. companies is their tendency to pay out excessive capital to investors, especially in the form of stock repurchases at prices that turn out to be too high. But this last practice, however widespread, may not be as troubling as it has been made out to be. Although it involves a wealth transfer from existing to selling shareholders, overall investor value is lost only if such buybacks lead to corporate underinvestment. But, as a number of panelists (including the activist investors) point out, such payouts of capital have generally functioned as a demonstration of corporate managers' commitment to investing and operating with the optimal, or value‐maximizing, level of capital—neither too much nor too little.     

University of Texas Roundtable on The Role of Private Equity in the Financing and Restructuring of Oil and Gas Companies

In this second of two University of Texas roundtables, four highly successful veterans of the U.S. energy industry, with considerable experience running both public and private companies, discuss recent developments in this rapidly evolving industry. Among the most remarkable—and a major focus of this discussion—is the dramatic expansion of the output and productivity of the Permian Basin of West Texas, and the role of private equity in accomplishing it. Although the Permian has been a major source of oil and gas since 1920, the combination of massive horizontal drilling and hydraulic fracturing has contributed to a tripling of production volumes from about 800,000 barrels per day to 2.5 million during the past ten years. In fact, the productivity gains are said to be so great that, even with the huge run‐up in the cost of acquiring acreage (to as high as $40,000 per acre), today's producers are projecting annual operating returns of 20% even if oil prices fail to rise above their current level of about $50 a barrel. What's more, there appears to have been a fairly clear division of labor between private and public companies in this recent development of the Permian. With most of the high‐priced acreage now being acquired by larger public companies, the primary role of private equity has been to identify and make good on opportunities to increase the productivity and value of smaller operations that can then be sold to public companies—companies that have the size and access to capital to benefit from the economies of scale produced by combining them with their other operations. Thanks to their earlier position in the value chain, investments by private equity groups have generally not only produced higher payoffs, on average, but involved larger operating and financial risks. And this difference in risk profile is reflected in a notable difference in hedging practices between public and private equity‐controlled companies. This difference was summed up as follows by a private equity partner who has also run several public oil and gas companies: To a much greater extent in private equity than in public companies, we think of our projects and companies as delivering value that is largely independent of changes in oil prices. Hedging is our way of saying we don't want to take oil price risk if we don't have to. We do not count on price increases to make our required returns. The returns come from operating the company successfully without the help of commodity prices.     

Foreign issuers in the U.S. PIPE market

We document that the use of private investment in public equity (PIPE) by foreign firms listed on U.S. exchanges is growing even faster than its use by U.S. firms. On average, foreign firm PIPE stock deals represent a similar proportion of the firm's market capitalization to U.S. firm PIPEs, but suffer less of a share price discount than U.S. firm PIPE issuances, a relation that is robust to consideration of exchange, deal size, share turnover and return volatility. We document that hedge funds are only small investors in foreign firm PIPEs issued in the U.S., which tend to be purchased by pensions, government funds and corporations. PIPE, in combination with the reverse merger method of going public, provides a cost-effective means for foreign firms to raise capital in the U.S. capital market.     

The economics of PIPEs

Private investments in public equities (PIPEs) are an important source of finance for public corporations. PIPE investor returns decline with holding periods, while time to exit depends on the issue's registration status and underlying liquidity. We estimate PIPE investor returns adjusting for these factors. Our analysis, which is the first to estimate returns to investors rather than issuers, indicates that the average PIPE investor holds the stock for 384 days and earns an abnormal return of 19.7%. More constrained firms tend to issue PIPEs to hedge funds and private equity funds in offerings that have higher expected returns and higher volatility. PIPE investors’ abnormal returns appear to reflect compensation for providing capital to financially constrained firms.     

Private Equity 4.0: Using ESG to Create More Value with Less Risk

A growing number of private equity firms have responded to the increased focus on climate change, social issues, and technology disruption by broadening their corporate mission to encompass all important stakeholders, as well as their limited partners. And in the process, the management of ESG risks and pursuit of ESG opportunities have become increasingly fundamental to the staying power and value creation potential of PE firms by reducing the risk of their investments, discovering new sources of growth, and increasing their resilience to changes in the political and regulatory environment. This article tells the story of how the Nordic PE firm, Summa Equity, has turned its ESG approach into a core competence and a source of competitive advantage that has enabled the firm to distinguish itself from its competitors and bring about significant improvements in the financial performance of its portfolio companies while providing benefits for their stakeholders. Using the U.N. Sustainable Development Goals to guide them, the firm invests in companies they perceive to be addressing major environmental or social challenges in an innovative and commercially successful way. This has led to investments in significant growth opportunities in areas such as health care, education, waste management, and acqua‐culture. And the firm's returns to its investors have been high enough—and the perceived social benefits large enough—that the firm recently closed its second fund (which was significantly oversubscribed) for 650 million euros, and received the ESG award at the 2019 Private Equity Awards in London.