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economics of private equity mkt

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Title PagePrefaceContents1. IntroductionWhat is the Private Equity Market?Overview of the Organized Private Equity MarketIssuersIntermediariesInvestorsAgents and AdvisersSources of Data2. Development of the Private Equity MarketThe Early Stages: 1946 to 1969Seeds for Future Growth: The 1970s and the Limited PartnershipInvestment ActivityRegulatory and Tax ChangesExplosive Growth: The 1980s and 1990sVenture CapitalNon-Venture Private EquityPrivate Equity Outstanding Today3. Issuers in the Private Equity MarketA Taxonomy of IssuersFirms Seeking Venture CapitalEarly-Stage New VenturesLater-Stage New VenturesMiddle-Market Private FirmsChange in Ownership or Capital StructureExpansion by Acquisition or Purchase of New PlantFirms in Financial DistressPrivate FirmsPublic FirmsPublic BuyoutsOther Public FirmsEmpirical Examination of Issuers of Private EquityIPO Firms that Received Private Equity BackingVenture-Backed New FirmsReverse-LBOsFirms that Issue Agented Private Equity4. Intermediaries in the Private Equity Market: The Role of PartnershipsRationale for Intermediation in the Private Equity MarketOverview of Private Equity PartnershipsRelationship between a Partnership and its Portfolio CompaniesSelecting InvestmentsDue DiligenceSyndicationStructuring InvestmentsThe Partnership's Ownership StakeManagerial IncentivesManagerial Stock OwnershipType of Equity Issued to InvestorsManagement Employment ContractsMechanisms of ControlBoard RepresentationAllocation of Voting RightsControl of Access to Additional FinancingOther MechanismsManaging InvestmentsExiting InvestmentsRelationship between the Limited Partners and the General PartnersFund Raising and the Role of ReputationPerformance MeasurementTransparency of the Partnership StructureThe Partnership AgreementGeneral Partner CompensationManagement FeesCarried InterestPartnership CovenantsOversight and Control RightsDirect InvestmentCo-investmentDirect Investment other than Co-investmentSimultaneous Direct Investment and Partnership InvestmentConclusion5. Investors in the Private Equity MarketCorporate Pension FundsPublic Pension FundsEndowments and FoundationsBank Holding CompaniesWealthy Families and IndividualsInsurance CompaniesInvestment BanksNonfinancial CorporationsPrivate Equity Holdings of Major Investor Groups6. The Role of Agents and AdvisersAgents for Portfolio FirmsWhat Do Agents for Portfolio Firms Do?Search and EvaluationNegotiationWho Are the Agents for Portfolio Firms?Agents for Limited PartnershipsAdvisers to Institutional Investors7. The Returns on Private Equity Investments and their DeterminantsData from Venture EconomiesIRRs of Liquidated FundsIRRs as of 1993 of Active Venture Capital PartnershipsIRRs as of 1993 by Year of FormationIRRs as of 1993 by Investment Focus and SizeIRRs as of 1993 of Active Non-Venture Capital PartnershipsDeterminants of Private Equity ReturnsOutlook for Future ReturnsAppendix: Estimation of Private Equity CapitalBasic Estimation MethodSummary: Estimates of Total, Venture, and Non-Venture Private Equity CapitalReferences168 The Economics of the Private Equity MarketGeorge W. Fenn and Nellie LiangStaff, Board of GovernorsStephen ProwseStaff, Federal Reserve Bank of DallasThe staff members of the Board of Governors ofthe Federal Reserve System and of the FederalReserve Banks undertake studies that cover awide range of economic and financial subjects.From time to time the studies that are of generalinterest are published in the Staff Studies seriesand summarized in the Federal Reserve Bulletin.The following paper, was summarized in theBulletin for January 1996. The analyses andconclusions set forth are those of the author anddo not necessarily indicate concurrence by theBoard of Governors, the Federal Reserve Banks,or members of their staffs.Board of Governors of the Federal Reserve SystemWashington, DC 20551December 1995PrefaceIn preparing this study we were helped by manyinstitutions and individuals that participate in theprivate equity market. We are especially gratefulto the following individuals for their participationin formal interviews: Kevin K. Albert, Eduard H.Beit, Christopher Brody, Leslie A. Brun,Walter M. Cain, Alicia Cooney, Renee Deger,Timothy J. Donmoyer, Craig Farnsworth,Pamela D. Gingold, David B. Golub, LairdKoldyke, Dennis M. Leary, Erwin Marks,Robert Moreland, Howard H. Newman, StevenO’Donnell, Claire M. Olstein, Lionel I. Pincus,Guy C. Roberts, J. Stevens Robling, William A.Sahlman, Thomas J. Salentine, John Sallay,John Schumacher, Samuel L. Shimer, Paul T.Smith, Phillip Smith, Scott Sperling, Russell W.Steenberg, Jordan Stitzer, Tracy Turner, JeffreyWalker, William Wetzel, G. Cabell Williams,and Brooks Zug. We also are grateful toSteven Galante and Jesse Reyes for providing uswith data and other information.Among the other individuals that contributed tothis study, we are especially grateful to Edward C.Ettin, Jean Helwege, Joshua Lerner, and MarthaScanlon for many helpful comments; to Sherrell E.Varner for superb editorial and production assis-tance; and to Kyle Nagel, Michelle Ricci, andJim Yeatts for excellent research assistance.Finally, we would like to express our appreciationto John Rea for initiating and encouraging thisstudy and to the Division of Research and Statis-tics for its support.The opinions expressed in this study are thoseof the authors and do not necessarily reflect theviews of the Board of Governors, the FederalReserve Bank of Dallas, other Federal ReserveBanks, or members of their staffs.Contents1. Introduction ................................................................................................................ 1What Is the Private Equity Market? ................................................................................. 2Overview of the Organized Private Equity Market .............................................................. 3Sources of Data ............................................................................................................ 52. Development of the Private Equity Market..................................................................... 7The Early Stages: 1946 to 1969 ....................................................................................... 7Seeds for Future Growth: The 1970s and the Limited Partnership ......................................... 9Explosive Growth: The 1980s and 1990s .......................................................................... 11Private Equity


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