An Analysis of the Belgian Private Equity Market

An Analysis of the Belgian Private Equity Market

This Master’s Thesis attempts to give an overview of the most popular beliefs about private equity. The second part is a quantitative analysis of the Belgian private equity business.

Private equity (PE) means to investors an alternative to more widespread financial instruments such as stocks or commodities. The four prototypes of portfolio companies owned by a private equity house are family firms, subdivisions/spinoffs from companies, public-to-private transactions and secondary buyouts. I highlighted two special types of private equity funding along with their particularities: business angels and venture capitalists.

Next, I grouped the PE firms according to their acquisition strategy and the extent to which they are actively managed: generalists, specialists, financial engineers and internationalist investors. The bulk of the literature focuses on what influence the performance of the PE firms and its portfolio companies. I chose eight forces that affect the capability of private equity to add value: monitoring activities, higher remuneration to the portfolio companies’ executives, its role as an intermediate, networking, the skills of the general partners, growth pace, size of the fund and its innovative capabilities.

I subsequently discussed the dynamics behind the process of valuing target companies, emphasizing the role of the PE firm’s size.

As private equity firms and their portfolio and target companies are managed by human beings, I pointed out some common problems that these people are faced with: information asymmetries, agency costs and adverse selection. I made a distinction between three points in time where these problems arise, i.e. before the acquisition, during the holding period and when the portfolio company is offered for sale. Doing so, this enabled me to show clearly how PE firms deal with them and how PE may be a solution to these problems.

So far, I have been limiting myself mostly to explain how PE adds value. Opposing to this viewpoint, a chunk of the literature discusses the downside of private equity. Controversial issues are job losses due to PE investments and the degree to which PE firms destroy value in order to generate cash flow to service debt.

The last section of the literature review looks at the consequences of the recent credit crunch and its implications for the future.

The first step of my quantitative analysis explains the procedure of searching for a maximum number of Belgian companies that are financed by private equity. I use their annual accounts to calculate performance metrics so as to test three hypotheses:

Hypthesis I: government-backed portfolio companies outperform independent portfolio companies Hypthesis II: private equity portfolio companies outperform all other Belgian companies Hypthesis III: financial engineers have a lower performance compared to the portfolio companies as a whole

The analysis consists of testing some theory for the Belgian PE business as proposed by the literature. I look into the difference between various types of PE firms as well as a financial ratio comparison between the portfolio companies and their non-private equity-backed peers. The outcome of the first hypothesis is that government-backed portfolio companies have lower profitability ratios compared to the independent portfolio companies. For the second hypothesis I calculate the ratios for 2009. As a validity check, I carry out the same exercise for the previous years. Unfortunately, my samples are not big enough, which makes the figures unreliable. Conditional on the data I obtained, I carefully conclude that Belgian companies are more profitable than their private equity-backed peers. The third hypothesis’s result is that financial engineers-backed portfolio companies add less value when comparing them with all other portfolio companies.

Lastly, my research can be further expanded both horizontally and vertically. Horizontally, other parameters than merely liquidity, solvency and profitability ratios can be considered, such as the effect of PE on the job market. Vertically, the analysis can be deepened by granulating to the industry level and by making sure every single sample is statistically significant.