The Internationalization of Private Equity

May 11 - May 13, 1998

Course Overview

The past several years have seen a boom in international private equity activity, fueled largely by institutional investors based in the United States. Fundraising by private equity partnerships based in Asia, Canada, Europe and Latin America climbed from $7.6 billion in 1991 to $22.o billion in 1996, and is expected to be even higher in 1997.

These patterns are even more impressive on a country-by-country basis In 1994 alone, private equity funds based in Hong Kong and China raised a total of $3.1 billion in capital. Two-thirds of the capital came from outside Asia, with the single largest source being U.S. institutions. This sum was more than the total raised by professional private equity organizations located there since the first fund was raised in Hong Kong in 1981. India, Eastern Europe, South Africa, and Israel are just a few of the other areas where multiple private equity funds have recently been or currently are being raised. In addition, funds based in the U.S. are increasingly investing directly in international transactions, often in conjunction with country- or region-specific funds. A critical factor in the growth of international private equity investing has been the perception of the increasing difficulty of finding attractive private equity investment opportunities in the developed nations, particularly the United States. The pool of private equity under management in the U.S. has grown from $4 billion in 1980 to about $150 billion in 1997. This growth has largely been attributable to the relaxation of the formal and informal curbs that limited private and pension funds from investing in private equity.

This growth, many institutional investors argue, has had three deleterious consequences. First, the increase in the size of many private equity funds has altered the incentive structure of these funds. In particular, the management fees charged by private equity investors have remained relatively constant as a percentage of capital, averaging about 2% (typically calculated as a percentage of capital under management). But since the capital managed per partner has increased dramatically, these fees have become an increasingly significant source of income. Many investors fear that the incentive provided by the share of the profits reserved for the private equity investors has consequently become less effective. Second, many private equity organizations have encountered strong demand when they seek to raise new funds, allowing them to negotiate partnership agreements without the many covenants that protect investors in these funds. If an institution insisted on the inclusion of a particular form of protection, the venture capitalists could simply exclude them from the transaction. Finally, many institutional investors argue that the current market is characterized by an imbalance between the supply of capital and the number of attractive investments. Many argue that this has led to unjustifiable increases in prices, or, more colloquially, the phenomenon of "money chasing deals."

These concerns are also leading to institutional investors, particularly in the U.S., to increasingly consider private equity funds specializing in foreign investments. This interest is illustrated by a 1995 survey of 204 of the largest U.S. institutional investors conducted by Goldman Sachs and Frank Russell Capital. It found that international private equity had increased from representing 0.0% of all alternative investments in 1992 to 5.8% in 1995. In a few short years, participation in this asset class (by the institutions that had invested in any alternative assets) went from virtually zero to 51%. Of the remaining firms, more than one-half indicated that they were currently considering investments in international private equity funds. Furthermore, international private equity was the asset class that the institutions identified as the most attractive and with the highest expected future returns.

Course Structure

In many respects, private equity in the United States and abroad is similar. In both settings, professional investors provide equity or equity-linked capital to privately held firms. Another key element is the ongoing involvement of the private equity investor in monitoring and assisting the company. Where international private equity differs is in its implementation. The significance of these differences can be illustrated through the experience of several of the most sophisticated institutional investors in private equity in the United States. While each subclass of its domestic private equity investments has returned over 30% over the past two decade, their international returns have been in the single digits.

This course will examine the opportunities and challenges of international private equity investing. Through a combination of case studies and lectures, we will examine the key aspects that make investing in international private equity unique:

The challenge of assessing foreign markets. While the U.S. entrepreneurial market is a vibrant one, assessing opportunities for foreign private equity investing is a challenging one to institutional investors and private equity groups alike. Government policies and economic performance are crucial to the health of private firms. Similarly, the structure of local markets, the nature of competition, and the ability to access trained personnel are critical in determining the attractiveness of a market for private equity investment.

The management of successful funds. The key success factors for an international private equity organizations may be quite different than a U.S. fund. For instance, while many domestic private equity groups resist affiliating with a financial institution because of concerns about the potential conflicts that such a tie may bring, these affiliations have often been cited as essential to international private equity investing. The organizational structures employed—from stand-alone country funds to loose multinational affiliations to centrally managed funds—have also displayed a great deal of variation.

The types of transactions. While many international investments resemble those in the U.S., others are quite unique. For instance, in the developing world many private equity groups have invested in strategic alliances between corporations without a detailed knowledge of the local business environment and domestic partners. Another example is infrastructure funds, which have financed major projects in Asia and Latin America.

The exiting of investments. Perhaps the most vexing aspect of venture investing outside the U.S. has been the difficulty of exit. Studies of the U.S. market suggest that the most profitable private equity investments have, on average, been disproportionately exited by way of IPOs and that there has been a strong link between the health of the IPO market and the ability of private equity funds to raise capital. International private equity groups have employed a wide variety of strategies—from listing on local exchanges, turning to U.S. markets and encouraging the development of international exchanges—with varying success.

The measurement of returns. Measuring investment returns in private equity is critical to asset allocation and bench-marking returns, but poses substantial challenges. Due to the limited historical data and the special measurement issues, these problems are particularly severe for international private equity investors and funds.

This is the third consecutive year that the Focused Financial Management Series has featured a module on private equity. In 1996, participants in "Conflict and Evolution in Private Equity" examined the evolving relationships between private equity fund managers and institutional investors. In 1997, "Corporate Venture Capital: The Third Wave," examined the growth of corporate-affiliated programs.

Participant Profile

The Internationalization of Private Equity is intended for:

Case Studies

In the addition to lectures, discussions, and group exercises, the case study method, pioneered by the Harvard Business School, is an integral course component. Specific cases to be studied include:

Schedule and Dates

Participants will arrive and register Monday morning, May 11, 1997. Classes will begin that morning and conclude at noon on Wednesday, May 13.

Powerful Learning Environment

The Internationalization of Private Equity combines lectures, case studies, discussions, and group exercises to create an environment where interaction between faculty and participants and among participants themselves promotes an ongoing exchange of knowledge, experiences, and insights.

The course module will be conducted in newly designed classrooms with amphitheater seating, and participants will live in suites of individual rooms arranged around a common area. These facilities are specifically designed for executive education to foster shared learning and out-of-class discussion.

Participants will have ready access to Baker Library, the largest business library in the world, as well as the new Research and Technology Lab, which houses state-of-the-art audio, computing, imaging, projection, and Internet equipment. They’ll also have full use of Shad Hall, the School’s athletic facility and fitness center.

Harvard Business School Faculty

The course heads are Paul Gompers and Josh Lerner:

Paul Gompers, Assistant Professor of Business Administration, specializes in research on financial issues related to start-up, high growth and newly public companies. He received his A.B. in biology from Harvard College in 1987. After spending a year working as a research biochemist for Bayer Chemical AG, he attended Oxford University on a Marshall Fellowship where he completed an M.Sc. in economics. He completed his Ph.D. in Business Economics at Harvard University in 1993. Professor Gompers spent two years as an Assistant Professor of Finance at the Graduate School of Business, the University of Chicago where he created a new course entitled "Entrepreneurial Finance and Management." His research focuses on the structure, governance, and performance of private equity funds, sources of financing, incentive design, and performance of private firms, and long-run performance evaluation for newly public companies. He has published papers in a variety of academic journals, including the Journal of Finance, the Journal of Financial Economics, and the Journal of Law and Economics.

Josh Lerner is an Associate Professor at Harvard Business School, with a joint appointment in the Finance Area and the Entrepreneurial Management Interest Group. He graduated from Yale College with a Special Divisional Major which combined physics and the history of technology. He worked for several years on issues concerning technological innovation and public policy at the Brookings Institution, for a public-private task force in Chicago, and on Capitol Hill. He then undertook his graduate study at Harvard's Economics Department. His research focuses on the structure of venture capital organizations and their role in transforming scientific discoveries into commercial products. He also examines how intellectual property protection shapes high-technology industries. His work has been published in a variety of academic journals, including the Journal of Finance, the Journal of Financial Economics, the Journal of Law and Economics, and the Rand Journal of Economics. He designed and teaches an MBA elective course, "Venture Capital and Private Equity," for which he has written over thirty cases. He serves as Faculty Chair of the Focused Financial Management Series.

Also teaching in the course will be:

Jay Light is a graduate of Cornell University (BEP) and Harvard University (DBA). He worked in the US space program, in investment research, and in management consulting before joining the faculty of the Harvard Business School in 1970. He was the Director of Investment and Financial Policies for the Ford Foundation from 1977 to 1979. He has taught Investment Management, Capital Markets, and Corporate Financial Management in the second year of the MBA Program, and various executive programs in investment management and capital markets. Professor Light authored the book The Financial System and numerous articles and cases. Formerly, he was Chairman of the Finance Area, Senior Associate Dean,and Director of Faculty Planning at HBS. He is currently a Trustee and Member of the Executive Committee of TIAA/CREF, a Director of the Harvard Management Company, a Trustee and Chairman of the Investment Committee of Brigham & Women's Hospital, a director of several public corporations, a Director of several private funds, an Advisor to several corporate pension funds, Faculty Chairman of the AIMR Investment Management Workshop, and a Consultant on investments to major institutional pools of capital.

Andre Perold is the Sylvan C. Coleman Professor of Financial Management at the Harvard Business School, where he teaches MBA courses in Investment Management and Capital Markets, and currently serves as Chair of the Finance area. Perold's recent research has investigated questions relating to risk management and capital allocation within principal financial firms, derivative instruments and their relation to the payment system, implementation costs within investment organizations, management of currency risk, and stock market efficiency and liquidity. He is the developer of a widely-used software package for portfolio construction. He has recently co-authored The Global Financial System: A Functional Perspective and Cases in Financial Engineering: Studies of Applied Financial Innovation. Perold serves on the editorial board of the Financial Analysts Journal.. He is consultant to a number of financial institutions and investment firms, and serves as a Director/Trustee of a variety of organizations and large investment pools. Perold holds a BSc (Hons) from the University of the Witwatersrand, Johannesburg, and an MS and PhD in Operations Research, both from Stanford University.

Other 1998 Focused Financial Management Series Modules

Corporate Financial Engineering: Advancing Business Strategies May 13 - May 16, 1998

Focusing on significant business opportunities, this module teaches participants how to incorporate financial engineering into corporate activities. Participants will examine the application of financial engineering in traditional treasury activities, in risk management programs, and in designing new business models and strategies.

Valuation May 17 - May 20, 1998

Participants will learn how to value opportunities and make effective management decisions based on value. This module examines the tools and techniques for assessing the value of major assets in the context of capital projects, corporate control transactions, liability management, and international investments

Creating Value through Corporate Restructuring May 20 - May 22, 1998

This module teaches corporate managers how to identify and respond to potential restructuring opportunities by focusing on financial strategies aimed at repositioning and revitalizing companies. Participants will gain an understanding of "best practices" for achieving competitive advantage and maximizing shareholder value. .

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Note: Fees, faculty, course content, and dates are subject to change. Affirmative Action/Equal Employment Institution.

Paul A. Gompers

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