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The use of financial information by private equity funds in evaluating new investments

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  • Jan Smolarski
  • Neil Wilner
  • Weifang Yang
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    Abstract

    Purpose – The purpose of this paper is to examine the use of financial information and valuation methods among private equity funds in Europe and India. The authors analyze differences in the choice of valuation methods and how the use of financial information differs among funds in the UK, Pan Europe and India. Design/methodology/approach – A survey approach was utilized in collecting proprietary data from European and Indian private equity funds. The data were classified according to fund type, country grouping, size, risk profile, labor cost and industry structure and analyzed using MANOVA and ANOVA. Findings – The results show that the use of valuation models is relatively homogeneous across countries and that the use of financial information appears to be driven to a large extent by fund type and fund focus. The use of audited financial statements appears to increase as firms mature. Significant differences were found in standard financial adjustments between the two fund types and between the country groupings. Results based on labor cost are weakly significant whereas industry structure does not appear to have an impact on how fund managers evaluate investments. Research limitations/implications – The results indicate that fund managers adapt their decision-making behavior according to investment type and risk. The authors argue that understanding asymmetrical and structural issues may potentially improve investment decision-making processes. The main conclusion for researchers is that buy-out and venture capital funds should not be combined as one asset class. Since a survey approach was used, the study is subject to the belief that fund managers do not internalize decisions well, which could reduce the effectiveness of the research design. Originality/value – There are few studies in the areas covered by this paper due to the proprietary nature of the private equity industry. The results are important because they help in understanding how fund managers use decision aids such as financial statements and valuation techniques. A better understanding of current practices will help fund managers and fund sponsors in devising improved decision aids and processes, which ultimately may lead to fewer non-performing investments. This is especially important in private equity since investment decisions are often irreversible and binary.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Review of Accounting and Finance.

    Volume (Year): 10 (2011)
    Issue (Month): 1 (February)
    Pages: 46 - 68

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    Handle: RePEc:eme:rafpps:v:10:y:2011:i:1:p:46-68

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    Related research

    Keywords: Equity capital; Europe; Financial reporting; Financial risk; India; Venture capital;

    References

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    1. Repullo, R. & Suarez, J., 1998. "Venture Capital Finance: a Security Design Approach," Papers 9804, Centro de Estudios Monetarios Y Financieros-.
    2. Gavin C Reid & Nicholas G Terry & Julia A Smith, 1995. "Risk Management in Venture Capital Investor-Investee Relations," CRIEFF Discussion Papers 9505, Centre for Research into Industry, Enterprise, Finance and the Firm.
    3. Dossani, Rafiq & Kenney, Martin, 2002. "Creating an Environment for Venture Capital in India," World Development, Elsevier, vol. 30(2), pages 227-253, February.
    4. Mike Wright & Andy Lockett & Sarika Pruthi & Sophie Manigart & Harry Sapienza & Philippe Desbrieres & Ulrich Hommel, 2004. "Venture Capital Investors, Capital Markets, Valuation and Information: US, Europe and Asia," Journal of International Entrepreneurship, Springer, vol. 2(4), pages 305-326, December.
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    6. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
    7. repec:wuk:andedp:9616 is not listed on IDEAS
    8. Richard Fairchild, 2004. "Financial Contracting Between Managers And Venture Capitalists: The Role Of Value-Added Services, Reputation Seeking, And Bargaining Power," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 27(4), pages 481-495.
    9. Wright, Mike & Lockett, Andy & Pruthi, Sarika, 2002. " Internationalization of Western Venture Capitalists into Emerging Markets: Risk Assessment and Information in India," Small Business Economics, Springer, vol. 19(1), pages 13-29, August.
    10. Healy, Paul M. & Palepu, Krishna G., 2001. "Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 405-440, September.
    11. Dave Valliere & Rein Peterson, 2005. "Venture Capitalist Behaviours: Frameworks for Future Research," Venture Capital, Taylor & Francis Journals, vol. 7(2), pages 167-183, February.
    12. Zacharakis, Andrew L. & Meyer, G. Dale, 1998. "A lack of insight: do venture capitalists really understand their own decision process?," Journal of Business Venturing, Elsevier, vol. 13(1), pages 57-76, January.
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