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The Economics of Private Equity Funds

  • Andrew Metrick

This article analyzes the economics of the private equity industry using a novel model and dataset. We obtain data from a large investor in private equity funds, with detailed records on 238 funds raised between 1993 and 2006. We build a model to estimate the expected revenue to managers as a function of their investor contracts, and we test how this estimated revenue varies across the characteristics of our sample funds. Among our sample funds, about two-thirds of expected revenue comes from fixed-revenue components that are not sensitive to performance. We find sharp differences between venture capital (VC) and buyout (BO) funds. BO managers build on their prior experience by increasing the size of their funds faster than VC managers do. This leads to significantly higher revenue per partner and per professional in later BO funds. The results suggest that the BO business is more scalable than the VC business and that past success has a differential impact on the terms of their future funds. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhq020
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Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 23 (2010)
Issue (Month): 6 (June)
Pages: 2303-2341

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Handle: RePEc:oup:rfinst:v:23:y:2010:i:6:p:2303-2341
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  1. Axelson, Ulf & Stromberg, Per & Weisbach, Michael S., 2008. "Why Are Buyouts Levered? The Financial Structure of Private Equity Funds," Working Paper Series 2008-15, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
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  6. Cao, Jerry & Lerner, Josh, 2009. "The performance of reverse leveraged buyouts," Journal of Financial Economics, Elsevier, vol. 91(2), pages 139-157, February.
  7. John Y. Campbell & Martin Lettau & Burton G. Malkiel & Yexiao Xu, 2000. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," NBER Working Papers 7590, National Bureau of Economic Research, Inc.
  8. Thomas Hellmann & Manju Puri, 2002. "Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence," Journal of Finance, American Finance Association, vol. 57(1), pages 169-197, 02.
  9. Ludovic Phalippou & Oliver Gottschalg, 2009. "The Performance of Private Equity Funds," Review of Financial Studies, Society for Financial Studies, vol. 22(4), pages 1747-1776, April.
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  11. Cochrane, John H., 2005. "The risk and return of venture capital," Journal of Financial Economics, Elsevier, vol. 75(1), pages 3-52, January.
  12. Hellmann, Thomas & Puri, Manju, 2000. "The Interaction between Product Market and Financing Strategy: The Role of Venture Capital," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 959-84.
  13. Steven Kaplan & Antoinette Schoar, 2003. "Private Equity Performance: Returns, Persistence and Capital," NBER Working Papers 9807, National Bureau of Economic Research, Inc.
  14. Gompers, Paul & Lerner, Josh, 1999. "An analysis of compensation in the U.S. venture capital partnership," Journal of Financial Economics, Elsevier, vol. 51(1), pages 3-44, January.
  15. Jonathan B. Berk & Richard C. Green, 2002. "Mutual Fund Flows and Performance in Rational Markets," FAME Research Paper Series rp100, International Center for Financial Asset Management and Engineering.
  16. David H. Hsu, 2004. "What Do Entrepreneurs Pay for Venture Capital Affiliation?," Journal of Finance, American Finance Association, vol. 59(4), pages 1805-1844, 08.
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