Private Equity and Venture Capital in Europe: Markets, Techniques, and Deals

By Stefano Caselli and Giulia Negri

Global financial markets might seem as if they increasingly resemble each other, but a lot of peculiar aspects qualify different markets with different levels of development. Private equity investors can take advantage of these variations. Structured to provide a taxonomy of the business, Private Equity and Venture Capital in Europe, Second Edition, introduces private equity and venture capital markets while presenting new information about the core of private equity: secondary markets, private debt, PPP within private equity, crowdfunding, venture philanthropy, impact investing, and more. Every chapter has been updated, and new data, cases, examples, sections, and chapters illuminate elements unique to the European model. With the help of new pedagogical materials, this Second Edition provides marketable insights about valuation and deal-making not available elsewhere.

• Covers new regulations and legal frameworks (in Europe and the US) described by data and tax rates
• Features overhauled and expanded pedagogical supplements to increase the versatility of the Second Edition
• Focuses on Europe
• Includes balanced presentations throughout the book

• Language: English
• Publisher: Academic Press
• Release date: Jan 26, 2018
• ISBN: 9780128122556

Stefano Caselli

Stefano Caselli is Vice-Rector for International Affairs at Bocconi University where he is a Full Professor of Banking and Finance and Chair in Long-Term Investment and Absolute Return. He is the Chair for the EMEA Region of Partnership in International Management, Executive Secretary of the External Advisory Board of the School of Transnational Governance at EUI and conducts numerous research and consulting projects with the most important financial institutions at European level and corporations for valuation and corporate governance issues.

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Part 1

General Framework and Private Equity Deals

Chapter 1

The Fundamentals of Private Equity and Venture Capital

Abstract

This chapter introduces the fundamentals of private equity and venture capital. The second section covers private equity and venture capital, underlining important differences between American and European approaches to funding start-ups and the typical characteristics of the business. The third section explains how private equity finance is different from corporate finance, emphasizing the distinguishing elements. The fourth section analyzes private equity and venture capital from the entrepreneur's perspective, while the last section discusses the views of all types of potential investors. The chapter concludes with an overview of the private equity market in 2015.

Keywords

Private equity; Venture capital; Private equity investors; Venture capital investors; Private equity finance; Corporate finance

1.1 Introduction

This chapter presents the fundamentals of private equity and venture capital. The second section covers private equity and venture capital, underlining important differences between American and European approaches to funding start-ups and the typical characteristics of the business and presents specific characteristics of the business, in the end it describes why a company should address to a private equity investor. The third section explains how private equity finance is different from corporate finance, emphasizing the distinguishing elements. The fourth section analyzes private equity and venture capital from the entrepreneur's perspective, while the last section discusses the views of all types of potential investors. The chapter concludes with an overview of the private equity (PE) market in 2015.

1.2 Definition of Private Equity and Venture Capital

There is evidence that investing in the equity of companies started during the Roman Empire. However, the first suggestion of a whole structured organization that funded firms to improve and make their development easier was found during the 15th century, when British institutions launched projects dedicated to the increase and expansion of trade to and from their colonies.

From an institutional point of view, private equity is the provision of capital and management expertise given to companies to create value and, consequently, generate big capital gains after the deal. Usually, the holding period of these investments is defined as medium or long.¹

Modern private equity and venture capital have been around since the 1940s when it started to be useful and essential for financial markets and companies’ development. Financing companies with private equity and venture capital has become ever since increasingly more important, both strategically and financially.

Because this type of business has been around for so long, and ever since the 1940s it evolved under many different aspects, one worldwide definition and classification for private equity and/or venture capital does not exist. However, it is clear that a broad definition does exist: private equity is not public equity because it includes investments realized outside the stock market only.

This provocative sentence means that private equity encompasses investments made by a financial institution in the equity of a company, whose shares are not listed.

As venture capital, which will be illustrated later in the book, was in fact born before the rest of private equity, many terms, definitions, and associations’ names are named after it, even though they refer to both kind of deals, those in the first stages of life of the company and those in a mature age. This is why the company in which the private equity is investing is called Venture-Backed Company regardless the kind of deal that is being made. Hereinafter, the company in which the investment is made is called Venture-Backed Company or, simply, VBC. Besides the ultimate destination of the money injection (i.e., listed and unlisted shares), under three other aspects private equity differs from public equity (see Table 1.1):

•Pricing. As shares are publicly traded, in public equity the price is driven by the market fluctuations, either upwards or downwards. On the other hand, the price of a share of a private company is defined on the basis of the negotiation between the preexisting shareholders and the incoming shareholder, which is to say, the private equity investor.

•Liquidity. Publicly traded stocks are characterized by a high level of liquidity, whereas private equity stocks are illiquid. In fact, the selling of a private equity share corresponds to the exit of a private equity investor from an investment, where the private equity investor has to find another potential buyer for the stake.

•Monitoring. Investments in publicly traded stocks are strongly regulated by domestic and international laws and supervisors. On the contrary, investments in private equity are safeguarded by a contract between the parties (i.e., the preexisting shareholders and the private equity investor).

Table 1.1

The definition provided earlier in this chapter, even if very broad, cannot be applied to the whole world, because operators’ national associations (i.e., NVCA, Invest Europe, BVCA, AIFI, EVPA²), or central banks interpret the definition according to the countries in which they operate. For this reason, many definitions still exist. For instance, according to the American approach, venture capital is a cluster of private equity dedicated to finance new ventures. Therefore, venture capitalists fund companies in their initial phases of life or that are seeking for sources to expand and develop the operations, whereas private equity operators finance companies that have completed at least their first/fast growth process.

The European definition proposes that private equity and venture capital are two separate clusters based on the life cycle of the firm. Venture capitalists provide the funding for start-up businesses and early stage companies, whereas private equity operators are involved in deals with firms that find themselves in their mature age of the life cycle.

In recent years, the American definition has been adopted in the European context too. As such, in this book the American definition will be considered when mentioning private equity and venture capital, where the private equity label embeds the venture capital deals.

Regardless of the approach used for the main definition, in every deal of private equity it can be assessed that a strict relationship between the investor and the entrepreneur is created. This is a unique characteristic not found in any other financial institution. This is attributed to the typical characteristics of private equity and venture capital financing schemes:

•modification of shareholder composition (see Fig. 1.1) as a result of the investor investing in the equity of the VBC,

•knowledge and nonfinancial support, and

•predefined time horizon of the investment.

Fig. 1.1 Basic representation of the functioning of a private equity