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

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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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