Conceptual Model for Private Equity Markets: Proposal and Empirical Test on Fundraising

Abstract

The absence of a theoretical basis that could explain capital flows within private equity markets has prompted us to seek a general explanation for the process that could be applied to any given country. In our opinion, the interaction between supply and demand is directly affected by four conditions, basically: the size of the domestic market, the accessibility of a stock market for growing companies, the existing regulations on capital gains taxation and the social climate regarding entrepreneurial activity. The conceptual model presented here has been partially tested with a sample of 16 European countries during the period from 1987 to 2000 and using panel-data techniques. The authors examine the factors, both environmental and industrial, that explain, in aggregate terms, the growth of new funds raised for private equity investments in Europe since the late-eighties. In addition to the identification of environmental factors, such as the creation of a new stock market or the recently-gained access to one, we also provide a measure of the rigidity of labour markets, focusing on the aggregated investment and divestment activities recorded in the past. The authors find that the amounts invested and successfully divested in the previous year, plus the existence of a market for growing companies, have positive and significant impacts on fundraising. When the variable divestment is substituted with four different exit possibilities, only divestments through sales to a third party is significant, and it is hardly coincidental that this has always been the most common way of exiting in Europe. The results obtained here are also consistent with the theoretical model proposed.