Regulation and Value Creation in Private Equity Fund Owned Portfolio Companies

Mads Gram Brogaard & Nicolai Münster Nielsen

Student thesis: Master thesis

Abstract

This thesis sets out to provide an in-depth analysis of how private equity firms create value in their portfolio companies and how this value creation is affected by the Danish Companies Act and sector specific regulation. The thesis identifies four value drivers which can be divided into operational (EBIT, Growth Rate and Invested Capital) and financial (WACC) value drivers. Private equity firms do not have direct control over the operational value drivers as these are managed by the executive board of the portfolio company. The analysis concludes that private equity firms are actively involved in their portfolio companies and use monitoring and incentive programs to ensure alignment of interests. This is also done by demanding executives to acquire an equity stake in the company. The analysis finds that the use of monitoring and incentive programs are regulated only to a limited extent by the Danish Companies Act. As a result, it is concluded that the regulation does not affect the value creation through the operational value drivers. Private equity firms can directly affect the financial value driver. Private equity firms create value by reducing the cost of capital in their portfolio companies through an optimization of the capital structure. This includes increasing the leverage and debt structuring. Private equity firms can reduce a portfolio company’s financial distress costs because they can act swiftly and infuse more capital if needed. Furthermore, private equity firms have financial expertise and close relationship with banks. The analysis finds that the portfolio companies should typically have a capital outflow in connection with the restructuring of the capital structure which usually takes place right after the takeover. This is required to achieve the optimal amount of debt in the portfolio company whilst the amount of free reserves is kept at a minimum. The capital outflows are regulated by the Danish Companies Act’s rules on legal financial assistance and dividend distribution and by the Danish AIFM Act. Legal financial assistance is a less desirable method when optimizing the capital structure as there is still legal uncertainty surrounding it and because the price to be paid must be made public. Therefore, private equity firms prefer the use of dividend distribution even though Article 75 of the Danish AIFM Act puts a restriction on the dividend distribution and the subsequent use of debt push downs. Finally, the restrictions of the Danish AIFM Act negatively affect the value creation because the portfolio company may not be able to raise the optimal amount of debt or that the portfolio company has too many free reserves which should have been distributed.

EducationsMSc in Commercial Law, (Graduate Programme) Final Thesis
LanguageDanish
Publication date2018
Number of pages126
SupervisorsPeer Schaumburg-Müller