seeking differentiation at a time of change* · management to implement strict cash flow and cost...

Seeking differentiation at a time of change*Global Private Equity Report 2008

*connectedthinking

Investment Management and Real Estate

Contents

1 PricewaterhouseCoopersGlobal Private Equity Report 2008

01 Introduction/highlights 2

Differentiating private equity businesses in difficult markets 2

02 Analysis 4

Sustainable growth becomes critical 4

Building the business model 8

Reconciling responsibility with returns 12

Fair value challenges in the current environment 16

Addressing tax in a wider world 20

BRIC opportunities – and the accompanying risks 26

03 Statistics 38

The world view: investment & fund raising trends 40

The world view: high-technology investment trends 44

The world view: expansion investment trends 45

The world view: buyout investment trends 46

Data sources 47

North America 48

Europe 50

Asia Pacific 52

04 Disclaimer and contacts 54

01 Introduction/highlights

Differentiating privateequity businesses indifficult marketsAfter the unprecedented financial events of the past year, private equityis operating in an environment where fundraising will become morecompetitive. What is more, as the turbulence affects the ‘realeconomy’, so investing will be more difficult.

In this new world, the industry needs to make use of the flexibility it has been so well-knownfor over the years.

PricewaterhouseCoopers1 believes private equity is embarking on a new phase – that theindustry is at an inflexion point, if you like – and that firms need to adapt. They need to looklong and hard at how they create value. They need to consider how this is reflected in theirbrands. Not only will they have to change, they will have to demonstrate how they areanticipating tomorrow’s world, to differentiate themselves.

The data at the back of this report shows how much the world has changed in just a fewmonths. Our comprehensive global investment and fundraising data for 2007 demonstratesan industry where buyout investment was still thriving, and high-technology and expansioncapital activity was in line with 2006 levels.


Brendan McMahonPricewaterhouseCoopers(Channel Islands)+44 1534 [email protected]

1 PricewaterhouseCoopers’ refers to the network ofmember firms of PricewaterhouseCoopersInternational Limited, each of which is a separateand independent legal entity.


Clearly, in the autumn of 2008 no privateequity firm can take growth for granted.Based on our internal experience andconversations with leading industry players,this report highlights some of the challengesand opportunities we view as shapingprivate equity’s future.

Key report headlines

Below is a brief summary of the issuesaddressed in the report:

Sustainable growth becomes criticalThe most important form of differentiationis performance. This is becoming far harderto achieve. With a less supportive capitalmarket environment, firms have few optionsother than to achieve this by improving the businesses in which they invest – soincreasing the pace of growth. This means ashift in skill sets and culture for many firms.

Building the business modelThe logic for private equity firms to diversifyinto other alternative asset classes isnot diminished by the downturn. Asmacroeconomic and capital marketconditions change, so opportunities emergefor different strategies. Building bigger, morediversified businesses introduces a whole

new set of management and controlchallenges.

Reconciling responsibility with returnsUntil recently corporate responsibilityappeared to offer few advantages for privateequity. It was chiefly seen as having a brandor investor relations benefit for companies inthe public arena. Now this is changing, assustainability issues look likely to have amajor impact on companies’ bottom lines.

Fair value challenges in the currentenvironment The move to fair value reporting in today’smarket conditions, made necessary by newaccounting conventions, will make for adifficult 2008 year-end accounting process.Achieving it means addressing a whole setof practical issues. But with investorsgenerally dissatisfied with the standard ofreporting received from alternativeinvestments, fair value is an important stepin the right direction.

Addressing tax in a wider worldAs private equity has become a globalbusiness, and an owner of increasingly high-profile businesses, so the tax issuesit faces have become more complex.

In certain countries, tax structures thatappeared secure are being challenged. Agreater awareness of tax risks is required.

BRIC opportunities – and theaccompanying risksWhile emerging markets are clearlyvulnerable to the global crisis, their medium-term growth prospects still appear betterthan those of the developed economies.Expansion of their middle classes is leadingto huge new consumer markets. Privateequity houses need to have emergingmarket strategies. Yet these economieshave idiosyncratic regulatory, legal andtaxation environments. Careful planning,structuring and due diligence is essential.

A new phase

Taken individually, these issues haveimplications of varying seriousness forprivate equity. When combined, however,they mean that firms have to makesignificant changes across their firms –from value creation, through to structuring,controls, reporting and so on. In addition,they may face greater regulation – notablywithin the European Union, where there arecalls for tougher capital requirements.

Just as the benign conditions of the pastfive years fostered a phase of growth whenlarge buyouts became increasinglydominant, so in the coming years theindustry will reshape itself again to adapt tothe new environment.

Brendan McMahonGlobal Investment Management &Real Estate Private Equity Leader

02 Analysis Sustainable growthbecomes criticalThe economic slowdown is forcing private equity firms to focus onearnings growth as the primary driver of internal rates of return. Somefirms will find this easier to achieve than others.

Tougher trading conditions throughout most economic sectors are hastening a significantshift in the way that private equity creates value. For several years, firms have been steppingup their efforts to increase growth in their portfolio companies. Now, the downturn meansthey are focusing on this as a matter of urgency.

Whereas previously private equity firms have achieved high returns through cleveracquisitions, balance-sheet restructuring and rising valuations, today their investment theseshave little choice but to target growth improvements. In order to achieve this, they need tobe able to help businesses make organisational changes and operational improvements.

Consequently, private equity firms are working their portfolio companies harder and makingsolid business management skills a core competency. Those that do not already haveappropriate in-house expertise are hiring operationally experienced managers andspecialists in organisational change and turnarounds, to complement existing in-houseresources.


Chris HemmingsPricewaterhouseCoopers (UK)+44 20 7804 [email protected]


Competition increases

As the private equity asset class has grownand matured, so the basic premise for valuecreation has changed. In the industry’s earlydays it was possible to buy companies atrealistic prices and then incentivise themanagement to implement strict cash flowand cost disciplines. The resulting growth inearnings and surplus cash flow generatedsignificant equity value at the time of exit.

Over the past decade, however, it has beenharder to find undermanaged businesses inthe mature Western economies. Fortunately,during this period, private equity investorshave been able to rely upon increasinglevels of cheap debt, together withever-rising valuation multiples to createequity value. Leverage and multiplearbitrage were a potent cocktail forunusually high equity returns.

As has become painfully clear, however,the credit crunch has blown away thesefavourable conditions and they are unlikelyto return. In the absence of ever-increasingleverage and buoyant industry valuationmultiples, private equity investors must nowrely on EBITDA growth within their portfoliocompanies. This growth will have to begenerated through top-line revenue growth,

not just cost savings. Private equityinvestors ranking in the top quartile forinvestment returns in this next phase of themarket will be those who not only buy well,but also adapt quickest to the need forhands-on professional management.

What is more, hiring the right people tomanage the portfolio companies will ensurethat the dealmakers within firms are notspending all their time fixing the problemsemerging in existing portfolio companies.Instead, they can focus on taking advantageof the opportunities that will undoubtedlyarise in the volatile market we willexperience over the next 18 months.

Routes to earnings growth

Perhaps the most popular avenue forearnings growth by private equity firms isthrough ‘buy and build’ strategies infragmented industry sectors. Typically, thisis done by buying a core ‘platform’ businessand then using small bolt-on acquisitions toadd scale and create synergies. Further,small bolt-on acquisitions will generally bemade at lower multiples, and as such willaverage down the overall acquisition price.

‘It’ll be a period whereactually hard workwill need to be applied,and firms will have toget used to living withthe fact they’ve gotportfolios of companiesthat are not performingso well. It’s going to bequite a period ofchange.’Jon Moulton,Managing Partner, Alchemy Partners


Some firms are using buy and build as away of accessing the faster growthopportunities of emerging marketeconomies. Those that do not have officesin these countries are often nervous ofmaking direct investments and, therefore,prefer to gain exposure through theirportfolio companies.

These buy and build strategies work wellwhen the management team has goodintegration expertise. Sometimes, thisexpertise can be introduced through theappointment of new board members;however, there are many instances ofprivate equity firms embarking on sucha strategy without integrating properlythe acquired companies. The result is astring of related businesses, and little realvalue creation.

Another common approach is to useexternal consultants to work withmanagement to achieve best-practice in keyareas of operational performance.Previously, private equity firms might haveinsisted that a portfolio company’soperational key performance indicators(KPIs) be improved to match the best in itssector. Now, they may go further, askingwhich business sector has the bestperformance in each of those KPIs, studying

their business practices and then seeking toimplement these practices in their ownportfolio companies.

Changing the resource mix

The clearest sign of the changing valuecreation model is the evolving skill setswithin private equity firms. Broadlyspeaking, the change is least pronounced inthe US private equity firms as they havealways employed an operating partnermodel. This has involved the use of ex-industrialists and business managers whowould play an active role on the boards ofall their portfolio companies, helpingmanagement to implement change anddrive strategic developments. Bycomparison, the European firms tended toadopt a more hands-off role on operationalmatters. But now, many Europeans arerecruiting operationally qualified people tohelp them take on a more proactive role ofportfolio management.

In the best of these firms, the portfoliomanagement team is now involved in aninvestment right from the inception of thedeal. They help to formulate and test theinvestment thesis. They then actively assistthe company’s management with its

Sustainable growthbecomes critical


implementation, bringing in relevantexpertise as necessary to facilitatestrategic change.

Securing a profitable exit

When it comes to exiting a portfoliocompany, demonstrating a sustainableearnings growth profile will becomeincreasingly important. Generally speaking,buyers will be harder to find since privateequity investors are less inclined to buyfrom each other and the public equitymarkets will become increasinglydiscriminating at a time when there is littleconfidence in capital markets. In order toachieve top quartile returns going forward,private equity investors will therefore have toput in place portfolio managementdisciplines, which will promote thedevelopment of clear market leaders in theirportfolio, with a demonstrable tradingrecord for revenue and earnings growth.Without these characteristics the list ofserious buyers willing to pay reasonableprices will remain short.

02 Analysis Building thebusiness modelShifting economic conditions are strengthening the motivation forbuilding diversified stables of investment strategies. Yet the creation oflarger businesses must be accompanied by appropriate controls.

The current uncertainty in financial markets appears likely to fortify the trend towardsdiversification of private equity firms’ business models. Firms have been steadily expandingtheir businesses beyond US and European leveraged buyouts for several years. Now, thereis an even greater logic in having a diversified product range – as some asset classes aremore suited to generating investment gains through the trough of the cycle than others.

Certainly, there are examples of private equity firms taking advantage of financial turmoil todiversify – either by buying new investment businesses from within troubled banks or byhiring experienced investment banking executives who can spearhead expansion into newasset classes and geographies.

This drive to build stable business models has also led to the listing of private equitybusinesses. By listing on public equity markets, firms gain an additional currency forattracting and motivating talented employees. Equally importantly, going publicinstitutionalises the issuer, solidifies the issuer’s institutional presence and enhancesthe brand name. On the debit side public listing brings with it a whole host of newresponsibilities and obligations as well as putting the spotlight on short-termearnings performance.


Brendan McMahonPricewaterhouseCoopers(Channel Islands)+44 1534 [email protected]


Profiting from and protectingthe brand

As managers seek to build bigger andbroader businesses, brand has becomeespecially important. Several of the largermanagers clearly believe long-termleadership in private equity has imbued theirbrand with value that facilitates expansioninto complementary new businesses. Theywill benefit from substantial synergiesacross all of these businesses, including theability to leverage the extensive intellectualcapital that resides throughout their firms.

When extending their businesses, firms arecautious not to take risks that coulddamage the brand. For this reason, theyhave tended to focus on asset classes thatrequire investment skills related to privateequity, such as infrastructure, real estateand debt. Expansion into the other bigalternatives area – hedge funds – hastended to be more limited, due to thedifferent skills required.

Brand is particularly important in today’suncertain environment. Those managerswith sustained performance, appropriatefiduciary controls and a good record formanaging talent will have enhanced brandrecognition. It is imperative that appropriatecorporate governance structures exist withinprivate equity firms to facilitate the long-term success of organisations. As privateequity managers have more significantjurisdictional and product diversity, suchgovernance structures are critical in order tomanage associated investment risk.

Investments for all seasons

Infrastructure is one of the asset classesthat private equity is diversifying into mostactively. Institutional investors have anappetite because they consider the stablecash flows of infrastructure assets – such astoll roads and power stations – resilient tofluctuating market conditions. US andEuropean managers have recentlyexpanded into this area and recruited appropriate expertise. They view this as anasset class that requires investment skillssimilar to those applied in their core privateequity business, and another source ofprofit with which to support resource-intensive international office networks.

‘I think what you aregoing to see is a naturalevolution of firms takingtheir networks and theirbrand into other fieldswhere they can geta return.’Marc St John,Partner, CVC Capital Partners


There is huge scope for infrastructureinvesting. This is a multitrillion-dollarglobal marketplace with enormous need forprivate investment. Developing countriessuch as China and India recognise thecritical role infrastructure plays in supportingeconomic growth.

Debt funds are a further example ofdiversification into an asset class whereprivate equity-type investment skills arerelevant. In the current environment,where banks have struggled to syndicateleveraged debt, there are uniqueopportunities for traditional private equitymanagers who have developed deepexpertise through decades of structuringleveraged financed buyouts.

Some private equity managers are goingfurther and establishing distressed debtfunds to take advantage of the increasingrange of loan types now trading at deeplydiscounted prices.

The challenge for managers looking todiversify into areas such as infrastructureand debt is to understand the specificrequirements of those sectors in termsof fund structures, managing the associatedtax risks, recruiting suitable expertiseand shaping investor reporting. Theyalso need to formulate a controlenvironment to mitigate, among otherthings, investment risk.

Going public

In the past few years, private equity groupshave raised significant funds at thecorporate level through public marketlistings, partly to finance the handover ofprivate equity firms from the foundingpartners to a new generation of managers.In the current environment, listing isobviously more difficult, although thereremain strong reasons to do this, rangingfrom motivation of employees toinstitutionalising the brand and gaining anacquisition currency.

Other firms have gained investment fromsovereign wealth funds (SWFs), which areinvesting directly into private equitymanagers, as well as in their underlyingmanaged funds. Through such strategicinvestments private equity managers arebuilding strong relationships with SWFs,which facilitate fundraising in the future.Given that private equity firms are unlikely tobe accorded a high valuation in today’smarkets, SWF investment may be a betteralternative for some firms.

Yet, being a public-listed vehicle bringsa host of additional responsibilities –not least the need to demonstrate strongand appropriate corporate governancemodels. Most alternative asset managersthat have listed have invested significanttime and money preparing their internalcontrol structures. In some cases, they willbe required to comply with Section 404 ofthe Sarbanes-Oxley Act 2002, concerningthe scope and adequacy of the internalcontrol structure and procedures forfinancial reporting.

Building thebusiness model


Controlling diversity

In order to support diversified productranges, a number of private equitymanagers – now more akin to fully fledgedalternative investment managers – aretransforming their internal corporatemanagement structures, and this hasincluded the appointing of chief executiveofficers and chief administrative officers.Building robust management structures iscritical for attracting investors looking toshift assets to leading global alternativemanagers, particularly those with strongbrand recognition and diversity ofinvestment strategy.

Clearly then, private equity players willcontinue to develop new businessesand capital sources to further leveragetheir brand, information advantage,substantial resources and sourcingcapabilities…compelling economics andscale! They will, however, have to make surethat internal processes support suchgrowth. Industry players moving in thisdirection will be the leading alternativeinvestment managers of the next decade.

02 Analysis Reconciling responsibilitywith returnsAs pressure increases on private equity to become more accountable,corporate responsibility appears increasingly likely to affect investmentreturns.

Until recently corporate responsibility appeared to offer few advantages for private equity.It was chiefly seen as having a brand or investor relations benefit for companies in thepublic arena. Now this is changing, as sustainability issues look likely to have a majorimpact on companies’ bottom lines.

Additionally, pressure from stakeholders such as politicians and union officials has led tocalls for private equity to become more accountable. This has resulted in the UK’s WalkerReport transparency guidelines – published in 2007 – and current pressure for legislationwithin the European Parliament.

For private equity companies, then, sustainability is showing signs of affecting their ability –both positively and negatively – to deliver returns for investors. For example, environmentalissues are both creating opportunities for businesses to grow and significant potentialliabilities that have to be managed. The move towards a cleaner world is opening upwhole new product markets, while at the same time gradually forcing companies to pay fortheir pollution.


Geoff LanePricewaterhouseCoopers (UK)+44 20 7213 [email protected]

Phil CasePricewaterhouseCoopers (UK)+44 20 7213 [email protected]


Yet, although climate change is currently themost urgent issue within the sustainabledevelopment agenda, other issues such aspoverty, natural resource depletion andscarcity, population increase anddemographic changes may also affect theprospects of private equity portfoliocompanies.

Specific benefits

PricewaterhouseCoopers’ work withcorporate clients to quantify the value ofsustainability-related programmes hasimportant lessons for private equity portfoliocompanies. Our work is demonstrating thefollowing benefits:

• Adding to cash flow in the long termthrough ‘eco-efficiencies’ and operationalcost reductions;

• Ensuring easier access to finance byreducing risk, therefore achieving a lowerweighted average cost of capital;

• Creating major new ‘green’ product lines,with opportunities for increased revenue,especially through ‘clean technology’.

Evidently, then, for private equity firms,factors such as these could have significant

effects on exit values. Indeed, assustainability becomes more acceptedfor its relationship to a business’s value,it may also help private equity firms todifferentiate themselves – both toprospective portfolio companies andinvestors. In a tough fundraising climate,this could be especially useful.

Data shows clearly how energy technologyinvestments are multiplying as countriesstrive to achieve ambitious targets forgreenhouse gas reductions under the KyotoProtocol framework. According to NewEnergy Finance, investment in clean energyrose by 60% in 2007 to US$148.4 billion,due to supportive policies around the world,high oil prices and growing consumer andbusiness awareness.2

But new investment opportunities arenot only related to well-publicised productssuch as wind turbines or solar panels.There is an increasingly clear focus onthe value of carbon, which is influencingproject economics: the availability of carboncredits from a Clean DevelopmentMechanism project, for instance, might turna marginal project into a profitable one.By contrast, a company that is bad atmanaging emissions will increasingly havea substantial cost to bear. 2 www.newenergymatters.com/download.php?p=about&n=NEF_Week_in_Review_04-03-2008.mht&f=WiR_mhtfile&t=weeklybriefing.

Figure 1: CR as a key driver of added value

Increasing value

• Reputation enhancement

• Product/servicedifferentiation

• Sustainable operating model

• Operational risk

• Licence to operate

• Regulatory compliance

• Reputational risk

Operational efficiency

Op

por

tuni

tyR

isk


With a growing acceptance that doingnothing is not an option, private equitycompanies must choose their strategicstance, both at an organisational andinvestment level. At one end of the scale,management might prefer to take adefensive, compliance-based approach.At the other, as shown in Figure 2, theycould use corporate responsibility topositive effect. They could embed corporateresponsibility throughout their firm, soenhancing the value of portfolio companiesand making their brands synonymous withthe sustainability agenda.

What private equity can do

Those private equity houses that haveactively begun work on the corporateresponsibility agenda have started byensuring that their own operations are beingrun on environmentally and sociallyresponsible lines, through energy efficiencyprogrammes, employee equality anddiversity initiatives, and so on. However, byfar the bigger prize, and therefore wheremost investment is being made, is in thearea of investment policies and procedures.

Of course, a degree of environmental duediligence has long been a feature ofinvestment appraisal. However, to be trulyeffective investment screening now needs toinclude consideration of longer term trendsfor consumer or supply chain demands,resource availability and human rights andlabour issues (particularly for investments indeveloping countries). At the aggregateinvestment portfolio level too, attention isneeded. A series of investments, which bythemselves appear to carry acceptablelevels of corporate responsibility risk, maytogether represent a very different ‘basket’of risk. This is particularly the case ifstakeholders can identify trends in a patternof investment that they considerirresponsible and unacceptable.

So the identification of wider stakeholdersand the undertaking of a ‘risk mapping’exercise (where issues are linked to thosestakeholders most affected or concerned) isa useful starting point for strategic corporateresponsibility management. In this way,reputational risks related to investments canbe identified early.

There are already cases where high-profiledeals have been restructured for corporateresponsibility reasons. In one case, when alarge US private equity firm acquired a USstate’s largest power generator, a criticalcondition of the deal was scrapping all but 3of 11 planned new coal-fired stations.This was due to controversy over theirenvironmental impact, the potential costsof carbon emissions and related impact onthe generator’s share price. The generator isnow investing US$400 million over fiveyears in energy efficiency and conservation,introducing corporate policies tied toclimate stewardship and strengthening itsenvironmental policies. Since thisannouncement, the company’s share pricehas improved.

Looking forward, we believe that privateequity firms will start to take corporateresponsibility increasingly seriously, both inresponse to external pressure and as itbecomes increasingly relevant to portfoliocompany performance.

Our experience suggests that theassessment and management of materialnon-financial issues is already affectingcompany valuations. Responsibility is beingreconciled with returns.

Reconcilingresponsibilitywith returns


Business and financial services embraces corporate responsibility

The concept of sustainable development has increasingly gained currency. Climate change is currently the most high-profile issuewithin the sustainable development agenda, although poverty, natural resource depletion and scarcity, population increase anddemographic changes are also receiving increasing attention – nationally and internationally – among both government and privatesector organisations. Underlying this is the recognition that these challenges are increasingly affecting government and private sectororganisations’ ability to operate. Business’s crucial role in contributing to sustainable development through corporate responsibility byachieving an appropriate balance between environmental, social and economic impacts is now widely acknowledged.

Given its facilitation of all forms of economic activity, financial services is regarded as having an important role in promoting greatercorporate responsibility. Many leading banks and insurance companies have made significant progress in managing the direct andindirect environmental and social impacts of their core-lending and investment activities.

Recent examples of guidelines and voluntary principles related to environmental, social and governance issues, adopted by thefinancial services industry are: The UN Principles for Responsible Investment, an investor initiative developed in partnership with theUN Environment Programme Finance Initiative and the UN Global Compact. As of January 2008, the guidelines had been adopted bynearly 360 financial institutions globally, representing over US$14 trillion in assets under management, up from 180 signatories andUS$8 trillion in assets under management in 2007.

‘When we come tothink about theprogression of abusiness to an exit,there’s plenty ofevidence now toshow that the valueof a company willbe enhanced if thepotential shareholdersfeel confident abouta company’sgovernance, in termsof its approach to therange of issues underthe CSR agenda.’Chris Rowlands,3i Managing Partner for Asia

02 Analysis Fair value challenges inthe current environment Fair value presents challenges, but is also an opportunity to improvetransparency for investors.

Fair value is one of the hottest topics facing the alternative investments sector today. We areseeing an increase in the pressure that investors, regulators and auditors are placing onvaluation at a time when we are experiencing:

• The most difficult economic conditions in years;

• A significant decrease in stock market values across most sectors;

• An increased focus on debt values; and

• A decrease in the number of transactions.

This combination of events promises to make the current valuation process extremelydifficult at a time when falling stockmarket valuations are likely to mean significant writedowns for private equity investments at the year end. As a result, we expect to see a highdegree of internal and external challenge in the valuation of unlisted investments by privateequity companies and hedge funds this year.


Nick ReaPricewaterhouseCoopers (UK)+44 20 7212 [email protected]


The journey to ‘fair value’

The old principle of keeping investments atcost (less any diminution) provided far fewerchallenges, especially in a rising market.Now, fair value is increasingly required, dueto the accounting requirements ofInternational Financial Reporting Standards(IFRS) and US generally acceptedaccounting principles (GAAP), and theincreased application of the InternationalPrivate Equity and Venture CapitalGuidelines (IPEVCG) and US Private Equityand Investment Guidelines (PEIGG).

These guidelines advocate the use ofcertain valuation methodologies and providesome structure to enable consistency ofapproaches in the industry.

However, these guidelines alone will onlyhelp to a certain extent and there are anumber of areas that are subjective and forwhich judgement will be required.

We have observed that some companieshave responded well to this challenge,whereas many have struggled. As a resultthere is some inconsistency in approach

and policy in the industry. This factor,alongside the lack of transparency ofvaluation techniques and assumptions, is inpart responsible for recent initiatives suchas the Hedge Fund Working Group and thedevelopment of International Organisationof Securities Commissions (IOSCO) andAlternative Investment ManagementAssociation (AIMA) guidelines – all of whichhighlight valuation as a key area forimprovement. In addition, in the UK we haveseen the Walker Guidelines that look attransparency in its wider contextsurrounding private equity.

This is supported by the recentPricewaterhouseCoopers/EconomicIntelligence Unit briefing on alternatives‘Transparency versus returns: Theinstitutional investor view of alternativeassets – March 2008’3. This highlightedthe disconnection between the perceptionsof investors and providers of information.Some 63% of companies considered thattheir valuation policies were effective atmanaging risk, but investors largelydisagreed. Only 25% of private equityinvestors thought that valuation policieswere effective in this respect.

3 PricewaterhouseCoopers/Economic Intelligence Unit briefing on Alternatives ‘Transparency versus returns: The institutional investor view of alternative assets, March 2008’, pages 12 and 27.

2227

14

59

50

56

12 14

21

7 99

% Institutional investors’ views on the quality of information of valuation techniques

60

70

50

40

30

20

10

0Very good or good Average Poor or very poor Don’t know

■ Hedge Funds ■ Private Equity ■ Private Equity


In addition, it emerged that only aroundone in five respondents considered thecurrent disclosure levels to be ‘good’ or‘very good’ across the alternatives industry,as shown below in the chart opposite.

So why is fair value important? Some in theprivate equity industry would argue that, asportfolios are usually held in close-endedfunds, cash at exit is all that matters and,therefore, fair values are purely anaccounting issue.

However, the briefing again provides aninteresting perspective on this. Performancewas the overriding criteria for considering athird-party provider of alternativeinvestments, with 72% of respondentshighlighting this compared to just 33% forquality of reporting. Yet, when it comes todeselecting a provider, these factors areconsidered of equal importance, 41% and40%, respectively. Clearly, investors wantregular and robust information and will exitfunds if this is not made available.

Practical issues

We see a number of practical issuesincluding:

• Use of companies that are notcomparable or incomplete list ofcomparable companies used – whenusing an earnings-based approach, thechoice of comparables and where thischanges from prior year needs to beunderstood.

• Averaging – The averaging of multiples isnot best-practice valuation and while it ismentioned in the IPEVCG and PEIGGguidelines, it is not recommended best-practice. The average of values derivedfrom different approaches is also to beavoided.

• Application of generic assumptions –Items such as marketability discount rateson an investment-by-investment basis.

• Maintainable earnings and applicationof a consistent multiple – The fair valueof an investment should be based upon asale in its current condition and based onan appropriate multiple.

• Debt value – Consider the fair value ofdebt and do not simply assume that bookvalue is appropriate.

• Fund of funds – The lack of detailedinformation to arrive at fair value isproviding difficulties for fund of funds,particularly as they meet the requirementsof FAS 157 in terms of the determinationof ‘principal market’ and ‘marketparticipant’, the lack of identical activelytraded investments, the concept of orderlytransactions and secondary marketconsiderations.

Response to the challenges

We are seeing some private equity housesand hedge funds applying significantresources to the valuation exercise,including the use of third-party experts. It isalso apparent that the level of internalchallenge on valuations involving pricing orvaluation committees is increasing.

There are clear benefits from a rigorous andregular valuation process, including theability for investment managers to:

Fair value challenges inthe current environment


• Communicate to investors where value isbeing added or lost over time in a fund byreference to the fair value of specificportfolio companies;

• Make informed decisions on entry andexit by understanding upside anddownside scenarios;

• Meet the requirements of IFRS and USGAAP accounting standards and thereforeto satisfy auditor review; and

• Produce regular valuations whereinvestors trade on monthly net asset value(NAV) in respect of open-ended funds.

Whether valuations are done in house or byan external party, we think that the followingare essential to a smooth process:

• Involve the investment manager –Do not leave the valuation in the handsof a member of the finance team alone,as they may not be involved in themanagement of the investment. However,be aware the dealmaker’s interpretationof fair value may not necessarily beconsistent with the requirements of IFRSor US GAAP.

• Document your rationale – All valuationsare underpinned by judgement – ensurethe thoughts and drivers are clearlydocumented and cover all key points.

• Sense check results – Think about anddocument how the proposed valuecompares to last year, recent transactionsand the entry multiple.

• Be consistent – Use the same valuationmethodology from one period to the nextand avoid changing approachesunnecessarily. This will help to identify realvalue movement.

• Consult – Developing a robust approachcan be time-consuming. Be sure you haveconsulted internally (and with externaladvisors) before developing the valuationprocess.

Conclusion

Historically, some private equity firms havebeen criticised for applying excessivecaution – quick to write down, slow to writeup. It is clear that such an approach isgenerally no longer consistent with GAAPand such practices are coming underincreasing scrutiny from investors,regulators and auditors who demand arobust assessment of fair value.

While this represents a challenge for allthose in the industry, a key positiveoutcome would appear to be an opportunityto maximise client retention. This is essentialfor any private equity company operating inthe increasingly uncertain and volatilemarkets today.

‘Fair valuing positionsis a big challengefor funds-of-funds.Typically funds-of-funds rely on thefunds’ fair marketvaluations.’ Christophe Florin,Managing Director of Asia,AXA Private Equity.

02 Analysis Addressing tax in awider worldThe increasingly global presence of fund managers, coupled withthe growing sophistication of tax authorities, makes building holisticinternal procedures to manage tax risk essential.

As their investment portfolios become ever global, private equity houses are confrontedwith increasingly complex tax risks and structuring challenges. The private equity industryhas undergone unprecedented global expansion in recent years and many of the newterritories in which funds are invested, or looking to invest, have relatively undeveloped(and in some cases unpredictable) taxation systems, particularly where international taxissues, such as permanent establishment (PE) and beneficial ownership are concerned.

In the more developed economies – which remain important markets for privateequity houses – tax risks are increasing, as we see a proliferation of audit activityaround transfer pricing, jurisdictional substance and PE, as well as a plethora of newanti-avoidance measures.

More positively, increased global competition has prompted many governments to introducefavourable provisions, exemptions and safe harbours in a concerted effort to enticeinvestment managers and funds onshore.

This article considers certain key tax risks and opportunities in the new global private equitylandscape. It offers some practical recommendations and perspectives on how privateequity houses can effectively manage these new challenges, as well as avail themselves ofcertain opportunities.


Oscar TeunissenPricewaterhouseCoopers (US)+1 (646) 471 [email protected]

Thomas GroenenPricewaterhouseCoopers (US)+1 (646) 471 [email protected]


The importance of managingtax risk

It is incumbent upon fund managers tomanage tax risk effectively on a global basisfor the funds they manage – not only todischarge fiduciary responsibilities they haveto investors, but also to avoid potentialfinancial loss and reputational damage.There have recently been a number of well-publicised disputes between fund managersand tax authorities around the world,resulting in unwelcome reputational damagefor the manager, even where the challengewas ultimately unsuccessful. In the mostserious of situations, noncompliance withlocal tax laws can lead to financial penaltiesor even jail time for executives.

A fund manager’s ability to manage tax riskis becoming an ever-important selectioncriterion for investors, who are becomingincreasingly sophisticated, knowledgeableand experienced. For example, we areseeing a greater allocation of funds fromlarge institutional investors.4 Further, theadvent of FIN 48 (which is relevant for thosefunds using US GAAP and discussed inmore detail below) has further heightenedthe importance of managing tax risk on aglobal and ongoing basis.

Managing ‘permanentestablishment’ (PE) risk

Investment capital and the management ofit are highly bifurcated functions in today’sglobal financial services world. Typically,private equity houses set up funds injurisdictions whose corporate lawenvironments are favourable and taxregimes flexible. The fund manager and itssub-advisory entities are usually formed inonshore jurisdictions, such as the UnitedStates or the United Kingdom, or, morerecently, in countries that are geographicallyproximate to the manager’s target markets(e.g. Brazil, Russia, India or China).Managing capital in a taxing environmentinvariably exposes the fund to a certaindegree of PE risk, i.e. the risk that a taxingauthority could deem the fund to have ataxable presence, either because itconducts its business through a fixed placeof business or through a dependent agent.5

Private equity managers have traditionallyestablished themselves in financial centressuch as the United States or the UnitedKingdom. However, with the increasingglobalisation of investment portfolios,investment professionals are beingdeployed on a more global basis,

particularly across the emerging markets,to go where the deal is. That is to say, theanalyst or portfolio manager may want to belocal to a specific deal, to be on the groundto take part in negotiations, to do physical,on-the-spot research or simply to be able toassess the deal in person without any timezone delays. Managers are now extremelymobile and often undertake their duties inmultiple locations throughout the year.A critical question is whether this behaviourcould create a taxable presence (i.e. a PE)for the lead manager, or, worse still, thefund, in these global locations? Given thedraconian consequences associated with aPE finding, managing PE risk should be atthe core of a manager’s overall riskmanagement strategy.

Mitigating PE risk:PE risks can be mitigated in various ways.The use of operating guidelines (curtailinglocal investment professionals’ authority andability to make decisions), as well as soundcorporate governance arrangements, aretwo common techniques. PE risk can alsobe mitigated by strategically deployingsenior investment professionals (e.g. thoseindividuals who have discretionary authorityto bind the fund) to jurisdictions thathave introduced trading safe harbours.

4 PricewaterhouseCoopers/Economic Intelligence Unitbriefing on Alternatives ‘Transparency versus returns:The institutional investor view of alternative assets, March2008 revealed a strong desire among investors for betterrisk management, controls and transparency.

5 In the international tax context, and in accordance withguidance issued by the Organisation of EconomicCooperation & Development (OECD), a dependent agentis generally considered to be a person who acts on behalfof a foreign enterprise and has, and habitually exercises,an authority to conclude contracts in the name of theenterprise.


Trading safe harbours are favourableprovisions that allow advisory entities to tradewith discretion on behalf of nonresidentfunds without creating a PE for the fund.

Trading safe harbours around the world arenot uniform. For example, certaininvestment transactions or asset classesmay be covered by the UK InvestmentManager Exemption, but not the Hong KongTrading Safe Harbour. Private equity housesshould look to take advantage of sucharbitrage opportunities, particularly intoday’s environment where deals arebecoming more esoteric and the financingof them more complex. Further, fundmanagers should continually monitor thescope of any safe harbour upon which theyrely, or they are considering relying on, asthe rules can and do change.6

In jurisdictions that do not have trading safeharbours, PE exposures are generallymitigated by limiting the activities of localinvestment professionals to research andperform other sub-advisory services.Operational guidelines are typically used todo this. From an operational (i.e. doingbusiness) standpoint, it is often desirable toimbue local investment professionals with acertain amount of authority to interact withlocal targets and shareholders. However,

negotiating on behalf of an offshore fund,even within clearly defined and limitedparameters, can in some jurisdictions leadto a PE finding. Certain countries, typicallythose in the emerging markets, afford localmanagers a certain degree of latitude tonegotiate within predefined limits (withoutcreating a PE for the fund). However, this isa contentious, and often grey, area ofinternational tax law that can be subject tosudden change and interpretation by ataxing authority. The ability to negotiatelocally should be reviewed on a case-by-case basis, in light of prevailing laws andpractice. Where a certain amount ofdealmaking authority has been delegated,the parameters should be very clearlydefined and documented. Should a localsub-advisor wish to exceed its imbuedauthority, it should do so only under explicitauthorisation from the lead manager, andsuch authorisation should be clearlydocumented. Depending on the jurisdiction,operating in this way may expose the fundto an unacceptable degree of PE risk andfund managers may wish to limit, in formand in substance, certain delegatedauthority.

Care must be taken when forming theinvestment committee (i.e. the body that

ultimately instructs the fund, or the generalpartner of the fund, to invest or divest).If locally based investment professionals,responsible for sourcing investmentopportunities, serve on the investmentcommittee, care must be taken as thisarrangement could expose the fund tobinding authority PE challenges in certainjurisdictions. Ideally, local investmentprofessionals should not serve oninvestment committees. If their participationis important from a commercial perspective– which can be the case – they shouldabstain from voting on any investments oropportunities that were within their sourcingmandate. Professionals based in certainjurisdictions should not be on theinvestment committee whatsoever given theunderlying risk and uncertainties.

Activities undertaken forportfolio companies:Directors or employees of the managementcompany will typically perform servicesfor portfolio companies, ranging fromdirectorships to active participation inday-to-day operational affairs. Such servicearrangements should be carefullystructured. Care should be taken todemonstrate that local investmentprofessionals are, in substance and form,

Addressing tax in awider world

6 For example, the Singapore safe harbour was recentlychanged with the issue of two circulars in June 2007 andAugust 2007. The new circulars abolished the ‘80:20 rule’and expanded the definition of designated investments.A qualifying fund will now be granted the exemptionregardless of the residency of its investors.

7 These provisions do not provide a safe harbour for certainactivities, but rather require that the investment managerin Japan is independent from the fund, requiring a case-by-case analysis.

8 Circulars were issued June and August 2007.


acting for, and on behalf of, the portfoliocompany, and not as representatives for thefund. Certain practical measures can betaken to evidence the former, for example,by ensuring that local investmentprofessionals enter into separate contractswith portfolio companies pursuant to whichthey (or the local sub-advisors by whomthey are employed) are remunerated directlyfor services rendered.

Opportunities:While global tax risk is arguably increasing,funds, fund managers and their principalshave been presented with a number ofopportunities in recent times. For example,in a quest to become financial centres ofchoice, certain jurisdictions have liberalisedtheir trading safe harbours, and in somecases introduced a plethora of domesticexemptions, designed to entice hedge andprivate equity managers to migrate orestablish their operations onshore.

Japan, for example, has recently introducedan independent agent exception, whichallows an independent agent to trade inJapan on behalf of a nonresident fundwithout creating an agency PE.7 Anattractive feature of this regime is the rulingprocedure, which can allow fund managersto operate with a high level of certainty.

Singapore has recently expanded thedefinition of ‘designated investments’ thatqualify for its fund regime and has simplifiedthe regime by abolishing the ‘80:20 rule.’8

A qualifying fund will now be grantedexemption, regardless of the residencystatus of its investors.

In Switzerland, while there is no trading safeharbour, per se, private equity and hedgefund managers can negotiate favourable taxrulings with the Swiss tax authorities, whichwill allow them to exercise discretionarytrading powers without creating a PE for theoffshore fund. There are also proposals tointroduce favourable rules governing thetaxation of income earned by private equityprincipals (e.g. carried interest) who resideand work in Switzerland.

Fund managers should consider the arrayof opportunities on offer, recognising thedichotomy that can exist betweenjurisdictions whose goal is to attract privateequity houses, and those who view theindustry as a target for raising revenues.

Managing tax residency risk

Tax residency risk, i.e. the risk that an entitycould be considered tax resident outside ofits jurisdiction of incorporation and subject

to tax on its worldwide income, is anotherimportant risk that private equity groupsshould carefully manage. If an offshore fundor special purpose vehicle (SPV) was foundto be resident outside of its country ofincorporation, the consequences could bedraconian – not least because anyincremental tax paid by the fund couldrepresent a ‘deadweight’ cost for the SPVand its investors.

While the criteria for determining taxresidency can differ across jurisdictions, it iscommon for a company to be considered atax resident in the jurisdiction in which it isincorporated and/or effectively or centrallymanaged and controlled.

Factors that can heighten taxresidency risk:Certain foreign taxing authorities havebegun to focus on residency as a potentialmeans to increase tax revenues and certainfact patterns may, or are more likely to,trigger residency inquires. For example,where some or all of the directors of anoffshore SPV reside in one taxingjurisdiction, directors who regularly travel toa particular jurisdiction and makemanagement decisions there, aconcentration of directors in one jurisdiction,or board arrangements under which

decision-making powers are not exercisedequally by all directors. In the UK, forexample, the revenue authority has alludedto the possibility that a foreign companycould potentially be considered a UK taxresident if UK resident directors routinelyparticipate in board meetings by telephonefrom the UK. Most tax practitioners wouldnow generally advise UK resident directorsagainst dialling in to board meetings fromthe UK.

Mitigating tax residency risk:Tax residency risk can be mitigated throughthe use of guidelines and sound corporategovernance arrangements. The best formof defence from any revenue authoritychallenge that a company is resident (say ina taxing jurisdiction) is to have a properlyconstituted board that holds genuine boardmeetings overseas with nonresidentdirectors, making real decisions that aredocumented. Further, there should beadequate guidance and controls in placeregarding the conduct of board meetingsand other management decision-makingactivities, reflecting any specific residencyrules in each of the relevant jurisdictions.


Transfer pricing

In recent years, transfer pricing (TP) hasattracted a lot of attention from taxingauthorities around the world, particularly inthe asset management space. A robust TPpolicy should be a critical component of anyglobal private equity manager’s overall taxrisk management strategy. While TP isprimarily an issue for the manager, in termsof how to allocate management andperformance fees across the managementcompany and sub-advisory structure on anarm’s length basis, in some cases weak orinadequate TP could adversely affect thefund. In Japan, for instance, where anindependent agent was introduced earlierthis year, TP for the investment manager isexpected to be critical to its application.

A recent judicial pronouncement in Indiafurther underscores the importance ofrobust TP, as an Indian court held thatwhere a foreign enterprise has a dependentagent in India (and thus an agency PE), thennothing further is taxable in India in thehands of the foreign enterprise if the correctarm’s length price is applied and paid. Asprivate equity houses expand their globalmanagement company footprint and deploymore senior executives to local sub-

advisory offices, fund managers shouldrevisit their TP models as historicmethodologies, e.g. cost plus may nolonger be appropriate; transfer pricing isneither an exact science nor a static target.

Treaty-based structures

Most private equity houses employ treaty-based structures to mitigate exposure tosource country taxation by investing throughtreaty-protected special purpose holdingcompanies. The use of SPVs to obtaintreaty protection and other tax benefits (e.g.reduced withholding taxes) is subject toever-increasing scrutiny by taxing authoritiesacross the world. In the UK, for example, anonresident treaty lender, who wishes to usea double-tax agreement to exempt UK-sourced interest payments from withholdingtax, must first obtain treaty clearance beforeinterest can be paid gross.

In India, the tax authorities have beenscrutinising private equity investments andhave been aggressively investigating dealsinvolving the transfer of interests incompanies with underlying Indianinvestments. In the high-profile Vodafonecase, the Indian tax authorities attempted totax a nonresident on the profit from the

transfer of shares in a Mauritius companyon the basis that the profit arose from theunderlying shares in an Indian company.The matter is currently pending before the Bombay High Court, and the Indian revenueauthorities have proceeded to issue noticesto several other multinational companies insimilar situations. In light of the prevailinguncertainties, fund managers should treadcarefully when structuring in to India.

Substance:A sustainable treaty-based structure is onethat has sufficient legal, operational andeconomic substance in the jurisdiction inwhich the SPV (or SPVs) is incorporated.If there is ‘insufficient’ substance in the SPV,a taxing authority in an investee jurisdictioncould seek to deny it treaty benefits andother domestic exemptions. The difficulty isthat substance requirements are determinedprimarily by the countries where the assetsare located, rather than by the territorywhere the entity is established. This makesit difficult to provide a universally accepteddefinition of substance as the requirementsvary from country to country.

Building sufficient substance for taxpurposes can give rise to practicaldifficulties and challenges, particularly asthere are no agreed-upon standards.9

Addressing tax in awider world

09 The term ‘beneficial owner,’ for instance, can be difficultto define. It is typically an undefined term in double-taxagreements, left to be interpreted under domestic law.The OECD Working Party 1 will be considering thedefinition of ‘beneficial owner’ as a result of some recentcases in this area. See, for example, the Indofood case inthe UK, where it was held that an interposed companywould not have been entitled to treaty benefits. IndofoodInternational Finance v. JP Morgan Chase Bank, [2005]EWHC 2103 (Ch.) rev’d [2006] EWCA Civ 158.

10 Prevost Car Inc. v. Her Majesty the Queen, 2008 TCC231. This case considered the meaning of the term‘beneficial owner’ in the context of Canada’s income taxtreaty with the Netherlands. A Dutch holding companyreceived dividends from a Canadian company and madedistributions to its shareholders in Sweden and the UK.The Canadian tax authorities attempted to deny benefitsunder the Canada-Netherlands treaty and levy the higherrates of withholding tax applicable under theCanada–Sweden and Canada–UK treaties. It wasultimately held that the Dutch company was in fact thebeneficial owner of the dividends and entitled to thereduced withholding tax rate applicable under theUK–Netherlands treaty. The court concluded that thebeneficial owner of a dividend is the person who‘assumes and enjoys all the attributes of ownership’ ofthe dividend.


Tax authority practice is a very importantaspect of determining whether the level ofsubstance in an SPV is sufficient, and treaty-based structures can be vulnerable tosudden changes in tax authority practice.What constitutes ‘sufficient’ substance ishighly fact-specific and must be assessedon a case-by-case basis. There are,however, certain best-practices that canbe implemented to evidence substance fortax purposes, for example, holding regularboard meetings in the jurisdiction ofincorporation, having local directors and alocal office with local employees. It is alsoimportant to respect the form of thestructure chosen and the underlyingtransactions. For example, ensuring thatfunds flow through local bank accountsowned by the SPV is very important.Further, following recent cases likePrevost,10 the SPV should have as much‘dominion’ and ‘control’ over the funds andincomes it receives; conduit arrangements,whereby the SPV is contractually compelledto pay out any income received, shouldbe avoided. The notion of beneficialownership in the international tax context isa fluid concept which fund managers shouldmonitor in light of their structures.

‘Super’ holding company platforms:Private equity houses have traditionallyemployed treaty platforms on an investment-by-investment basis. Building sufficientsubstance in each SPV can be challengingand in some cases simply not practical.For this reason, PE groups are nowconsidering the use of ‘super’ holdingplatforms where substance is built in a singleentity, rather than across many. If properlyimplemented, such a structure may be lesssusceptible to challenge by a foreign taxingauthority than the traditional multiple holdingcompany model. Private equity housesshould consider ‘super’ holding companystructures, recognising that poolinginvestments through a single holdingcompany can pose practical complicationsand fiduciary issues and may, depending onthe investor mix, be impractical.

FIN 48

The advent of FIN 48 (the FinancialAccounting Standards Board’s clarificationof accounting for uncertainty in incometaxes) has served to heighten theimportance of managing global tax risk, asprivate equity houses (whose funds use US

GAAP) must now formally document andassess their inventory of Uncertain TaxPositions (UTPs). The issues discussedabove – PE, residency, TP and treatyshopping issues – are all, by their nature,potential UTPs.

Investments in certain jurisdictions cancause specific issues from a FIN 48perspective. For example, for nonresidentfunds (hedge and private equity) makinginvestments in Australia, gains may beconsidered at Australian source andtechnically subject to tax at 30%. Inpractice, this tax may never be collected,yet an accrual could still be required forfinancial statement purposes, resulting in apotential noneconomic liability, whichdirectly reduces the fund’s NAV and couldcause a myriad of problems if the liabilitystill exists when liquidating the fund.

Despite the challenges arising from FIN 48,some would argue that the standard hasameliorated the operational effectiveness ofmany in-house tax functions, as companiesmust now evaluate potential tax issues on areal-time basis and not, as historically mayhave been the case, upon audit.

Outlook

As investors become more sophisticated,coupled with the arrival of FIN 48, fundmanagers are under increasing pressure toeffectively manage tax risk. The advent of globalisation has only confounded thischallenge, as fund managers are confrontedwith increasingly complex tax structuringand compliance challenges in emergingand, in some cases, frontier markets, as wellas disparate sources of tax risk, which theyare obligated to monitor and manage.

As taxing authorities become increasinglysophisticated, the risk of triggering a taxnexus or filing obligation in an onshorejurisdiction for the fund is only likely toheighten and, therefore, whatever FIN 48’sdestiny, fund managers across the globeshould build and develop robust internalprocedures to holistically manage tax riskand stay abreast of key developments in theterritories in which they invest or deployinvestment professionals. Fund managersshould also look to take advantage of theopportunities that have surfaced ascompetition between financial centres, toattract asset management firms, intensifies.

02 Analysis BRIC opportunities – andthe accompanying risks11

Fund investment in the fast-growing economies of Brazil, Russia,India, China (BRIC) and other emerging markets has been growingrapidly, as the data in the final section of this report shows.Furthermore, the expansion of private equity portfolio companies intothese markets has been pronounced.

With rapid economic growth and the expansion of the middle classes, private equity firmshave been attracted to these countries by the significant earnings growth prospects that donot exist to the same extent in developed countries.

Yet these opportunities are accompanied by a different set of risks to those experienced inEurope and the US. These business risks are specific to each country and generally relate toregulatory and fiscal regimes.

Clearly, all international private equity firms have needed a BRIC strategy over the past fewyears. At the same time, however, they have needed to be highly aware of the challenges ineach country.

The articles below outline the growth of each of these markets, and some of theissues faced.


11 Source of acronym: Dreaming With BRICs: The Path to 2050, Goldman Sachs, 1st October 2003


BrazilAfter a long period of improvingmacroeconomic fundamentals, Brazilachieved an investment grade credit ratingin April 2008, when Standard & Poor’sraised the country’s long-term rating toinvestment grade BBB-. This was granted inrecognition of sustained economic, fiscaland political stabilisation. Significantly, therate of inflation has been substantiallyreduced and the external current accountand public sector deficits have beenbrought under control.

Against this background, economic GDPgrowth was 5.4% in 2007 and the Brazilianreal appreciated strongly. Furthermore, therewas significant M&A activity, setting apositive context for private equity. Thenumber of announced deals increased by25% to 718, compared to 573 in 2006.Market data also indicates a stable dealflow for 2008, which is positive given theturbulent global financial conditions.

Private equity has been increasingly active,gaining share within the Brazilian M&Amarket. Our survey data shows the value offunds invested in Latin America rising anenormous 74% to US$35.61 billion.

Fundraising for dedicated regional/countryfunds climbed by 54% to US$19.20 billion.With Brazil by far Latin America’s largesteconomy, it has taken a fair share of thisamount.

Many of the global private equity giantshave entered the market – joining otherinternational and local players that havebeen investing for some time. All of thesefirms have been competing vigorously foropportunities among themselves and withstrategic investors.

A significant part of this activity has involvedconsolidation opportunities. In 2007, themain acquisition targets for funds were realestate/shopping malls, as well ascompanies in the construction, food andconsumer goods, IT, education, finance andmining sectors. Additionally, deal sizestarted to increase from the small- to mid-market transactions that have historicallydominated the market.

Modernised regulation

In the past three years, regulations havebeen improved, taking into account thesophistication and complexity of privateequity transactions today. Most importantly,

in 2004, the Comissão de ValoresMobiliários (CVM – Brazil’s financialregulator) introduced regulation of privateequity activity. This regulation requires ahigh level of corporate governance andtransparency.

Additionally, Brazilian authorities arefollowing the trend towards accountabilityand transparency seen in other countries.They are currently considering whatconstitutes best-practice for evaluatingprivate equity portfolio investments.

Improved tax treatment

Recently, Brazil’s high tax burden has beenreduced in order to encourage investment.This particularly affected Brazilian privateequity funds and foreign investments madein the stock market.

Broadly speaking, provided some specificrequirements are followed, the incomederived from private equity funds – paid,credited or remitted to nonresidents – isexempt from taxes in Brazil. Certainly, thismore favourable tax treatment to foreigninvestments has encouraged the growth ofprivate equity.


Conclusion

In the first months of 2008, private equityinvestment activity gained momentum, evencompared with 2007’s high level. EconomicGDP growth is expected to be in the regionof 4.5% and the market is excited aboutconcentration opportunities and the ‘new’credit market (i.e. the availability of credit inthe real estate and auto markets, withassets being financed for the long term atreasonable interest rates).

The main sectors for investment are likely tobe healthcare and outsourcing services,agribusiness/ethanol and biotechnology,real estate/shopping malls, food andconsumer goods, IT, education and finance– these last ones for consolidation/bolt-onstrategies. Infrastructure, given Brazil’spublic sector deficit, is also a sector wherethere may be opportunity.

There is, however, no certainty that Brazil,along with all other countries, will not beaffected by the credit crisis. Furthermore,trends in inflation and commodity pricesmay impact economic growth. Longer term,however, the government’s hard-woneconomic reforms remain in place, andthere is a substantial amount of privateequity capital waiting to be invested.

Alexandre PierantoniPricewaterhouseCoopers (Brazil)+55 11 3674 [email protected]

João GandaraPricewaterhouseCoopers (Brazil)+55 11 3674 [email protected]

BRIC opportunities –and the accompanyingrisks


RussiaWith favourable macroeconomic conditions,Russia has been increasingly viewed as anattractive investment destination. It is notalways perhaps the simplest place globallyto invest, but the potential rewards canmore than adequately compensate for thenecessary additional effort.

The Russian economy for the last decadehas been a remarkable story of resurrectionand transformation. The economy hasgrown for the last five years at averageannual rates exceeding 7%. During thistime, the Russian rouble has alsoconsistently strengthened, as the country’sforeign currency reserves have grown fromUS$55 billion in 2003 to US$581 billion asof August 2008. In short, Russia hasbecome a more stable and extremelyprofitable place for business.

Prudent fiscal policy and sound economicreforms, such as the comprehensive taxsimplification, have supported thiseconomic renaissance. And public andprivate investment in infrastructure andconstruction has increased the economy’sefficiency. Rising real wages are drivingstrong consumer demand. Further, Russia

has benefited from rising global demandand prices for the many commoditiesit produces.

Consequently, rapid growth, high marginsand low competition – and numerousattractive target opportunities – add up toan attractive environment for private equity.Since foreign direct investment has beencomparatively low and the consolidationprocess still under way, there are manyfirst mover advantages for new entrants.Private equity investors can still makesubstantial gains from introducing higherquality management and controls. In moredeveloped markets, operational gainsoften come from cost-cutting measures –in Russia the major challenges arefrequently coping with growth and withupgrading technology.

Although the world financial crisis is alsoaffecting Russian companies’ liquiditypositions, it may reduce valuations ofRussian companies and open upopportunities for private equity to financecompanies that were previously planning toraise finance through initial public offerings(IPOs) or have outstanding short-termdebt instruments.

Private equity expansiondominated by local players

The Russian private equity market hasgrown rapidly over the last five years.Transactions have become larger, reachingan average of US$60 million in the first eightmonths of 2008, and the number of dealshas steadily risen, with 28 closed.12 Localplayers have dominated so far, with anestimated US$10 billion under management,but potentially as much as US$40 billion attheir disposal. Some are arms of investmentbanks. Others are connected to leadingfinancial industrial groups.

However, foreign players have struck manyof the largest private equity deals. Thelargest was the April 2008 US$800 millionacquisition by a US buyout group of a 50%stake in SIA International, Russia’s largestpharmaceutical distributor. Prior to this, thelargest private equity transaction was theOctober 2007 US$500 million acquisition ofNidan Soki, Russia’s leading juice producer,by a UK buyout specialist. However, mosttransactions have ranged between US$10million and US$50 million. The most activesector has been consumer products andretail, but activity has been robust also in

infrastructure, manufacturing, constructionand real estate, and financial services.

Five challenges when closingprivate equity deals in Russia

Yet Russia presents substantial challengesas well as compelling opportunities. Privateequity firms should be prepared tounderstand these challenges and adjusttheir business approach in order to addressthem successfully.

1. Local business practice and culturewill significantly influence the structureand timing

An understanding of ‘soft’ or culturaldifferences is often a key to success innegotiations with vendors. Proper duediligence is even more important in Russiathan in developed markets in order to havea clear picture of a company’s finances,operations and competitive position.

12 www.capitaliq.com


Many targets are unfamiliar with the duediligence process and are often surprised atthe detailed list of documents they have toprovide. Inexperienced vendors tend to relyon the private equity firm to arrange adviceon the transaction structure as well as howto address historical tax risks, identifiedduring the due diligence. Targetrepresentatives may have limited experienceof dealing with international holdingstructures. Commonly, Russian targetsprefer Cyprus or Cyprus-BVI as a locationfor holding companies, and rarely haveexperience with the Netherlands orLuxembourg.

Also, dealmaking can be more complex andtake longer than in other, more orthodoxmarkets. Some regulatory processes (e.g.anti-monopoly clearances) may play asignificant role in the transaction timing.

2. Anticipate a higher level of uncertainty

It is important to understand that taxlegislation in Russia was put in place onlyapproximately 15 years ago and is stilldeveloping. Lack of official interpretations,guidelines and precedents add to theuncertainty in assessing tax risks associatedwith investments.

Typical tax issues related to leveragedbuyouts (LBOs), such as deductibility ofinterest on acquisition debt and VATtreatment of transaction costs are often notexplicitly covered by the legislation. Thetreatment is, therefore, based on generalprovisions of the law, which are sometimesambiguous.

Determining market level interest rates onshareholder loans and guarantee fees,which is usually required in LBOs, is also achallenge in countries where limited publicinformation is available. In particular, taxauthorities sometimes do not understandthe underlying concepts of pricing debt,different levels of security, subordination ofloans and other factors, which explain thevariance in interest rates on different typesof debt.

Binding rulings, which are widely used inWestern Europe, are usually not available inRussia. To keep risk at a reasonable level itis crucial to understand both the wording ofthe law and the approach of the taxauthorities, as well as the trends inlegislation and practice. Upfront discussionswith the tax authorities are largely unhelpful,because of their inexperience, somewhatbureaucratic approach and propensity tochange their opinions later.

Tax risks are an important area of focusduring the due diligence, since aggressive‘tax optimisation’ methods applied bypotential targets often result in substantialhistoric tax risks for buyers. To decrease taxobligations, companies sometimes transactbusiness through SPVs at non-marketprices. Even companies that prefer tooperate transparently are sometimespressed to engage in such practices, merelyto remain competitive in the marketplace.Such practices can distort the financialcondition and performance of theenterprise, making valuation of potentialacquisitions more difficult.

However, the extent of aggressive taxavoidance schemes began to fallsubstantially after 2005. This is particularlyimportant, as the statute of limitations formost tax-related matters is three years; soas of this year, the potential tax exposure forpast transgressions is substantially reduced.Another way to minimise exposure tohistoric tax risks is through carefulstructuring of the transaction. For example,it is possible to purchase only selectedcompanies or assets, leaving potentiallyriskier elements of the business outside ofthe transaction.



3. Presume complex debt pushdownstrategies

Pushing debt down into the operatingcompanies is a typical requirement oflending banks, since they require directaccess to cash for debt servicing and to theassets in the case of default. Moreover, thetax savings from deduction of acquisitiondebt interest at the level of operationalcompanies may have a considerable impacton the economics of the deal for privateequity investors.

Tax grouping, one of the simplest methodsfor achieving tax deduction of interest onacquisition debt in Western Europe, isnonexistent in Russia – although there isdraft legislation that may introduce it soon.

Traditional debt pushdown techniquesgenerally do not work, mainly for accountingand legal reasons (for example, technicalinsolvency). Therefore, more complexalternatives need to be devised, ofteninvolving group restructuring at acquisition.This significantly affects the timing of thetransaction and may increase overall risk.

This is one of the reasons why, unlike inmore mature markets, leverage is notcommonly used. However, historically,

growth rates have been high enough thatleverage is not actually a critical element tomake a deal profitable. In addition, financingis less readily available, as Russia has notyet developed high yield bond or mezzaninefinance markets. Eventually, however, as theRussian market matures, leveraged dealswill probably become more common for thesame reasons leverage is a value driverelsewhere.

4. Manage cash flows with more care

While the deal structure usually does notdirectly affect the generation of cash fromoperations, it may significantly affect thepracticality of moving cash quickly forservicing the debt. If the acquisition loan isprovided to a holding company, the legalrestrictions on paying dividends and makingother cash transfers from operationalsubsidiaries to the parent company need tobe taken into account.

Since Russia is not part of the EU, it cannotrely on the EU Parent-Subsidiary Directiveto avoid taxation of distributed dividends.Therefore, the double-taxation treatynetwork and withholding tax rates oninterest and dividend payments must betaken into account when developing holdingand financing structures. This ensures

minimal tax leakage at completion, duringthe life of the investment and upon exit.

Cyprus is a commonly used jurisdiction; inmany cases the targets already have Cypriotholding companies. However, other popularlocations for intermediary holding andfinancing companies are also possible, e.g.the Netherlands due to their beneficialholding regimes.

5. Expect more complex securitypackages for banks

The provision of debt financing isconditional on providing an adequatesecurity package to banks. This is mostcommonly achieved through a combinationof pledges on shares and assets, andprovision of guarantees, ideally by targetcompanies.

On the one hand, Russia does not have anyfinancial assistance rules, which oftencomplicate structuring security package insome European countries. On the otherhand, banks typically require that extensivecross-guarantees be provided byoperational and holding companies. InRussia, the tax treatment of provision ofguarantees free of charge is unclear andmay lead to a tax exposure. In addition,

cross-guarantees within the group exposesome loans from third parties to thin-capitalisation restrictions, whereas normallythis would not be the case.

Conclusion

There are plenty of opportunities for privateequity in today’s Russia, as long asinvestors understand and mitigate the risks.Doing so requires patience, careful studyand due diligence, and advisors who knowthe local market and conditions.

Galina NaumenkoPricewaterhouseCoopers (Russia) +7 495 232 5784 [email protected]

Andrey Shpak PricewaterhouseCoopers (Russia)+7 495 967 6244 [email protected]

Richard Gregson PricewaterhouseCoopers (Russia)+7 495 967 6327 [email protected]


IndiaIndia is a trillion-dollar economy and a majoremerging global market. Economic GDPgrowth has been 8-9% for each of the lastfour financial years, making India one of theworld’s fastest growing economies. Thegovernment has targeted an annual growthrate of 9% till 2012, although it has revisedits GDP estimate to 7.8% for FY09.

Healthy characteristics of India’s growthhave been the consistently increasingsavings and investment rate, as well as itsbroad-based nature. Both ‘new economy’industries like information technology andbiotechnology, and ‘old economy’ sectorslike metals and capital goods havebeen major contributors. Signifying thestrength of India’s economy, by May 2008foreign exchange reserves reachedUS$316.2 billion.

There is a rising middle class and largeworking age population. Roughly a quarterof the world’s population under the age of25 live in the country – and 80% of Indiansare under 45. The BRICs report13 estimated that India’s working-age population (15–60 years) would peak around 2020 at just over

60% of the total population – continuing for15 years before declining.

India is the third largest economy in theworld in terms of purchasing power parity.And McKinsey & Co predicts that if Indiacontinues its current growth path, it maybecome the world’s fifth largest consumermarket by 2025.

Private equity doubles in a year

Such rapid growth has caught the attentionof global and domestic private equityplayers alike, leading to an upsurge in theactivity from 2004. In 2007 alone, privateequity investment rose by a staggering136% to US$17.5 billion.14

During 2005 and 2006, activity was primarilyconcentrated around IT and outsourcing.However, since then sectors like engineeringand construction, banking, financialservices, insurance, manufacturing, energy,real estate and telecom have all becomeactive. There has also been progress in thedevelopment of infrastructure projects,especially in transport, power and telecom.

A number of international private equityfirms have entered the market in recentyears – both large houses and smaller

mid-market firms. At the same time, somelarge Indian firms have been established.

Investments have included late stage,venture capital and private investment inpublic entities (PIPE).

Respectable returns have been achievedover the past two years (2006 and 2007),encouraging more investment. Furthermore,the average deal size has increasedremarkably from about US$16 million in2005 to US$36 million during 2007.15

Regulatory aspects

Private equity funds are controlled byregulations, which specify how and wherethey can invest.

Foreign Direct Investment:Most private equity funds make foreigndirect investment (FDI) under the automaticroute, which does not require any priorapproval. There are exceptions, however.Some sectors investments have caps oninvestment (e.g. 26% in insurance, 74% inbanking, etc.). And in others, specificconditions must be satisfied (e.g.construction development projects,non-banking finance companies). FDI isprohibited in a few sectors (such as


13 Dreaming With BRICs: The Path to 2050, GoldmanSachs, 1st October 2003.

14 PricewaterhouseCoopers/AVCJ Guide to Venture Capitalin Asia.

15 Venture Intelligence.


multi-brand retail trading, gambling andbetting, etc.) and in certain other sectors(such as broadcasting, courier services,print media, etc.), it is only allowed with theapproval of the Foreign InvestmentPromotion Board (FIPB).

Foreign institutional investors:Foreign institutional investors (FIIs),including private equity funds so registered,investing in the public markets, have tocomply with the Securities and ExchangeBoard of India (SEBI) (Foreign InstitutionalInvestors) Regulations, 1995. These limitFII investment in an Indian company to10% of the capital, and limit the aggregateinvestments of all FIIs and its sub-accountsto 24%, the latter limit being amenable tomodification subject to sectoral limits.

Foreign venture capital investors:Foreign venture capital investors (FVCIs) aregoverned by the SEBI (Foreign VentureCapital Investor) Regulations, 2000, whichrequire at least two-thirds of all investmentsto be made in unlisted equity shares orequity-linked instruments. Under this route, a foreign investor registered as an FVCI caninvest in a Venture Capital Undertaking,either directly, or through a DomesticVenture Capital Fund. The FVCI structurehas advantages over the pure FDI structure,

including exemption from certain pricingguidelines prescribed by the Reserve Bankof India. Further, while SEBI guidelinesfor public share issues require a minimumone-year lock-in after IPO, FVCIs areexempted from this lock-in requirement ifthey have held the shares for at least oneyear before the IPO. They can, therefore,exit immediately.

Taxation aspects

Mitigating the risk of PermanentEstablishment (PE) status arising is essentialif a fund is to avoid paying local tax.In particular, it is important to take caresince more value-added asset managementfunctions are being carried out in thecountry. The structure and operations of thefund, the asset management company andthe Indian adviser all need to be carefullyconsidered. As an observer member in theOECD, India has provided comments inthe 2008 update of the OECD Model TaxConvention. Some of these commentswhich impact the PE status deviate fromOECD positions and need to be carefullyconsidered while structuring investmentsinto India.

‘Private equity willbecome a moreimportant source ofcapital going forward –given it is stable andlonger term in naturecoupled with the factthat a lot of alternativesources such as hedgefunds and proprietaryinvestments by bankswill certainly be hiton account of therecent crises.’Amit Chandra, Managing Director,Bain Capital Advisors (India)



A recent telecom deal has brought to thefore a new tax issue. India’s revenueauthorities have sought to tax the capitalgains arising on the sale of shares of anoffshore holding company, claiming that thecontrolling interest in an Indian telecomcompany was being transferred. The case iscurrently being contested before the IndianCourts. In the interim, one needs toconsider its implication while structuring theinvestment into India.

The Apex tax court in India, a few yearsago, rendered a landmark ruling where itaccepted the tax residency certificate assufficient evidence to claim treaty benefits.Newspaper reports have however surfacedtime and again around negotiations oftreaties offering capital gains tax protection.Recently, another favourable ruling wasdelivered where the court held that thepayment of a correct arms-length price by aforeign entity to a dependant agent in Indiawould mitigate any further tax liability to theforeign entity.

Outlook

The current turmoil in global financialmarkets is bound to adversely impactoverall investment sentiment and private

equity inflows into India in the next fewmonths. Private equity in India has presentlyadopted a cautious wait-and-watchapproach. However, private equity isexpected to continue to be active, giventhat the long-term India story remains intactand the Indian economy will continue to beattractive, clocking higher growth ratesrelative to the mature developed economies.Further, a strong demand for stable capitalby Indian companies to fund their high-growth plans, an uninspiring IPO market,high interest rates and an expectedreconciliation by Indian promoters to thenew market realities, will all support privateequity’s growth trajectory. This will continueto be maintained in the future…albeit, at aslower pace in the short- to medium-term.

Bimal TannaPricewaterhouseCoopers (India)+91 22 [email protected]

Gautam MehraPricewaterhouseCoopers (India)+91 22 6689 [email protected]


ChinaFamously, the country’s growth rate hasbeen sustained at a high level since thegovernment introduced free market reformsin 1978. In 2007, GDP growth was 11.4%.

China’s rapidly expanding middle class, andincreasing disposable wealth, provide ahealthy long-term backdrop for manycompanies – particularly those targetingdomestic consumption such as food,beverage, entertainment and constructionand infrastructure. Additionally, the Chineserenewable energy industry is becoming asignificant exporter.

The economy is not immune, however,from global financial markets and inparticular the impact of rising commodityprices. Furthermore, it has to deal withrising labour costs, following theintroduction of the new labour law at thebeginning of 2008. These factors are drivingsignificant cost pressures, which need to befactored into the growth story.

Opportunities in a complex market

In spite of the country’s rapid growth,private equity investment only increased by3% to $10.62 billion in 2007, according toour survey data. Capital raised for investingin the country climbed by 19% to US$11.0billion. For private equity investment, Chinawas ranked seventh in Asia during the year.

The 2006 and 2007 bull market in equitiesreduced the attractiveness of private equity,as high valuations – 40x price/equity ratios –were routine for IPOs. Coupled with thelarge amount of money targeting too fewChina opportunities, this lifted assetvaluations to levels that many private equityhouses found unattractive.

Since November 2007, however, capital hasbecome less freely available. Domesticequity markets have fallen significantly andcompanies are willing to sell at morereasonable valuations. Furthermore, bankliquidity has been tight, following successivehikes in interest rates and increases in bankreserve ratios – although this trend may bereversing with the first rate cut in six yearsamid the market turmoil in September.

Controlling interests are difficult to acquire,as entrepreneurs often have no need to sellout and, broadly speaking, have yet to facesuccession issues. For this reason, themajority of deals are in the venture andgrowth capital categories – with buyoutsgrowing, but still relatively uncommon. Withequity markets depressed, private equityinvestors are increasingly looking at public-to-private transactions and consideringbacking the long queue of companies thatdid not manage to list their shares in the bullmarket. Investing in state-owned-enterprises (SOEs) remains a challenge forforeign investors, due to local sentiment andgovernment regulations.

The domestic private equity industry isdeveloping rapidly. Certain financialinstitutions are allowed to make proprietaryprivate equity investment. Provincial andmunicipal governments in more affluentareas are investing a small amount of theirsubstantial reserves in local companies, andSOEs are making strategic investments intononcompeting companies and domesticindustrial funds.


The private equity market is largely shapedby the participation of three types of players– large international private equity houses(foreign funds), domestic boutique fundhouses and large domestic onshore fundssuch as industrial funds, institutionalinvestors and the sovereign fund (domesticfunds). Both the foreign funds and thedomestically based boutique funds houses,which traditionally offer offshore products,are increasingly looking to set up onshorerenminbi funds to tap into the plentiful localcapital and to remain competitive inexecuting deals (see ‘International firms faceregulatory disadvantage’).

Some foreign private equity players havepartnered with large domestic players withextensive local connections. Deal sizes tendto be smaller for domestic private equityplayers – frequently below US$10 million.Foreign private equity investments tend tobe larger. A few leveraged buyouts havebeen completed, but they are usuallyfunded offshore.

International firms face regulatorydisadvantage

Due to its soaring trade surplus thegovernment continues to tighten controls onforeign capital inflows, which is slowing theinvestment process for overseas investors.To mitigate this problem, some internationalprivate equity firms are establishingrenminbi-denominated funds. Even so,restrictions on what they can invest in, andthe proportion of foreign capital they canaccept, remain major hurdles.

During 2007, new regulations wereintroduced to encourage private equity.These allowed qualified domestic securitiescompanies and certain insurancecompanies to invest in private equity.Additionally, a new limited partnershipstructure was created (comparable to thepartnership law in many other countries),which many domestic funds are adopting.However, this structure does not allowforeign investors to participate as limitedpartners. Additionally, most domestic privateequity funds still use a limited liabilitycompany structure because the regulatoryframework for limited liability companies ismuch more developed.

Most international private equity firms havetended to invest through SPVs, based in alow-tax offshore jurisdiction, for exampleBarbados or the Cayman Islands. Morerecently, though, Hong Kong has updatedits tax treaty with Mainland China, and isbecoming a popular domicile. This isparticularly the case following theintroduction of a new PRC corporateincome tax law, which no longer offerswithholding tax exemption on dividendrepatriation. Effective 1 January 2008, theChinese government introduced a 10%dividend withholding tax on repatriation ofdividend income to foreign investors fromChinese corporates; however, there is apreferential treaty rate of 5% for paymentsto Hong Kong.

Investing as a foreign fund via an SPVstructure requires a longer timeline forregulatory approvals than would be typicalin Europe and the US. Even incorporating alocal fund using a limited partnership of aforeign-invested venture capital enterprisedoes not entirely level the playing field withdomestic players. Typically, joint venturepartners are used by foreign investors toleverage their local experience.



Due diligence is typically more time-consuming and deeper in China, as thequality of financial information is generallypoor and significant, tax, employee,social welfare and other exposures arenot uncommon. Additional time is oftenrequired around intellectual property rights,and the various required licences and landuse rights.

Local governments may affect the localoperations of renminbi funds, due to theirinexperience in dealing with such funds,especially in the area of taxation status.This may discourage investment, or distortreturns over the investment cycle.

Conclusion

There are considerable opportunities forprivate equity as China’s economycontinues to grow rapidly and sectorscontinue to open. However, there areregulatory and due diligence issues toovercome. Deal sizes are continuing toincrease and there are signs that controldeals, once considered too risky, maybecome more common, although buyoutswill remain the exception until the local debtmarkets fully mature.

Shirley XiePricewaterhouseCoopers (Hong Kong)+852 2289 [email protected]

Matthew PhillipsPricewaterhouseCoopers (China)+86 21 6123 [email protected]

‘Every time we lookat investing in abusiness, we askourselves what theimpact of Asia is on it.Is Asia a threat or anopportunity?’Marc St John, Partner,CVC Capital Partners

03 Statistics StatisticsPricewaterhouseCoopers’ most recent survey of private equity datafrom across the world confirms the rise of the emerging markets as adestination for private equity investment. It also illustrates the generallybuoyant level of private equity activity globally, as at the end of 2007.

Demonstrating the rapid growth of private equity investment in emerging markets, eight outof the ten fastest growing countries for private equity investment in the ten years to end2007 were either from the Asia Pacific or Africa (the data does not break out Latin Americaor Eastern Europe by individual country).

In 2007, India ranked third in terms of funds invested with US$17.5 billion invested,representing a growth of 136% over the previous year. China ranked third, with US$10.62billion invested, although the year-on-year expansion here was only 3%.

In Asia Pacific as a whole, private equity investment rose by 36% to US$86.3 billion in 2007,which was equivalent to 0.68% of GDP – almost as high as in North America, the home ofprivate equity.

Global growth

By comparison, approximately US$297 billion of private equity was invested globally in2007, over a quarter more than the US$235 billion invested in 2006. As a percentage ofglobal GDP, 2007 investment was equivalent to 0.55%.



Fundraising reached a record US$459 billionglobally for 2007, rising 5% to exceed eventhe US$437 billion total for 2006. Our surveydata details activity in 2007, and provideswhat is probably the most comprehensiveglobal picture of private equity activity.We aggregate the data from leading industrysources across North America, Europe, AsiaPacific, Central and South America, and theMiddle East and Africa.

As such, we are able to provide detailedregional comparisons of data. Our datatracks investment and fundraising backover 10 years, to 1998. It shows thatglobal annual investment has grown ata compound average rate of 17.44%since our data collection started in1998 when investment was US$70 billion.Fundraising has expanded at the slightlylower rate of 14.70%.

Rise of emerging markets

The most striking finding from the report isthe continued rise of the emerging marketsas investment destinations. In addition toIndia and China’s rises as investmentdestinations, the following countries standout: Malaysia (+608% to US$5.40 billion),Singapore (+157% to US$5.35 billion),

South Africa (+270% to US$4.65 billion) andHong Kong (+220% to US$2.87 billion).

The amounts invested in individual countrieswere small by the standards of today’s hugetransactions, but they undeniably show asignificant shift in investment. Once again,investments made exceeded locally raisedfunds, showing that capital has beentransferred from North America and Europeover the study period of 1998 to 2005. Forexample, in the Asia Pacific US$265.77billion was invested in the 10-year period,compared with just US$190.68 billion offunds raised.

North America remains largestmarket – and primary sourceof funds

North America remains far and awaythe largest private equity market.Funds raised continued to climb in 2007to US$302.8 billion, a rise of 18% on 2006.Some US$107.1 billion was investedin the country, up 35% on 2006. Thiswas equivalent to 0.71% of NorthAmerican GDP.

Reflecting its position as the most matureprivate equity market, the annual compoundaverage growth rate for investment from1998 to 2005 was just 11.50%. Fundsraised expanded at a higher rate of 13.63%as the continent exported capital to therest of the world. This average masksconsiderable volatility, with investmentpeaking at US$129.6 billion in 2000and touching a low of US$42.7 billion in2002. Funds raised peaked at US$180.5billion in 2000, but bottomed at US$57.1billion in 2002.

Europe stalls

European activity moved sideways in 2007,with US$86.5 billion of private equityinvested, up just 3% on 2006. Meanwhile,US$92.5 billion of funds were raised, down30% on 2006. Investment was equivalent to0.50% of GDP.

Buyouts grow – high-technologyand expansion capital are flat

Buyouts, the largest sector, were the onlysector to show material growth in 2007.Investment activity totalled US$197 billionglobally, up from US$146 billion in 2006.

Activity in high-technology and expansioncapital was static. High-technologyinvestment totalled US$84 billion in 2007,compared with US$82bn in 2006, whileexpansion capital totalled US$42 billion forboth years.

Over the period 1998 to 2007, buyoutinvestments expanded at an annual averagecompound rate of 23.06%. Expansioncapital investment grew at 8.23% andhigh-technology at 12.72%.

03 Statistics The world viewInvestment & fund raising trends

Full Year 2007

Main Headlines

• Approximately $297 billion of private equity and venture capital was invested globallyin 2007 – an increase of 26% on the 2006 level of $235 billion.

• This is equivalent to 0.55%* of the world’s gross domestic product.

• A record $459 billion of funds were raised globally in 2007 – up 5% from $437 billionin 2006.

Sub Headlines

• Technology investments totalled approximately $84 billion in 2007 – 28% oftotal investment.

• Approximately $42 billion was invested in expansion stages in 2007 – up 1.5% on2006 levels.

• Just under $197 billion was invested globally in buyouts in 2007 – an increase of 35%on 2006.

*Based on 2007 GDP, from World Bank Development Indicators – $54,347 billion

Note: Historical data has been revised based on amendments published in 2007. Data converted to US dollars using a fixedexchange rate from 1998 obtained from oanda.com.



North America

1. USA (1)

Europe

2. United Kingdom (2)

6. France (4)

8. Germany (9)

12. Sweden (8)

14. Netherlands (15)

16. Spain (13)

19. Italy (10)

20. Denmark (-)

Middle East & Africa

13. South Africa (18)

Asia Pacific

3. India (7)

4. Japan (5)

5. Australia (3)

7. China (6)

9. Malaysia (-)

10. Singapore (16)

11. Taiwan (11)

15. Korea (17)

17. Hong Kong (-)

18. New Zealand (14)

Central & South America

Note: Individual country data is not availablefor Central and South America.

The world view Top 20 Countries (Based on Investment)

Note: Figures in brackets indicate their position in 2006

Investments Funds raised

Investment: Compound average growth rate = 17.44%

Funds Raised: Compound average growth rate = 14.70%

Note: The data for Eastern Europe (investment only), Middle East & Africa and Central & South America has beenup-weighted to take account of under-reporting in these regions

Note: Israel did not raise any funds in 2002, but returned $145 million

Source: The PricewaterhouseCoopers/Venture Econmics/National Venture Capital Association MoneyTreeTM Survey /Thomson Financial / Buyout Newsletter / Private Equity Analyst / CVCA Annual Statistcal Review / EVCA Yearbook / AVCJGuide to Venture Capital in Asia / Venture Equity Latin America / LAVCA / SAVCA Private Equity Survey / IVC Online

Investment and fund raising trends (US$ billion)500

450

400

350

300

250

200

150

100

50

01998 1999 2000 2001 2002 2003 2004 2005 20072006

8887

177

262

133134

277

437

459

154

93117

112

157

297

235

191

70103

123


The world view Top 20 Countries (Based on Investment) US$ billion

Country Ranking Investment Value Funds Raised

1. USA 105.72 302.00

2. UK 40.10 48.52

3. India 17.51 5.94

4. Japan 14.71 4.62

5. Australia 14.61 6.46

6. France 14.40 7.68

7. China 10.62 11.00

8. Germany 8.73 6.63

9. Malaysia 5.40 1.29

10. Singapore 5.35 4.03

11. Taiwan 4.93 0.11

12. Sweden 4.89 5.49

13. South Africa 4.65 2.79

14. Netherlands 4.60 3.68

15. Korea 4.28 0.85

16. Spain 3.58 3.86

17. Hong Kong 2.87 15.52

18. New Zealand 2.73 -

19. Italy 1.71 2.82

20. Denmark 1.42 0.42

The world view % Change in Investment 06/07 US$ billion

Country Ranking Investment Value % Change

1. USA 105.72 +35%

2. UK 40.10 -16%

3. India 17.51 +136%

4. Japan 14.71 +28%

5. Australia 14.61 -12%

6. France 14.40 +22%

7. China 10.62 +3%

8. Germany 8.73 +112%

9. Malaysia 5.40 +608%

10. Singapore 5.35 +157%

11. Taiwan 4.93 +23%

12. Sweden 4.89 -2%

13. South Africa 4.65 +270%

14. Netherlands 4.60 +64%

15. Korea 4.28 +130%

16. Spain 3.58 +8%

17. Hong Kong 2.87 +220%

18. New Zealand 2.73 -8%

19. Italy 1.71 -57%

20. Denmark 1.42 +228%

Source: The PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree™ Survey /Thomson Financial / Buyout Newsletter / Private Equity Analyst / CVCA Annual Statistical Review / EVCA Yearbook / AVCJGuide to Venture Capital in Asia / Venture Equity Latin America / LAVCA / SAVCA Private Equity Survey / IVC Online



The world view Cumulative Investments and Funds Raised (98-07) US$ billion

Region Investment Value Funds Raised Overhang

Global 1,490.88 2,215.34 724.46

North America 709.83 1,410.92 701.09

Europe 451.91* 569.03 117.12

Asia Pacific 265.77 190.68 -75.09

Middle East & Africa 27.75* 25.51* -2.24

Central and South America 35.61* 19.20 -16.41

North America

Note: The US compound average growthrate is 12%. Canada compound averagegrowth rate since 1998 is 2%.

Europe

3. Denmark (56%)

6. Sweden (40%)

11. Spain (27%)

12 France (24%)

14. Norway (22%)

15. Finland (20%)

16. UK (19%)

17. Switzerland (17%)

18 Netherlands (16%)

19 Germany (16%)

20. Belgium (15%)


9. South Africa (31%)

Asia Pacific

1. India (79%)

2. Malaysia (67%)

4. Australia (53%)

5. Pakistan (51%)

7. Japan (36%)

8. Singapore (33%)

10. China/Hong Kong (29%)

12 Korea (24%)



The world view Top 20 Countries (Based on Growth – CAGR 98-07)

Note: Only countries with investments of at least $1.00billion shown – other than Pakistan which went down to$0.08 billion in 2007.

Note: *The data for Eastern Europe investment, Middle East & Africa and Central & South America has been upweighted totake account of under-reporting in these regions



The world viewHigh-technology investment trends

North America

1. USA ($35.49)

15. Canada ($1.18)

Western Europe

2. United Kingdom ($10.50)

5. France ($3.11)

7. Sweden ($2.52)

8. Germany ($2.18)

14. Spain ($1.20)

17. Netherlands ($1.03)

18. Switzerland ($0.71)

19. Denmark ($0.64)

20. Finland ($0.59)


13. Israel ($1.20)

Asia Pacific

3. India ($5.17)

4. Korea ($3.18)

6. Singapore ($2.89)

9. New Zealand ($2.13)

10. Japan ($1.93)

11. China ($1.41)

12. Hong Kong ($1.24)

16. Australia ($1.07)



The world view Top 20 Countries (Based on high-tech investment)

Please note 2007 high-tech data for Canada is not yetavailable. The Canadian estimate in this slide is based ondata for the previous 5 years.

Investments High-Technology


High-Technology: Compound average growth rate = 12.72%

Please not 2007 high-tech data Canada is not yet available. Estimated based on previous 5 years

Source: The PricewaterhouseCoopers/Venture Econmics/National Venture Capital Association MoneyTree SurveyTM /Thomson Financial / Buyout Newsletter / Private Equity Analyst / CVCA Annual Statistcal Review / EVCA Yearbook /AVCJ Guide to Venture Capital in Asia

High-Technology Investment trends (US$ billion)300

250

200

150

100

50

01998 1999 2000 2001 2002 2003 2004 2005 20072006

4258

119

2950

8284

5939 46

70

123

191

103

157117

112

87

235

297


The world viewExpansion investment trends

North America

1. USA ($10.85)

11. Canada ($0.78)

Western Europe


7. France ($1.22)

8. Spain ($1.03)

12. Germany ($0.75)


14. Sweden ($0.53)

17. Finland ($0.35)

18. Switzerland ($0.32)

19. Italy ($0.32)

20. Belgium ($0.26)


6. South Africa ($1.30)

16. Israel ($0.36)

Asia Pacific

2. India ($7.18)

4. China ($4.69)

5. Korea ($2.32)

9. Japan ($1.01)


15. Vietnam ($0.48)



The world view Top 20 Countries (Based on expansion investment)

Please note 2007 expansion data for Canada is not yetavailable. The Canadian estimate in this slide is based ondata for the previous 5 years.

Investments Expansion


Expansion: Compound average growth rate = 8.23%


Expansion Investment trends (US$ billion)300

250

200

150

100

50

01998 1999 2000 2001 2002 2003 2004 2005 20072006

2139

86

2129 42

4246

24

22

70

123

191

103157

117

11287

235

297


The world viewBuyout investment trends

North America

1. USA ($76.31)

Western Europe


4. France ($12.42)

6. Germany ($7.23)


10. Sweden ($3.82)

14. Spain ($2.10)

16. Italy ($1.30)

18. Denmark ($1.17)


12. South Africa ($3.02)

Asia Pacific


5. Japan ($9.68)

7. Malaysia ($4.80)

8. Singapore ($3.92)

11. Taiwan ($3.10)

13. New Zealand ($2.23)

15. Korea ($1.68)

17. Hong Kong ($1.25)

19. India ($0.97)

20. China ($0.82)



The world view Top 20 Countries (Based on buyout investment)

Investments Buyouts




Buyout Investment trends (US$ billion)300

250

200

150

100

50

01998 1999 2000 2001 2002 2003 2004 2005 20072006

73

324030

89

146

197

41 45

6670

123

191

103

157117

112

87

235

297


Data sources North America: The PricewaterhouseCoopers / Venture Economics / National Venture Capital Association MoneyTree™ Survey www.pwcmoneytree.com

Thomson Financial Investment Analytics Report (ad-hoc data)

Buyouts, a Venture Economics publication www.ventureeconomics.com

The Private Equity Analyst, published by Asset Alternatives, Inc., Wellesley Massachusetts www.assetnews.com

Canadian Venture Capital Association (CVCA) Annual Statistical Review, prepared by Macdonald and Associates Limited www.cvca.ca

Europe: European Private Equity and Venture Capital Association (EVCA) Survey www.evca.com

Asia Pacific: Asian Venture Capital Journal (AVCJ) Private Equity and Venture Capital Review 2008and estimates from the AVCJ www.asianfn.com

Private Equity Analyst, Thomson Financial www.thomson.com

Central/South America: Latin American Venture Capital Association www.lavca.org

Venture Equity Latin America Year-End Report www.ve-la.com

Middle East and Africa: The Kesselman and Kesselman PricewaterhouseCoopers™ MoneyTree Survey, Israelwww.pwcmoneytree.com

Israel Venture Capital Research Centre Annual Survey www.ivc-online.com

KPMG and the South African Venture Capital Association (SAVCA) Private Equity Survey www.savca.co.za

03 Statistics North AmericaFull Year 2007

Main Headlines

• $107.1 billion of private equity and venture capital was invested in North America in 2007– an increase of 35% on 2006.

• This is equivalent to 0.71%* of North American GDP.

• $302.8 billion funds were raised in North America in 2007 – up 18% on 2006 levels.

Sub Headlines

• Approximately $36.7 billion was invested in technology investments in North America in2007 – an increase of 17% on 2006.

• Approximately $11.6 billion was invested in expansion stages in 2007 – a decrease of 4%on 2006.

• Approximately $76.3 billion was invested in buyouts in 2007 – an increase of47% on 2006.


Data Sources:

The PricewaterhouseCoopers/Venture Economics/National Venture Capital Association MoneyTree™Survey www.pwcmoneytree.com

Thomson Financial Investment Analytics Report(ad-hoc research)

Buyouts, a Venture Economics publicationwww.ventureeconomics.com

The Private Equity Analyst, published byAsset Alternatives, Inc., Wellesley Massachusettswww.assetnews.com

Canadian Venture Capital Association (CVCA)Annual Statistical Review, prepared by Macdonaldand Associates Limited www.cvca.ca

*Based on 2007 GDP for USA and Canada, from World Bank Development Indicators – $15,138 billion

Note: Historical data has been revised based on latest amendments


300

250

200

150

100

50

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Investments Funds raised High-technology




Please not 2007 high-tech data Canada is not yet available. Canadian estimate expansion on this is baesd for based on data for previous 5 years

Source: The PricewaterhouseCoopers / Venture Econmics / National Venture Capital Association MoneyTree SurveyTM /Thomson Financial / Venture Economics Buyout Newsletter / Private Equity Analyst / CVCA Annual Statistcal Review

Investment trends by stage (US$ billion)140

120

100

80

60

40

20

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Investments Expansion Buyout



Buyout: Compound average growth rate = 17.40%

Please not 2007 high-tech data Canada is not yet available. Canadian estimate expansion on this is baesd for based on data for previous 5 years

Source: The PricewaterhouseCoopers / Venture Econmics / National Venture Capital Association MoneyTree SurveyTM /Thomson Financial / Venture Economics Buyout Newsletter / Private Equity Analyst / CVCA Annual Statistcal Review

19.1 39.944.5

91.4

23.8 24.4 23.9 26.4 31.3 11.0

40.2

78.3

129.6

59.4

42.7

61.9

46.5

107.1

36.740.2

78.3

129.6

59.4

107.1

79.664.6

46.550.6

61.9

42.7

95.9103.6

180.5

117.9

57.1 85.9

160.5

256.1

302.8

79.6

64.6

30.8

61.5

23.8

13.210.6 9.8 9.2 12.1

11.618.0 22.5 20.1 16.4

19.0

41.0

22.9 44.4

51.9

76.3

6%302.0

105.7

% stage of investment 2007 (US$ billion)

100

90

80

70

60

40

50

20

10

30

0

$107.1

2007

■ Early stage ■ Expansion ■ Other late stage ■ Buyout

Data for North America has been created by adding data from MoneyTreeTM / Thomson Financial and CVCA

Source: The PricewaterhouseCoopers/Venture Econmics/National Venture Capital Association MoneyTreeTM Survey /Thomson Financial / CVCA Annual Statistcal Review

Investments and funds raised by country 2007 (US$ billion)

280

3200.77%

0.81.4

0.10%

240

200

160

120

80

40

0

Investment as% of GDP

Total invested(billions)

USA Canada

■ Investments ■ Funds Raised

Total investment: $107.1

Total funds raised: $302.8 billion

Source: The PricewaterhouseCoopers/Venture Econmics/National Venture Capital Association MoneyTreeTM Survey /Thomson Financial / CVCA Annual Statistcal Review

12%

71%

11%

03 Statistics EuropeFull Year 2007

Main Headlines

• Approximately $86.5 billion of private equity and venture capital was invested in Europe in2007 – a 3.7% increase on 2006.

• This is equivalent to 0.50%* of European GDP.

• At least $92.5 billion funds were raised in Europe in 2007 – down 30% on 2006 levels.

Sub Headlines

• Technology investments in Europe totalled approximately $23.7 billion in 2007 – down15% on 2006 levels.

• Approximately $11.0 billion was invested in expansion stages in 2007 – a decrease of17.9% on 2006.

• The buyout market totalled a record $68.3 billion in 2007 – up 15.8% on 2006.


Data Sources:

European Private Equity and Venture CapitalAssociation (EVCA) Survey www.evca.com

Data converted to US dollars using a fixed exchangerate from 1998 obtained from oanda.com.

*Based on 2007 GDP for Europe as calculated using The World Bank Development Indicators – $17,137 billion

Note: Actual data shown – not upweighted nor including Russia. Data converted to US dollars using a fixed exchange rate from 1998 obtained from oanda.com.


304050607080

20100

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007





Source: EVCA Yearbook

4.7

23.816.9

29.441.0

28.5 32.3

29.8

56.346.9

32.4

31.7

34.1

32.2

43.3

84.1

55.1

131.5

83.492.586.5

7.5 17.1


2030405060708090

100

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007






5.1 9.4 8.0 7.3 9.2 12.0

37.630.2

21.619.812.816.915.5

8.716.9

29.4

13.3

59.0

11.0

68.3

86.583.4

55.1

43.334.132.428.5

41.0

15.28.711.0 9.1 11.3 13.1 17.2

27.9 23.7

4.64.98.7

14.4

40.1

% stage of investment (total invested - billions)

100

90

80

70

60

40

50

20

10

30

0

$86.5

2007

■ Seed ■ Start up ■ Expansion ■ Replacement Capital ■ Buyout


Investments by country (top 5)

501.47% 0.56% 0.26% 1.10%

40

30

20

10

0


UK France Germany Sweden Netherlands

Total investment: $86.5 billion

GDP*: UK - $2,727.9 France - $256.3 Germany - $3,297.2 Sweden - $444.4 Netherlands - $754.2

The top 5 countries account for 84% of total investment in Europe.

*Based on 2007 GDP, as calculated using The World Bank Development Indicators


79%

13%

5% 0.61%

03

03 Statistics Asia PacificFull Year 2007

Main Headlines

• Approximately $86.3 billion of private equity and venture capital was invested in the AsiaPacific region in 2007 – up 36% on 2006 levels.

• This is equivalent to 0.68%* of Asian GDP.

• $51.6 billion of funds were raised in Asia Pacific in 2007 – up 25% on 2006 levels.

Sub Headlines

• Technology investments in Asia Pacific totalled an estimated $19.2 billion in 2007 – down1.4% on 2006 levels.

• Approximately $17.3 billion was invested in expansion stages in 2007 – an increase of18.4% on 2006.

• The buyout market totalled $41.5 billion in 2007 – up 37% on 2006.


Data Sources:

Asian Venture Capital Journal (AVCJ) Private Equityand Venture Capital Review 2008 and estimates fromAVCJ www.asianfn.com

Asian Venture Capital Journal (AVCJ) Guide toVenture Capital in Asia and estimates from the AVCJfor previous years www.asianfn.com

*Based on 2007 GDP, as calculated using The World Bank Development Indicators – $12,435 billion

No GDP data available for Taiwan


80

70

60

50

40

30

20

10

01998 1999 2000 2001 2002 2003 2004 200720062005




Buyout: Compound average growth rate = 67.82%

Source: AVCJ Private Equity and Venture Capital Review

0.80.42.4

4.91.06.0

9.14.1 4.6 4.9

8.5 9.29.111.212.3

30.2

4.5

86.3

17.3

14.62.12.5

2.0


30

40

50

60

70

80

20

10

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007






1.8

16.6 17.911.2

9.912.39.17.4

4.9

9.1

17.6 18.1

33.6

86.3

5.64.0 5.2 3.0

3.7

19.2

51.6

Investment by trends stage (Total invested - billions)

100

80

90

70

60

40

50

20

10

30

0

$86.3

2007

■ Start-up/early stage ■ Expansion ■ Mezzanine ■ PIPE financing ■ Turnaround ■ Buyout


20%

48%

20%

8%

1

3

5.4

10.6

14.614.7

17.5

Investments by country (top 5)

201.50% 0.34% 1.78% 0.32%

18

6

8

10

12

14

16

4

2

0


India Japan Australia China Malaysia

Total investment: $86.5 billion

GDP*: India - $1,171.0 Japan - $4,376.7 Australia - $821.7 China - $3,280.1 Malaysia - $180.7

*Based on 2007 GDP, as calculated using The World Bank Development Indicators


2.99%

63.5

41.2

28.3

11.5

3.3

5.0 7.2 5.0

19.5

1.9

17.6 18.1

11.2

33.6

6.8

63.5

04 Disclaimer and contactsDisclaimer

This report has been prepared by PricewaterhouseCoopers International Survey Unit.The data presented in the report has been generated via a range of independent surveysand from other ad hoc sources of information. PricewaterhouseCoopers conducts surveysin the USA and Israel and data from these surveys has been used extensively within thisstudy. For these surveys, PricewaterhouseCoopers has taken responsible steps toensure that the information has been obtained from reliable sources. However,PricewaterhouseCoopers cannot warrant the ultimate validity of data obtained in thismanner. PricewaterhouseCoopers does not accept responsibility for the other data sourcesused in this study.

While PricewaterhouseCoopers has assembled the data, this has not been subject toindependent review or audit by PricewaterhouseCoopers.

PricewaterhouseCoopers does not accept responsibility for any of the data included in thisreport, nor responsibility as regards any use that could be made of the data contained inthis report by third parties.

Except to the extent prohibited by law PricewaterhouseCoopers and their relatedpartnerships and corporations, and their partners, agents or employees disclaim all liabilityfor any decision made or action taken or not taken by any person in reliance on theinformation in this report.



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