A Comparative Examination of Private Equity in the United States and Europe: Accounting for the Past and Predicting the Future of European Private Equity

Article excerpt

ABSTRACT

Private equity has transformed from a small asset class into a major player in the global economy. Despite being a U.S. invention, the private equity model has also managed to spread throughout Europe. Recently, the spotlight has been put on the private equity industry for a number of reasons: the recent financial crisis; the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the U.S. and the Alternative Investment Fund Managers Directive in the E.U.; and the run of Mitt Romney, founder of the prestigious U.S. private equity firm Bain Capital, for President of the United States. Despite this attention, a comparative examination of private equity regulation is absent from academic literature. This paper seeks to fill that gap and offers a comparative assessment of the legal framework governing private equity firms and transactions in both Europe and the U.S. This comparative examination will reveal that Europe has a particularly restrictive legal environment, which one would assume would inhibit European private equity activity and cause it to substantially lag behind the U.S. Nonetheless, underlying economic forces have provided and continue to provide a boost to the European market, allowing Europe to compete with the U.S. on an equal footing. Unraveling these underlying economic forces shall be the other major goal of this paper. When it comes to European private equity, there is no causation between the strictness of the legal regime and economic development. Rather, economic development shapes its own path and is unaffected by the prevailing legal regime.

INTRODUCTION

Private equity has, for the first time, allowed ordinary citizens to act as the "capitalist" during one of capitalism's periodic frenzies of "creative destruction." This is giving the "little guy," via his or her pension fund, 80% of the upside in wealth creation that has historically been the exclusive preserve of the Rockefellers and Mellons of the world.

Thirty-four years after Kohlberg Kravis Roberts & Co. L.P. ("KKR") raised the first ever private equity fund to finance leveraged buyouts ("LBOs"),2 private equity firms are now widely regarded as the new kings of capitalism.3 Fueled by an abundance of liquidity in the financial system, private equity activity reached its greatest heights between 2003 and 2007. The peak of this period came in 2007, when an investor group led by KKR and Texas Pacific Group ("TPG") completed the buyout of TXU, which remains the biggest LBO in history.4 This golden era ended with the bursting of the housing bubble and subsequent credit crunch, which caused the collapse of the private equity market as bidders tried to terminate or renegotiate their pending acquisitions.5 Today, private equity activity has made some progress towards recovering but is still far from its heyday; this can be attributed to the current sovereign debt crisis in Europe as well as fragile debt markets, which further strain deal financing and evidence the dependency of private equity activity on credit market conditions.6 Nevertheless, the LBO association has managed to establish itself as a dominant organizational form providing an attractive alternative to the public corporation. Though Michael Jensen's famed 1989 prediction that the LBO association would eclipse the public corporation7 never materialized, the private equity model has successfully challenged the predominance of the publicly held corporation.

Private equity, a U.S. invention, gained mainstream attention during the takeover boom of the 1980s. According to Mitchell and Mulherin, 57% of large U.S. firms were either takeover targets or underwent a restructuring between 1982 and 1989.8 During this period, private equity received negative criticism due to its association with hostile takeovers and corporate bust-ups. However, in the years following, the private equity industry managed to disassociate itself from corporate raiders and their abusive practices, instead building the profile of a cutting edge industry that would promote U. …