An exploration of tools of analysis commonly used by private equity in making investment decision

AN EXPLORATION OF TOOLS OF ANALYSIS COMMONLY USED BY PRIVATE EQUITY IN MAKING INVESTMENT DECISION

By

STEVE ARMAND BOYOM KOUOGANG

LSC STUDENT NUMBER: L0938FKFK0210

UWIC STUDENT NUMBER: 10008097

Presented as part of the requirement for the award of MBA at University of Wales Institute Cardiff (UWIC)

September 2011

ABSTRACT

The concept of investing behaviour regarded as a probable cause of the decline in the number of investment activities of venture capital over the last three years constitutes the background of this dissertation. Its aims are to investigate the classic tools of analysis, which could be found in the financial literature, when it comes to make investment decision. Another objective is to determine the applicable technique of evaluating flexible and reversible start-ups' investment proposals. The third aim consists of conducting a survey of venture capital analysts to find out their practice by way of capital budgeting for start-ups. The fourth is to suggest beneficial solutions to both parties involved in making such an investment decision, that is to say private equity analyst and start-up company. The research questions are: what are the classic methods capable of helping venture capitalist to make investment decision devoid of any flexibility with regard to start-up companies? In case the newly created firm's project gets some flexible and reversible aspects, how should the venture capitalist make investment decision? What can we learn from an inquiry into the practice of venture capitalist in the field of determining the investment decision for newly created companies? Are the findings from the investigation into the way the venture capitalists make investment decision in practice profitable to both the main players, namely venture capital firms and new entrepreneurs? Both discounted and non-discounted cash flow methods are usable classic methods for appraising newly created firms' capital expenditure. Moreover, in making flexible investment decision for start-ups, real options turn out to be suitable. Furthermore, it emerged from data collected with the help of an electronic questionnaire and analysed in accordance with the qualitative philosophy of research that 50 percent of private equity firms were more attracted by investing in Health care. Concerning the techniques used by venture capital analysts in making start up organisations' non-flexible capital budgeting decision devoid of any flexibility, we noticed that a third of those analysts said referring to NPV. Conversely, the revelation appeared to be that private equity analysts did make a sweep clean of the IRR technique in this respect. Thirdly, by way of making flexible capital budgeting decision for start up organisations, the NPV method was in the lead with 37.5% of use when real options only scored 12.5%.

AKNOWLEDGMENTS

We would like to extend our warmest thanks to all those people and firms whose reviews and suggestions contribute to the achievement of this dissertation.

TABLE OF CONTENTS

CHAPTER I INTRODUCTION................................................................................... 5

CHAPTER II LITERATURE REVIEW ....................................................................8

CHAPTER III RESEARCH METHODOLOGY ......................................................21

CHAPTER IV FINDINGS AND DATA ANALYSIS ...............................................31

CHAPTER V CONCLUSION AND RECOMMENDATIONS ...............................51

BIBILOGRAPHY..................................................................................................59

APPENDIX ............................................................................................................. .....63

CHAPTER I INTRODUCTION

1.1 RESEARCH CONTEXT

There are a number of venture capitalists whose aims are to provide capital to ventures, which failed to obtain funds from the conventional sources such as banks as suggested by Wright and Robbie (1998).This does not mean that nothing could be easier than being funded by venture capitalists for start-up companies. In fact, in accordance with the British Venture Capital Association (BVCA), «Private Equity and Venture Capital firms invested £7.5 billion globally in 2009, compared to £19.5bn invested in 2008 and £31.6bn in 2007. In 2009, 987 companies received private equity or venture capital backing, in contrast to 1,672 in 2008 and 1,680 in 2007» (Private Equity and Venture Capital Report on Investment Activity, 2009).

Clearly, the above figures suggest investment activities of venture capitals have declined significantly reaching a half comparing with what they were 3 years ago. To what could this drop attribute? Broadly speaking, some (such as «2009 Fidelity Investments Couples Retirement Study, Executive Summary» cited by Roszkowski and Davey, 2010, p. 42-43) have put all the blame on the 2008 global economy collapse. Whereas, other have pointed out the notion of risk, especially the concepts of «risk tolerance» and «risk perception» arguing that both of those risks determine investing behaviour (Roszkowski and Davey, 2010, p. 43). The topic of this research rests on this background. Having said that, what are the objectives of this dissertation?