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

As far as research processes are concerned, two major types of reasoning are on focus:

Relating to inductive reasoning, Walliman (2005) suggested that it consists of the «inference of a general law from particular instances. Our experiences lead us to make conclusions from which we generalize» (2005, p. 433). The inductive reasoning is also called «bottom-up» approach (Bennison, 2006).

With regard to the deductive reasoning, or «top-down approach», it works anticlockwise to that of the inductive does. In this view, its starting point is a theory or a general idea, which gradually becomes narrower down to hypotheses. These hypotheses are to be confirmed or not by data collected. Be that as it may, the framework of data collection and analysis could be in the form of some sorts of research designs.

3.4.2. Research designs

Under this subdivision, will be by turns examined the following wide range of research designs:

With respect to the experimental design, its aim is to examine causal relationship effect (Saunders, Lewis and Thornhill, 2007, p. 136). There are two types, namely the classic and the quasi-experimental design. Concerning the former, two groups on focus are established: a treatment group and a control group. Then people are randomly divided up to each group. There is a pre-text of each group before the experiment and at the end of the day, there is as assessment of dependant variable before and after the experiment. However, in case of quasi-experiment, there is no control group and the independent variable is measured before and after.

Concerning the cross-sectional design, it is often called «social survey design» because it does resort to survey strategy (Easterby-Smith, Thorpe and Lowe, 2002). According to Kumar (2010, p. 107), the cross-sectional design, also referred to as «one shot or statues study» constitutes the most famous design in the social sciences. Its objective is to depict variation between people for example, and in a single point in time. Also, the cross-sectional design is aimed at describing the impact of a fact or an occurrence that can be observed. Moreover, it intends to give an account of in what way factors are connected within an organisation as suggested by Saunders, Lewis and Thornhill, (2007, p. 148).

With regard to the longitudinal design, its aims are to track changes over time instead. Therefore, in accordance with that research design, «the study population is visited a number of time at regular intervals, usually over a long period» as claimed by Kumar (2010, p. 390) and Kumar (2008, p. 10). The longitudinal research design has the distinctive feature of allowing the researcher to manage variables that he concentrates mainly on as long as there is no influence of research process per se on them as argued by Adams and Schvaneveldt (1991).

Concerning the case study design, Robson (2002) conceives it as a «strategy for doing research which involves an empirical investigation of a particular contemporary phenomenon within its real life context using multiple sources of evidence» (Robson, 2002, p. 178). In 2003, the relevance of the concept of context has been put forward by Yin (2003). In fact, according to him, there is not a real watertight compartment between the phenomenon that is subject matter of the study and the context within which it is carried out. There are various sorts of case study designs. When a case study aims at the veracity of a hypothesis, it is called a critical case. However, when its purposes are to deeply understand a particular case on the one hand, and closely investigate an issue which has been neglected on the other hand, it is appropriately named unique case then. With respect to the unique case study, Saunders, Lewis and Thornhill (2007) have suggested triangulation as a method of data collection. The notion of triangulation is regarded as «the use of different data collection techniques within one study in order to ensure that the data are telling you what you think they are telling you.» (Saunders, Lewis and Thornhill, 2007, p. 139). For instance, it is possible to value a questionnaire as a technique of gathering quantitative data thanks to semi-structured group interview. Concerning the unit of analysis, Yin (2003) distinguishes «embedded case study» from «holistic case study». The former consists in investigating some sub-units of a firm, such as departments or teams whilst the latter intends to examine the whole organisation instead.

Relating to the comparative design, it tends to give accounts for similarities or differences in order to encourage comprehension. In doing so, Bennison (2006) suggested the recourse to cross-sectional techniques like cross national, cross cultural, cross organisational, cross cultural, cross divisional methods.

In any case, whatever the research designs might be, the researcher needs to collect data.

To start with, it is worth saying that data can be described as «a series of facts that have been obtained by observation or research and recorded» (Bocij et al., 2006, p. 794). Concerning data collection methods, they could be identified according to the type of research strategy or design the work has adopted. Under this section, shall we say, the «Ariadne's thread» is to distinguish depending on whether quantitative, or qualitative strategy is on focus.

In case of a quantitative strategy, associated with an experimental design, the researcher has to rely, to a greater extent, on numerical data. Furthermore, he or she will resort to a «structured approach in order to reduce [his or her] influence on the research» (Bennison, 2006).

In the event of qualitative strategy, connected with case study design, the researcher will have to «use open ended methods of data collection to capture a wide variety of opinions» ( bennison, 2006).

Anyway, data collection methods, such as structured observations, interviews, and questionnaires sound more appropriate to quantitative strategy. Whereas observation, semi structured Interviews, questionnaires, focus or discussion groups appear to be suitable to qualitative methods. Relating to questionnaires as method of data collection, it has been devised as «a general term [including] all techniques of data collection in which each person is asked to respond to the same set of question in a predetermined order» (De Vaus, 2002). There are a wide a range of kinds of questionnaires depending on the way they are administered. When a questionnaire is filled by respondent himself, it is known as «self-administered» questionnaire. This sort of questionnaire can be electronically answered through internet or intranet, or mailed to respondent who will return it after completion. Conversely, whenever a questionnaire is answered during a physical contact with the respondent, it is named «interviewer-administered» questionnaire as claimed by Saunders, Lewis and Thornhill, (2007, pp. 356-357).

First of all, this paper does take into consideration some research strategies like axiology, ontology and epistemology. Axiology has been taking into account upstream from the selection of this topic. Actually, because it seems not to exist prior research on the techniques of investment appraisal used by private equity firms per se, we were led to all the relevance of this exploratory research. Furthermore, in the course of surveying the previously mentioned firms, we should be aware of their values and would be keen to admit them without passing any sort of judgment as demands the basic requirement of axiology strategy. Epistemology, and to be more accurate, interpretivism is considered throughout this work due to the specificity of business study; so, the qualitative philosophy of research will be utilised in order to interpretate, understand and conduct a thick description of reality of tools of investment appraisal used by private equity. Ontology is concerned here insofar as we should bear in mind enough objectivity in making analysis of data collected.

Secondly, as far as research design is concerned, this paper has opted for the cross-sectional design as long as patterns of association will be looked for and data collection will be based on electronic questionnaires.

The purpose of this chapter is to give an account of data collected in order to provide answers to the research questions that pertain to this work. To do that, as we have highlighted supra, questionnaires were opted for as methods of collecting data. As a matter of fact, 25 venture capital firms have received an electronic questionnaire via Survey Monkey. Only 13, that is almost half of them have provided responses, which have been deemed as a somewhat representative sample of the threshold population. The first task consists in analysing answers given by those respondents and the second task has something to do with summarising findings. Prior to these activities, it is worth reminding that ethical considerations, such as anonymity are taken into account in this work; thus, neither questions relating to personal details of the respondent nor the results of this study will be published.

In order to get a sound insight into the data collected within the framework of this study, both the display and analysis approach of Miles and Huberman (1994) have been adopted. Relating to data display and analysis in this work, it deals with an organisation and comment of data that are primarily related to research questions into diagrams. We will, therefore, give an account of the data collected compared with the following concerns:

- What are the classic methods of analysis used in practice by private equity firms in capital budgeting for start-ups devoid of any flexibility?

- What is the recent practice of private equity analysts in respect to techniques of start-ups companies flexible capital budgeting?

- 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?

4.1.1. Traditional tools of analysis used in practice by venture capitalist in making investment decision

We can learn from information gathered that Private equity firms, whatever industries they belong to (as shown on the first graph hereafter), do utilise classic methods for evaluating proposals. Those techniques include discounted cash flows methods such as the Net Present Value and the Internal Rate of return. Furthermore, venture capitalist does also resort to non-discounted cash flows methods, notably the payback rule, the profitability index and the accounting or book rate of return in making investment decision. These successive graphs are therefore an illustration of that state of affairs.

The above column chart indicates the 07 sorts of industries within the dozen of Private equity firms that have been surveyed could probably invest. On the whole, it is clear that Private equity analysts rather preferred health care and Consumer goods and services investment proposals to any other out of the list.

In fact, there was a sharp identical percentage, notably 33.3 percent, in the number of private equity, which could happily grant funds to technology industries start-ups as well as financial ventures. Concerning the former, telecommunication sector itself, included fixed line and mobile, and information technology were parts of technology sector. Relating to the latter, real estate, financial services per se, figured in financial component part. In addition, there was another identical proportion in the number of industry sectors selected by private equity organisations. In effect, approximately 8 percent of private equity analysts were choosing to spend money on basic materials, and oil and gas sectors likewise. Basic materials referred to chemicals, forestry and paper, industrial metals and mining, whilst oil and gas comprise alternative energy, oil and gas producers, and oil equipment services and distribution.

However, only probable acceptances of industrial investment projects represented a sixth of the number of private equity organisations on focus here. Industrial proposals alluded to aerospace and defence, construction and materials, electronic and electrical equipment, engineering, general industries, support services and transportation.

To sum up, it can be seen that Health care industry sector constituted the most popular choice out of the seven kinds of sectors of industry. Notwithstanding, private equity analysts did utilise classic methods for appraising venture start-up companies, regardless of the sector of industry they belonged to as demonstrated infra.

The above pie chart displays information about the percentage of techniques that take into consideration the sacrosanct principle of the time value of money in making investment decision for new ventures. Overall, it is obvious that the Internal Rate of return was the discounted tools of analysis most used by private equity in making investment appraisal.

As a matter of fact, the percentage of private equity firms that resorted to the Internal Rate of Return (IRR) constituted roughly the double of the proportion of those that utilised the Net Present Value (NPV), namely almost 67 percent.

To conclude, there is no doubt that the Internal rate of Return was by far the most popular method used by private equity analysts for making investment decision for start-ups. It should be worth moving on the question of what private equity firms think about these two classic discounted cash flows methods.

This stacked bar chart illustrates the views that surveyed private equity analysts took about the utility of a couple of discounted cash flows methods for capital expenditure of newly created firms. Generally speaking, the IRR technique did attract numerous private equity analysts.

In fact, as far as one of the overriding rules of financial theory is concerned, namely the time value of money, roughly half of the venture capital firms analysts did tend toward the use of the IRR method. Although there was one skipped question concerning this category, it did not affect the final results in terms of dominance of the IRR technique. Indeed, the results relating to NPV as discounted cash flows were completed and less than half of respondents were in favour of that method. Conversely, 6 among 12 private equity firms analysts did prefer IRR technique. The unique assumption that we could make is that if the participant who refrained from answering to that question selected any option apart from «agree», the superiority of IRR would still be valid.

Moreover, the trend of the prime importance of the IRR was further strengthened by the number of people who strongly disapproved the NPV as a practical means of evaluating start-ups investment proposals. Actually, only one venture capital analyst disagreed with the use of IRR whereas two people did not share the view that the NPV rule does recognise the principle of the time value of money.

With regard to the point of mutual exclusive proposals and the use of the NPV technique, it is clear that there was an enormous increase in the number of neutral participants, approximately 60 percent. Furthermore, there was a slight drop in the number of approvals of NPV as one useful technique of making investment decision for start-ups in case of non-concurrent projects.

In conclusion, regarding the opinion of private equity analysts about the usefulness of discounted cash flows tools of evaluating start-ups capital expenditure, the IRR method was more popular than its competitor, namely the NPV, notwithstanding one skipped question in the number of respondents related to the IRR as a discounted cash flows technique. This trend has been confirmed even in a more general aspect as shown in the next diagram.

The pie chart that appears at the bottom of the previous page displays information about the percentage of choice of two discounted cash flows methods for appraising start-up companies. On the whole, the gap in the selection between the IRR and NPV method by private equity analysts was not that large.

As a matter of fact, more than the half of the participants were attracted by the IRR as a technique of evaluating capital budgeting for newly created ventures. To be more specific, 53.8 percent of private equity firms did prefer IRR method to the NPV technique.

Nonetheless, NPV as a tool of analysis of investment appraisal of start-up firms was only selected by 46.20 percent of private equity firms that took part in this survey.

Finally, it is obvious that private equity analysts do prefer the IRR method to the NPV tool when it comes to make investment decision for start-up companies. These results seemed far too much similar to the findings of Graham and Harvey (2001) released 10 years ago. Their results showed that «74.9% [Chief Finance Officers] always or almost always use the internal Rate of return», which was roughly 1% more than those who referred to the Net present value criterion (Graham and Harvey, 2001, p. 193). Nevertheless, some distinction still needs to be drawn since Graham and Harvey (2001) did survey only Chief Finance Officers of 4,400 American firms, with the exception of Venture capital organisations. We should now move on finding out what the information collected reveals with respect to the use of non-discounted cash flows methods for capital expenditure of new ventures.

This line graph demonstrates the number of private equity firms that utilised non-discounted cash flows methods in making investment decision for start-up companies. As far as the overall trend is concerned, there was a gradual decline in the number of users of methods, which did not take into consideration the sacrosanct rule of the time value of money in making capital expenditure decision for start up companies.

At the beginning, among the 13 private equity analysts who took part in this survey five confirmed that they utilised the payback rule as a non-discounted cash flows technique of evaluating capital budgeting proposals for newly created ventures. That was a sharp percentage of 41.7.

In contrast, 33.30%, that is to say four respondents chose the profitability index; only a quarter was interested in the accounting or book rate of return as a criterion of an investment decision into start up firms' proposals. Unfortunately, there was one skipped question with respect to the issue of the use of non-discounted cash flows methods for appraising capital budgeting of start up companies; therefore, the above-mentioned proportions are no more and no less symptomatic of 12 effective respondents.

In a completely different respect, it has been argued that, although it was in a more general perspective, among non-discounted cash flows methods of capital budgeting the accounting or book rate of return looks like a poor relation with approximately 12 percentage of use by Chief Finance Officers (Graham and Harvey, 2001, p. 193). This trend has been somewhat confirmed here as long as only 25 percent of private equity analysts did say they resorted to that technique of capital budgeting for start up companies.

By way of conclusion, it can be seen that the payback rule was the most attractive technique among private equity organisations as far as non-discounted cash flows techniques that they resorted to in making investment decision for start-up companies were concerned. We should now examine the viewpoint of these private equity analysts about the realistic aspect of the previously mentioned non-discounted cash flows methods for evaluating investment decision for start up organisations.

The above chart constitutes an illustration of information concerning the perception that 13 private equity firms had about the practical aspect of three non-discounted cash flows tools of analysis for start-ups' capital expenditure. On the whole, it is obvious that point of views did not wildly fluctuate between the payback rule, the profitability index and the accounting or book rate of return.

Without any doubt, about 50 percent, in other words 6 out of 12 ( because there was one skipped question) private equity firms thought that the payback rule, as a method for evaluating investment decision for newly created ventures, was practical.

In addition, 4 private equity analysts out of 12 who really did answer this question, were attracted by the realistic feature of the accounting or book rate of return. This number stood for roughly 33 percent of the whole responses relating to the issue of the practical characteristic of non-discounted cash flows techniques of appraising start ups capital budgeting.

Conversely, the non-discounted cash flows method of capital expenditure for start-up organisation regarded as the least realistic, turned out to be the accounting or book rate of return. Oddly, only a sixth of private equity firms thought that that capital budgeting technique was practical for start up companies whilst a quarter previously claimed its utilisation in accordance with the results of the previous line graph that appeared at the bottom of page 34 of this work. Probably, there were other bases of that use, which the participants did not specify even though they have been suggested to do so within the framework of the questionnaire.

To sum up, it is clear that when it came to make investment decision for start up companies based on non-discounted cash flows methods, private equity analysts did consider the payback rule as more realistic than the two other techniques, namely the accounting or book rate of return and the profitability index. This work will hereafter inquire data in comparison with start up companies' capital budgeting where proposals cannot be adapted to a new situation.

This bar chart is a display of information about the best techniques that private equity analysts referred to when it comes to make capital budgeting decision that is devoid of any flexibility for newly created ventures. In general, for that purpose, all participants tended toward choosing among one of these methods, namely the profitability index, the payback period, and the NPV, excepted for the IRR.

As a matter of fact, a third of private equity analysts did prefer the Net present Value method in making non flexible capital budgeting decision for start up firms.

However, according to a quarter of private equity firms, the accounting or book rate of return was the best tool of analysis that they referred to in making non flexible investment decision for start up companies. Moreover, the same proportion considered the profitability index technique and the payback period as the best method of analysis on the subject aforementioned. Nevertheless, the IRR technique looked like a poor relation in the eyes of private equity analysts. In fact, none of the 13 private equity analysts who took part in this survey regarded this method as a useful technique in making non-adaptable investment decision for newly created ventures.

In summary, when it comes to make start up companies investment decision devoid of any flexibility, a simple majority of 4 out of 13 private equity analysts did prefer relying on the NPV technique rather than others classic methods such as the payback rule, the profitability index, and the accounting or book rate of return. The comment on this trend is that one of the Net Present Value's principal challengers, the Internal rate of Return method, has to say the least been downgraded, even ignored by the respondents. The peculiarity of these results stands out against prior research on the use of traditional methods of making investment decision in corporate finance as shown by scholars such as Graham and Harvey (2001, p. 193). Having said that, what practical tool of analysis do private equity firms resort to in making flexible investment decision for start-ups organisations?

4.1.2. Recent technique of analysis used in practice by venture capitalist in making flexible and reversible investment decision for start-up companies

The aim of this subdivision is to describe and explain the points of view of 13 private equity analysts with regard to the tools they use in making flexible investment decision for newly created ventures. Because capital budgeting seems far from being a commonplace decision on the one hand, and completely lacking of adaptability to new circumstances on the other hand, the financial theory developed by scholars like Myers (1977), Borison (2005, p. 17), Vernimmen et al., (2008, p. 374), Krychowski and Quélin, (2010, p. 65) has put forward real options. This work will thus make some incidental comparisons with previous studies. Boosted by what precedes, we should therefore examine viewpoints of private equity analysts as successively shown in the following figures.

Methods used by private equity analysts in making flexible investment decision for start-ups companies	Response count from 8 private equity analysts	Percentage
IRR	2	25%
NPV	3	37.5%
Real options	1	12.5%
The accounting or book rate of return	1	12.5%
The payback rule	1	12.5%
The profitability index	1	12.5%

Table 1: What do you resort to in making flexible investment decision for start-ups organisations?

The above table is a display of 08 out of 13 viewpoints of private equity analysts (as long as there were 5 skipped questions) with respect to the methods that they resort to when the investment projects submitted to them by start-ups are adaptable and / or reversible. Broadly speaking, it can be noticed that their opinions were eclectic enough.

First of all, 3 over 8 private equity analysts did maintain that they had recourse to the Net Present Value method of capital budgeting for newly created ventures. That figure stood for 37.5 percent and was the most used technique as far as private equity firms were concerned when it comes to make flexible investment decision for start-up companies. Moreover, a quarter, in other words 25 percent of these private equity analysts has claimed an exclusive recourse to the Internal Rate of Return.

However, only 12.5 percent of the respondents said that they utilised one of the following tools of analysis in assessing start-ups capital budgeting : real options, the accounting or book rate of return, the payback rule, and the profitability index.

To conclude, the findings regarding the techniques that private equity analysts do have recourse to in evaluating start-ups flexible capital expenditure clearly demonstrate the prime importance of NPV method over others. This result is surprising at least for a couple of reasons. In the first place, the shortcomings of the NPV tool of analysis per se have been deplored in a numerous financial academic writings as noted earlier in this work on page 10. Secondly, Net Present value does ignore «the value of managerial flexibility, in other words the options that the manager can exploit after an investment has been made in order to increase its value» (Vernimmen et al., 2009, p. 297). In the face of this situation, there is no need to make a mountain out of a molehill as long as private equity analysts should refer to real options in order to adjust the aforementioned NPV's restricting flaws.

Table 2: How do you rate Real options relating to making better flexible capital expenditure decision for start-up organisations?

Rating average

Response

count

Real options provides us with a better adaptability in the management of proposal

0.0%

(0)

0.0%

(0)

0.0%

(0)

8.3 %

(1)

50%

(6)

16.7%

(2)

0.0%

(0)

16.7%

(2)

0.0%

(0)

8.3% (1)

6.00

The table that comes into view at the bottom of the previous page displays information about the rating scale of real options as a technique of appraising flexible start-up firms' capital expenditure as far as private equity analysts are concerned. Overall, it is obvious that there was a substantial participation on behalf of private equity analysts regarding that question because 12 out of 13 private equity firms did give an effective response to that issue.

To start with, half of private equity analysts set value on real options as a technique whereby they evaluated flexible proposal from start-up companies. Indeed, on the scale of 10, 50 percent of respondents gave a rate of 5 to real options like a satisfactory tool of assessing reversible and / or flexible start-ups investment projects.

Furthermore, there was a double similarity in the number of respondents who concurred that real options were a helpful technique for making better flexible investment decision. Firstly, 8.3% of private equity analysts ascribed a rate of 4 over 10 to real options on the one hand, and a rate of 10 over 10 to real options on the other hand. The latter rate sounded somewhat astonishing and probably derived from the unique private equity analyst who pretended to refer to real options method according to the previous table. Secondly, roughly twice of the previous percentage, (in other words 16.7%) regarded real options as a useful method for evaluating start-up companies' flexible capital budgeting. In accordance with this viewpoint, 2 people gave a rate of 6 over 10 and 8 over 10 to real options respectively.

However, the scale rates of 1 to 3 as well as 7 have not been selected at all by private equity analysts in rating real options as a method that helps improving the evaluation of start-up companies' capital budgeting.

To sum up, it is clear that the rating average of real options conceived as a helpful technique that improves the adaptability of investment decision as far as start-ups companies was 6.00. We should now move on the question to find out the most used method for evaluating capital expenditure of start-up organisations regardless on the potential flexibility or not of the proposals.

Table 3: Out of the following, what is the most used technique in appraising project in your organisation?

Methods	Response percent	Response count
NPV	33.3	4 over 12
IRR	8.3	1 over 12
The payback rule	33.3	4 over 12
The profitability Index	25.0	3 over 12
The accounting or book rate of return	0.0	0
Real options	0.0	0

This table shows information with regard to the most attractive technique of investment appraisal used by 12 over 13 private equity analysts (because there was one skipped question). As far as the overall trend is concerned, it is clear that those private equity analysts were attracted by methods such as NPV, IRR, the payback rule, the profitability index, except for the accounting or book rate of return and real options.

To begin with, a third of private equity analysts said that the most used techniques for assessing investment projects submitted to them by start-up organisations were both the NPV and payback period methods. Therefore, we could argue that those two tools of analysis, which are discounted and non-discounted cash flow techniques respectively, were equally placed. These findings appear to be inconsistent in relation to those expounded at an earlier occasion supra, for example on page 34, under figure 2. To tell the truth, it is not the case. In fact, the finding, which stated that the NPV and payback period techniques were equally placed by private equity analysts, came from the question intending to determine which of the seven methods met with the greatest extent or frequency of utilization, regardless of its discounted or non-discounted characteristic. However, the results that regarded the NPV method as the most used discounted cash flow technique (as derived from analysis of figure 2 that appeared on top of page 34) aim at selecting between two discounted cash flow techniques, namely the NPV and the IRR.

Besides, only a quarter of private equity analyst said to make largely use of the profitability index whilst the IRR technique has, strangely enough, been most utilised by just 8.3 percent of private equity analysts. Unfortunately, the worst case comprised the accounting or book rate of return and real options techniques, which scored 0.0 percent of frequency of utilization.

To conclude, it is clear that private equity analysts had recourse to a couple of techniques, notably the NPV and the payback rule, to the greatest extent. As a result, the rest of five methods were further to be in the forefront. Be that as it may, it seems worth summarising the findings of this data analysis, which constitutes the second task of this chapter as stated right at the beginning.

The aim of this section consists in summarising the findings that derived from the analysis of data collected by means of an electronic questionnaire (comprising 10 questions as a sample is appended) sent to 25 private equity firms. Only 13 over those 25 private equity firms did return their responses to us with regard to the tools of analysis they referred to when it came to make investment decision for start up companies. These 13 participants, in other words roughly 50% of the threshold population, were deemed enough meaningful of the aim of catching on the practice of private equity organisations regarding methods of assessing start ups' capital budgeting. At any rate, in order to give a shortened version of the findings, we should refer to its main points that provide answers to the research questions that pertain to this work.

To start with, as far as sectors of industries were concerned, information collected taught us that 50 percent of private equity firms were happier with investing in Health care and approximately the same percentage in Consumer goods and services likewise. These findings would probably be beneficial to both parties involved because any start-up company would submit an investment proposal, which belongs to a relevant sector of industries for example.

With regard to the classic tools of analysis, which could be used by private equity firms in making investment decision for start-ups, we found that they resorted to both discounted and non-discounted cash flow techniques. Relating to the former, results demonstrated that 66.70 percent of private equity analysts did utilise the IRR technique whereas 33.30 percent claimed using NPV method. Moreover, that trend of the dominance of the IRR method over the NPV technique has been sealed by answers on what was the preference of private equity analysts out of those two techniques on the one hand. In fact, 53.80 percent said preferring the IRR technique whilst 46.20% selected the NPV method. These results appeared to get, shall we say, a sort of «family ties» with the findings of Graham and Harvey (2001) released 10 years ago. Their results showed that «74.9% [Chief Finance Officers] always or almost always use the internal Rate of return», which was roughly 1% more than those who referred to the Net present value criterion (Graham and Harvey, 2001, p. 193). Nevertheless, our results still stand out from Graham and Harvey (2001) findings as long as they did survey only Chief Finance Officers of 4,400 American firms, with the exception of Venture capital organisations, which were on focus here instead. Furthermore, the viewpoint of private equity analysts relating to the usefulness of those methods was another confirmation of the superiority of the IRR on the second hand. For the sake of illustrating, when asked to choose between IRR and NPV, the method that most abode by the sacrosanct principle of time value of money, roughly half ( that is to say 6 over 12 because of one skipped question) of the venture capital firms analysts did tend toward the use of Internal Rate of Return (IRR).

With respect to non-discounted cash flow method for evaluating newly created ventures' capital expenditure, 41.7% of venture capital analysts said using the payback period. In addition, when assessing investment proposals from start up companies, 33.3 percent of private equity analysts referred to the profitability index technique and only a quarter claimed the utilisation of the accounting or book rate of return as a criterion of an investment decision into start up firms' proposals. These latter findings could be regarded as an echo of the widely known argument that among non-discounted cash flow methods of capital budgeting, the accounting or book rate of return looks like a poor relation with approximately 12 percentage of use by Chief Finance Officers (Graham and Harvey, 2001, p. 193).

Another concern, which has possibly been sorted out by findings from surveying venture capital organisations, had something to do with their points of view with respect to the accuracy of non-discounted cash flow methods for evaluating start up firms' capital budgeting. In fact, 50% did approve the realistic aspect of the payback rule in making investment decision for start up companies when roughly 33% did so for the accounting or book rate of return.

Nonetheless, the non-discounted cash flows method of capital expenditure for start-up organisation regarded as the least realistic, turned out to be the accounting or book rate of return. There seemed to be something odd about this latter finding. In fact, only a sixth of private equity firms thought that the accounting or book rate of return, as a capital budgeting technique, was practical for start up companies whilst a quarter previously claimed its utilisation in accordance with the results of the previous line graph that appeared at the bottom of page 38 of this work. This result sounded to suggest that the percentage of use of the accounting or book rate of return was higher than that of its satisfaction, which its users could have with respect to its accuracy. To tell the truth, the reason of such a discrepancy in these percentages resides somewhere else. Probably, there were other bases of the use of accounting or book rate of return, which the participants did not specify even though they were required to do so within the framework of the questionnaire ( In fact, a line for «other» has been provided under this question yet).

As far as techniques used by venture capital analysts in making capital budgeting decision for start up organisations, which are lacking even a dash of flexibility were concerned, we found that a third of those analysts said referring to NPV. Conversely, one of main competitors of NPV technique, in other words the IRR method, has not been selected at all. This result sounded in contradiction with the classic corporate finance theory as illustrated by academics such as Graham and Harvey (2001, p. 193), Brealey, Myers and Allen (2008).

Concerning the method used by venture capital analysts when it comes to make flexible investment decision for newly created ventures, findings demonstrated that there was a somewhat eclectic taste in the answers of participants. As a matter of fact, the NPV method was in the lead with 37.5% of use when real options only scored 12.5%.

But the poor score of real options has been improved when private equity firms were asked to say to what extent they were happy with using a recent tool ( that is to say real options), which provides private equity analysts with better adaptability in the management of start-ups' investment. Indeed, 50 percent of venture capital analysts did approve the view that real options met their need of flexibility in making start-up firm's capital expenditure decision. This result was deemed symptomatic of the progress in practice of real options, despites its recent character as method for evaluating capital budgeting decision.

At last, private equity analysts were asked to state the technique of investment appraisal that they more often resort to. Our findings showed that a couple of techniques, notably the NPV and the payback rule, were used in the greatest extent. As a result, the rest of five methods were further to be in the forefront.

Highlighting the main points of this work on the one hand and making relevant suggestions on the other hand, are the purpose of this chapter. Notwithstanding, a sort of, shall we say, `exit' section will mainly concentrate on limitations because none of academic writing can neither be excellent or ideal in every way, nor an easy concern.

To begin with, in chapter one, which dealt with the introduction, we have outlined that the context of this research resides on the discussion between academics about the cause of the significant decline in the number of investment activities of venture capital organisations. Indeed, according to the British Venture Capital Association (BVCA), 3 years ago, 1680 firms were funded by private equity while in 2009 only 987 organisations obtained similar funds (Private Equity and Venture Capital Report on Investment Activity, 2009).That fall could be due to the 2008 global economy collapse in the eyes of some. However, investors' behaviour probably was an explanation of the aforementioned decline maintained other (Roszkowski and Davey, 2010, p. 43).

Because we agreed with the latter scholars, our aim was to go beyond the notion of investing behaviour and find out the various techniques, which they have recourse to in making investment decision for newly created ventures. In doing so, our objectives were first to investigate the classic tools of analysis, which could be found in the financial literature. Secondly, our aim was to determine the applicable technique in case of evaluating flexible and reversible start-ups' investment proposals. Thirdly, our objective consisted of conducting a survey of venture capital analysts to find out their practice by way of capital budgeting for start-ups. In the fourth place, this dissertation was aimed at suggesting beneficial solutions to both parties involved in making such an investment decision, that is to say private equity analyst and start-up company.

Achieving the goals previously mentioned demanded some research queries. Therefore, the following questions were raised: 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?

As far as the second chapter, which was entitled literature review was concerned, there seemed not to exist in the United Kingdom, and even abroad prior research itself on financial tools of analysis commonly used by private equity in assessing start-ups capital expenditure. In order to give an account of the relevant scientific writings that pertain to this work, we opted, therefore, for a deductive reasoning. In other terms, we resorted to some general knowledge contained in both books and articles and relating to any key word of our topic. Thus, from doing so it emerged that the concept of private equity was generally regarded both in the eyes of scholars (such as Brealey, Myers and Allen, 2008, p. G-10; Wood and Wright, 2009, p. 361), and professionals (namely, the BVCA, 2010, p.14), as money invested in venture and not listed companies. Moreover, regarding the meaning of the term start-up firm, it referred to as a start-up company or «startup» is a company with a limited or non-existing operating history (Arnold, 2004, p. 388). Furthermore, the notion of investment decision was devised as synonymous with capital budgeting decision (Brealey, Myers and Allen, 2008, p. 4) or «Capital expenditure -capex-», that is the «selection of investment projects» (Arnold, 2008, p. 50).

Concerning the financial theory on tools of analysis used by private equity in making investment decision, as mentioned earlier in this conclusion, there did not appear to be prior research in the United Kingdom, and even abroad. To tell the truth, numerous scholars tended to focus in particular on standards that venture capital firms refer to in making investment decision. For the sake of illustration figured the works of authors such as MacMillan, Siegel and Subbanarasimha (1985), MacMillan, Zemann and Subbanarasimha (1987), and Zacharakis and Meyer (2000). Primarily, the aforementioned benchmarks are consisted of four components: firstly product characteristics, secondly market characteristics, thirdly company's financial position and outlook, and finally the characteristics of the entrepreneur or management team. Besides, a survey of four Australian venture capital firms has been conductor by Wright and Proimos (2005). These authors found that those organisations did utilise Berger and Udell's (1998) three stages of investment model, that is to say selection, contracting and monitoring. To the credits of their paper, we thought that it seems to be a clear and recent contribution to the understanding of the series of actions taken into consideration by private equity for making investment decision. Nevertheless, Wright and Proimos (2005) did not dwell that much upon the methods as such used whilst appraising capital budgeting proposals. Boosted by all what precedes, we were to scrutinise the general financial knowledge on methods of evaluating capex.

In accordance with this view, there were both classic and recent techniques of making investment decision. As far as the former methods were concerned, we took up the distinction between discounted cash flow and non-discounted cash flow methods. The rule of thumb on which resided that difference was the sacrosanct principle of time value of money as argued by Arnold (2008, p. 50), Chandra (2008, p. 116), and Vernimmen et al. (2009, p. 289). Net present value (NPV) and Internal rate of return (IRR) were components of the discounted cash flow techniques. Broadly speaking, NPV was conceived as «project's net contribution to wealth» (Brealey, Myers and Allen, 2008, p.G-9). In referring to NPV method for evaluating a project, it was clear that a positive NPV meant that shareholder's wealth was better off when a negative NPV was tantamount to a non acceptance of the project. Because NPV was far from being a supposed for all investment appraisal problems, its flaws were highlighted by Vernimmen et al., (2009). He has criticised the lack of easiness in working it out instinctively and directly. In addition, to him NPV did not have a dash of high opinion of «the value of managerial flexibility, in other words the options that the manager can exploit after an investment has been made in order to increase its value» (Vernimmen et al., 2009, p. 297).

The shortcoming of NPV, which had something to do with its complex calculations, had been overcome by one of the NPV's principal competitors, in other words the IRR technique. This was defined by Brealey, Myers and Allen as the «discount rate at which investment has zero net present value» (Brealey, Myers and Allen, 2008, pp. G-7). Regarding the IRR calculation, academics suggested that it was found with the help of «trial and error» in a customary way (Droms and Wright, 2010, p. 194). With respect to the IRR rule by way of investment appraisal, it simply states that whenever the rate of return of an investment is beyond the minimum acceptable rate of return on a project of an investor, it is accepted (Vernimmen et al., 2009, p. 309; Brealey, Myers and Allen, 2008, p. 123). However, we found that the IRR method, likewise the NPV its challenger, could undergo some limits. In fact, Brealey, Myers and Allen (2008) have pointed out a wide range of problems with the application of the IRR technique. Indeed, many internal rates of return for a project could result from lots of changes in the sign of cash flows. In addition, in case of proposals that are mutually exclusive, the IRR probably provided with a deformed idea of the projects value. As a final point, the IRR method did make a clean sweep of the relative size of projects. ( http://portal.lsclondon.co.uk/resources/course/view.php?id=871).

Other than the NPV and IRR techniques of evaluating capex on the basis of discounted cash flows, we investigated non discounted cash flow methods, such as the Payback period, the Profitability index, and the Book or Accounting rate of return. As far as the Payback period was concerned, we learnt that it consists of selecting «any project with the shortest payback period» (Droms and Wright, 2010, p. 191). According to Brealey, Myers and Allen (2008), two examples of thing could go wrong with the payback technique. First, it does not encompass «all cash flow after the cut-off date; [secondly, the] «payback rule gives equal weight to all cash flows before the cut-off date» (Brealey, Myers and Allen, 2008, p. 121). With respect to the profitability index, the golden rule was to only choose the projects with the uppermost NPV per pound of initial amount of money spend. Relating to the book or Accounting rate of return, finally, Brealey, Myers and Allen (2008) taught us that it aimed at finding the potential book income «as a proportion of the book value of the assets that the firm is proposing to acquire» (Brealey, Myers and Allen, (2008, p. 119). Because the book rate of return is a sort of means across the total activities of the organisation, we considered that it was unlikely to be worthwhile dwelling too much upon it. As a matter of fact, we were exclusively focussed on the methods private equity use for investment decision making for start-up companies.

As far as recent tool of appraising capital budgeting was concern, we found the need of flexible investment proposals had been met by real options. In fact, flexibility of an investment has a value, the value of the option associated with it. For the sake of example, Vernimmen et al., (2009) have suggested that in the field of industrial investments, real options are equivalent of «the right not the obligation, to change an investment project, particularly when new information on its prospective returns becomes available» (Vernimmen et al., 2009, p. 374). Moreover, we took up the advantageous view of real options as highlighted by Krychowski and Quélin (2010) in the following way: «The main contribution of RO [this stands for Real Options] is to recognize that investment projects can evolve over time, and that this flexibility has value. Myers (1984) considered that RO is a powerful approach to reconcile strategic and financial analysis» (Krychowski and Quélin, 2010, p. 65).

We needed to find answers to research questions that pertained to this paper. Therefore, the primary purpose of the third chapter was to comprehend the notion of research methodology in the first place, and expound the approach that we selected in order to achieve our set objectives in the second place. With regard to the former aim of the third chapter, we shared the viewpoint of Saunders, Lewis and Thornhill on the notion of research methodology. In fact, it could be defined as the «theory of how research should be undertaken, including the theoretical and philosophical assumptions upon which research is based and the implications of these for the method or methods adopted» (Saunders, Lewis and Thornhill, 2007, p. 602).

Relating to the latter aim of that third chapter, we outlined the approach used in this work in order to attain our objectives. In this respect, we argued that this paper did take into consideration some research strategies like axiology, ontology and epistemology. Axiology was taken into account upstream from the selection of this topic. Actually, because it seemed not to be prior research on the techniques of investment appraisal used by private equity firms per se, we were led to all the relevance of this exploratory research. Furthermore, in the course of surveying the previously mentioned firms, we were aware of their values and strove to admit them without passing any sort of judgment in accordance with the core requirement of axiology strategy. Epistemology, and to be more accurate, interpretivism was considered throughout this work due to the specificity of business study; so, the qualitative philosophy of research was be utilised in order to interpretate, understand and conduct a thick description of reality of tools of investment appraisal used by private equity. Ontology was concerned here insofar as we were to bear in mind enough objectivity in making analysis of data collected. Finally, as far as research design was concerned, this paper opted for the cross-sectional design as long as patterns of association has been looked for and data collection based on electronic questionnaire designed with the help of a software called Survey Monkey.

From the fourth chapter, which dealt with data analysis and findings, it emerged firstly that 50 percent of private equity firms were more attracted by investing in Health care and roughly the same proportion in Consumer goods and services than technology industries, financial ventures, Basic materials, oil and gas, and industrials. Secondly, as far as techniques used by venture capital analysts in making capital budgeting decision for start up organisations, which are lacking even a dash of flexibility were concerned, we found that a third of those analysts said referring to NPV. In this respect and conversely, the revelation appeared to be that private equity analysts in making non-flexible investment decision for start-up firms did make a sweep clean of the IRR technique. 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%. However, relating to that latter tool of analysis and the viewpoint of their users on the satisfaction they got from it, 50 percent of venture capital analysts did approve the view that real options met their need of flexibility in making start-up firm's capital expenditure decision.

This paper was focussing on the tools of analysis commonly used by private equity in making investment decision. Broadly speaking, we noticed that private equity analysts did make capex decision in accordance with the general final knowledge as imparted by most of the textbooks. However, some suggestions could be made in such a way those investment decision be more fruitful and realistic. In addition, recommendations for further research have been taken into consideration.

Ø Private equity analysts should at least be aware of the use of IRR method and its advantages by way of making non-flexible investment decision for start up organisations.

Ø In case of flexible capital budgeting projects for newly created ventures, venture capital analysts should only refer to real options, so long as real options are the recent tool tailored for that purpose.

Ø In order to come off better, start up firms should strive in submitting investment projects that belongs to one of the most attractive sector of industry in the eyes of private equity analysts, namely health care and / or consumer goods and services.

Ø Most should be done in order to further make real options wildly understandable and appreciate by professionals.

· A sound inquiry into the private equity analysts' practice of real options appears to be relevant in understanding its relative achievement by way of investment appraisal for start up organisations.

· A paper, which only focuses on project analysis per se, would be both beneficial to all the parties involved. To be more specific, an exploration study of the usable techniques like Monte Carlo simulation, break-even analysis, and sensitivity analysis of identifying critical factors, which could undermine a start-up's project, should be significant.

Just like any other human activities, conducting a research appears not to be a small task. This sort of `exit' section aims at outlining, therefore, some factors that stood in the way of the easy progress of this piece of work.

Because there seemed not to be prior studies on the tools of analysis commonly used by private equity in making investment decision for start up companies in the United Kingdom and even abroad, we were to collect primary data in order to be consistent in our findings. In doing so, some private equity firms refrained from taking part in our survey under the grounds of confidentiality and privacy of the information needed. On top of that, they argued that their schedule at work was busiest.

In response to those difficulties in getting information, we were to opt for an electronic questionnaire as a non-time consuming way of collecting data and did attach a cover letter to the electronic mail that we sent to our sample population made of 25 private equity firms. At the end of the day, half of them were kind enough to come back to us.

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This survey comes within the academic framework of a Master in Business Administration dissertation in Finance, currently written by the interviewer. The aim of this questionnaire is to find out more about actual practice of private equity analyst in investment appraisal. There will neither be any question relating to personal details of the respondent and the results of this survey will nor be published. Therefore, the entire voluntary participation of the respondent as well as the confidentiality of his answers is absolutely ensured. Your opinion is very important and will be highly appreciated.

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

3.4.1. Research processes

3.4.2. Research designs