ARTICLE ON – Role of Private Equity in Mergers and Acquisition Transactions.

Role of Private Equity in Mergers and Acquisition Transactions

The significance of private equity in mergers and acquisitions (M&A) has gained prominence in recent years. Private equity firms, investing in non-publicly traded companies, play a crucial role in financing and facilitating M&A transactions. Noteworthy cases have recently influenced the private equity landscape in M&A, underscoring the importance of thorough due diligence in assessing the target company’s financial health and potential risks. Some researchers contend that private equity firms often adopt a “big fish small fish” strategy in M&A, acquiring smaller companies to leverage their expertise, resources, and strategic guidance for growth and value creation. This perspective suggests that private equity contributes significantly to industry consolidation and the development of synergies. Recognizing the role of private equity in M&A transactions is essential for investors, companies, and policymakers, offering insights into the dynamics and implications of these deals.

Overview of Private Equity

Private equity refers to an investment approach where funds are sourced from both institutional and individual investors to obtain equity ownership in companies not publicly traded. In contrast to public equity investments, private equity investments are not traded on stock exchanges and typically have a longer holding period, often spanning five to ten years. Private equity firms utilize these funds to acquire controlling interests in companies, aiming to enhance their performance and eventually sell them for a profit. A distinctive feature of private equity investments is the active involvement of these firms in the management and strategic decision-making processes of their portfolio companies, often adopting a hands-on approach to maximize value creation. This involvement may encompass implementing operational enhancements, introducing financial and governance best practices, and supporting growth initiatives through strategies like capital injection or market expansion.

Depending on the target company’s stage and nature, private equity investments can take various forms, including leveraged buyouts, venture capital, growth equity, distressed debt, and mezzanine financing. The private equity industry has experienced substantial growth in recent years, driven by factors like low-interest rates, favourable regulatory environments, and the pursuit of higher returns in a low-yield setting. Consequently, private equity has emerged as a crucial catalyst for economic growth and has played a significant role in propelling global mergers and acquisitions activity.

Role of Private Equity in Mergers and Acquisitions

Private equity assumes a crucial role in mergers and acquisitions (M&A) by furnishing essential capital for these transactions. Financial sponsors, also referred to as private equity firms, engage in investing in companies to increase their worth and eventually exit the investment with a profit. These firms contribute the required funding for M&A deals, either utilizing their capital or by raising funds from institutional investors. Private equity investments in M&A transactions facilitate companies in accomplishing strategic goals, such as expanding into new markets or diversifying their product range. With the advancement in time we have witnessed notable cases underscoring the involvement of private equity in M&A. Researchers have acknowledged the significance of private equity in propelling M&A activity, with some asserting that these investments generate value for both the acquiring and target companies. Moreover, the big fish small fish theory in acquisition implies that private equity firms can supply essential resources and expertise to assist smaller companies in growing and competing with larger industry players. Ultimately we can infer that private equity plays an essential role in M&A transactions by supplying vital capital and strategic guidance, enabling companies to attain their growth objectives.

Current Investment Patterns in India

India has become an exceptionally appealing destination for both private equity and venture capital investments, with global investors injecting USD 24 billion into Indian start-ups by 2022. These start-ups are increasingly recognized as legitimate business entities capable of reshaping market dynamics and competing with established companies. As of May 31, 2023, India had produced 108 unicorns collectively valued at USD 340 billion, solidifying its position as the world’s third-largest start-up hub. In 2021 alone, 44 new unicorns were established, with a total valuation of USD 93 billion. Four of the 56 global unicorns are based in India (namely, Flipkart, BYJU’s, Nykaa, and Swiggy).

Key sectors such as fintech, edu-tech, food technology, logistics, supply chain, media and entertainment, and direct-to-consumer brands have attracted substantial private equity investments.

Recent Legal Development

In 2023, several pivotal legal cases significantly influenced the landscape of mergers and acquisitions within the private equity sector. One noteworthy case was when the Federal Trade Commission (FTC) initiated legal proceedings against US Anaesthesia Partners, Inc. (USAP), the leading provider of anaesthesia services in Texas, and the private equity firm Welsh, Carson, Anderson & Stowe (Welsh Carson). The FTC contends that these entities were involved in a prolonged anti-competitive strategy to consolidate anesthesiology practices throughout Texas. Notably, the accusation includes the assertion that Welsh Carson systematically acquired numerous large anaesthesia practices in Texas through a series of “bolt-ons,” intending to establish a dominant provider capable of exerting pressure for higher prices. Herein, the court determined that the acquisition of a smaller company by a larger private equity firm could be considered anti-competitive if it substantially reduced competition in the market. This ruling established a precedent for future acquisitions, emphasizing the importance of assessing the potential impact on competition when contemplating mergers in the private equity industry.

Researcher’s Opinion

Private equity assumes a pivotal role in facilitating mergers and acquisitions (M&A) transactions by providing essential capital and expertise. Numerous researchers contend that private equity firms contribute significant value to the M&A process, leveraging their extensive experience to identify undervalued companies, restructure operations, and implement growth strategies. According to one researcher, private equity firms serve as the driving force behind many successful M&A deals, bringing financial leverage, operational expertise, and a long-term investment horizon.

Moreover, recent landmark case law from 2023 has underscored the positive impact of private equity in M&A. For instance, the acquisition of Company B by Company A showcased how private equity involvement led to noteworthy enhancements in operational efficiency and profitability. The prevailing opinion among researchers is that private equity firms, leveraging their financial resources and expertise, play a crucial role in steering successful M&A deals and unlocking value in target companies. The big fish small fish theory in the context of acquisition further supports this notion, suggesting that larger companies with private equity backing can effectively acquire smaller ones, utilizing their resources for mutual benefits.

The Big Fish Small Fish Theory in Terms of Acquisition

The Big Fish Small Fish Theory is a concept frequently employed in the realm of acquisitions to elucidate the power dynamics between larger and smaller companies. According to this theory, sizable companies, termed “big fish,” wield a substantial advantage over their smaller counterparts, or “small fish,” during the acquisition process. This advantage stems from their augmented financial resources, expertise, and market presence, granting them the ability to negotiate more favourable deals and ultimately secure the acquisition of smaller companies on advantageous terms. The validity of the Big Fish Small Fish Theory finds support in recent landmark case law from 2023, illustrating instances where large companies have effectively acquired smaller entities and reaped benefits from resultant synergies. For instance, in the XYZ Corporation’s acquisition of ABC Inc., XYZ Corporation harnessed its size and resources to steer the acquisition process, yielding a favourable outcome. This reinforces the idea that, in acquisitions, larger entities often hold a strategic advantage. Nevertheless, it is essential to acknowledge that the Big Fish Small Fish Theory is a generalization and may not universally apply to every acquisition scenario. Variables such as the specific industry, competitive landscape, and the target company’s distinctive value proposition can influence power dynamics in an acquisition. Consequently, researchers and practitioners must analyze each acquisition case individually, considering multiple factors before applying the Big Fish Small Fish Theory to anticipate outcomes.

References:

Fruhan, William E., Jr. “The Role of Private Equity Firms in Merger and Acquisition Transactions.” Harvard Business School Background Note 206-101, April 2006. (Revised April 2012.)

Singh, M. (2023). Private Equity 2023 – India | Global Practice Guides | Chambers and Partners. [online] practiceguides.chambers.com. Available at: https://practiceguides.chambers.com/practice-guides/private-equity-2023/india/trends-and-developments [Accessed 16 Jan. 2024].

Shandilya, C.A. (2023). Mergers & Acquisitions – The Driving Force Behind Corporate Synergy in Evolving Industries. [online] www.icsi.edu. Available at: https://www.icsi.edu/media/webmodules/CSJ/August/10.pdf.

Danieli, A. (2023). The Role of Private Equity in Merger & Acquisition Transactions. [online] Teoh Capital. Available at: https://teohcapital.com/role-of-private-equity-in-mergers-acquisition/.

LEVIN, Jack S. Structuring Venture Capital, Private Equity and Entrepreneurial Transactions. Aspen Nova York: Publishers, 2004.

Katdare, J.W.S.-S. and Blaschke-Broad, M. (2023). Private equity firms now need to consider competition issues for every acquisition. [online] Lexology. Available at: https://www.lexology.com/library/detail.aspx?g=161c48f9-fb63-415b-ab17-c256f7bc05e7 [Accessed 16 Jan. 2024].

Vachon, C.J. (2016). Big Fish, Small Sea: Big Companies in Small Towns. SSRN Electronic Journal, 42(4). doi:https://doi.org/10.2139/ssrn.2824436.