Valuing Private Equity

58 Pages Posted: 3 Oct 2012 Last revised: 14 Jun 2013

See all articles by Morten Sorensen

Morten Sorensen

Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER)

Neng Wang

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Jinqiang Yang

Shanghai University of Finance and Economics

Multiple version iconThere are 4 versions of this paper

Date Written: June 13, 2013

Abstract

We develop a dynamic valuation model of private equity (PE) investments by solving the portfolio-choice problem for a risk-averse investor (LP), who invests in a PE fund, managed by a general partner (GP). Key features are illiquidity, leverage, GP value-adding skills (alpha), and compensation, including management fees and carried interest. We find that the costs of management fees, carried interest, and illiquidity are high, and the GP needs to generate substantial value to cover these costs. Leverage substantially reduces these costs. Finally, we find that conventional interpretations of PE performance measures are optimistic. On average, LPs may just break even.

Keywords: Private equity, alternative investments, illiquidity, portfolio choice, asset allocation, management fees, carried interest, incomplete markets

JEL Classification: G11, G23, G24

Suggested Citation

Sorensen, Morten and Wang, Neng and Yang, Jinqiang, Valuing Private Equity (June 13, 2013). Available at SSRN: https://ssrn.com/abstract=2155741 or http://dx.doi.org/10.2139/ssrn.2155741

Morten Sorensen

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Neng Wang (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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Asian Bureau of Finance and Economic Research (ABFER) ( email )

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Singapore

Jinqiang Yang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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