Private Equity Funds Attracting Interest as a New Type of Financial Intermediary
October 20, 2008
In the latter half of the 1990s, as Japan's financial crisis deepened and the number of corporate bankruptcies rose, investment funds began to attract interest as potential agents of corporate revitalization. Investment funds can be divided into a number of categories according to their investment targets and methods. Private equity funds (PE funds) invest mainly in unlisted and privately held companies. Their aim is to derive profit by acquiring companies on the basis of a long-term strategy and enhancing their corporate value before floating or selling them on. The scale of PE funds is rising every year: the worldwide total value of transactions carried out by investment funds (including PE funds) in 2007 was in excess of $800 billion (excluding REIT and hedge funds; data from Thomson Financial).
In the European and American financial sectors, PE funds are gaining importance both as suppliers of funds and as targets for investment. The expectation is that the use of PE funds will bring benefits, on the financial side, through (i) the supply of funds and (ii) the diversification of asset management and, on the non-financial side, through (iii) the enhancement of corporate value and strengthening of corporate governance and (iv) the efficientindustrial reorganization. Japan would do well to follow the example of Europe and the United States in making active use of the financial resources and functions of PE funds to promote a smoother flow of funds, pursue the rationalization and streamlining of business management and bring out industrial reorganization, and so establish a basis for sustained economic growth.
Areas in which PE funds might play a useful role in Japan include (i) the restructuring of the business operations of large corporations, (ii) the global expansion of companies, (iii) the financing of small and medium enterprises (business succession, the restructuring of corporate business operations, organizations and capital, industrial reorganization, etc.), and (iv) regional finance (the regeneration and revitalization of local economies.) The use of PE funds would become an option for businesses wishing to pursue business plans or achieve a specific objective. However, many issues will have to be resolved before the use of PE funds can become established in Japan. These include (i) a shortage of specialists, business directors and other human resources, (ii) psychological resistance to the use of PE funds on the part of companies, (iii) the need for the establishment of infrastructure to serve as a basis for exit strategies, (iv) the problem of conflicts of interest, and (v) the uncertainty of systems (legislation governing mergers & acquisitions, tax systems).
In recent years, as PE funds have become more active in Japan, the range of situations involving collaboration with financial institutions has grown. For financial institutions, doing business with PE funds offers not only the opportunity to generate revenue through the supply of debt and commission on mergers & acquisitions or IPOs but also, by using the functions of PE funds to enhance the corporate value of companies with which they do business, the opportunity to strengthen their revenue base for the future. PE funds are still relatively new to Japan, and cannot yet be said to have gained adequate social acceptance. If the activities of PE funds are to gain acceptance in this country, the issues listed above must be resolved and the funds also need to steadily build up a track record as entities that complement and reinforce the functions of existing financial institutions.
For more information on the content of this report, please contact Atsuko Nomura, the Japan Research Institute, Limited.