Deal Pricing and Returns in Private Equity

Abstract

Deal returns of private equity (PE) transactions are strongly influenced by EV/EBITDA multiple expansion, which in turn is the result of differences in deal pricing from entry to exit. This article sheds light on how relative pricing, in comparison to market price levels, influences multiple expansion and thus deal returns. The authors analyze the influence of both market price levels by themselves, as well as of deal pricing in relation to those market price levels. In addition, they analyze the influence of this relative pricing on final deal returns. Using a sample of 2,174 unique PE transactions, they find that multiple expansion is an important factor in explaining deal returns. The authors further find that buying low and selling high in comparison to market prices from the same segment positively influences multiple expansion. While there is a need for both, selling high yields about twice as much as buying low. They attribute a skill set to general partners who are investing in PE deals, as general partners can influence the pricing when buying or selling companies through their negotiations. Because a negotiation is something entered consciously, the outcome—resulting in deal pricing—is not based on luck alone. The authors thus recommend that limited partners providing capital to PE funds look for fund managers with this skill set as it can help achieve higher than normal returns in their transactions and funds.