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9-208-037REV:JULY2,2009________________________________________________________________________________________________________________ProfessorJoshLernerandGonzaloPacanins(MBA1997)preparedtheoriginalversionofthisnote,“ANoteonPrivateEquityinDevelopingCountries,”HBSNo.297-039,whichisbeingreplacedbythisversionpreparedbyProfessorJoshLernerandResearchAssociateAnnLeamon.Copyright©2007–2009PresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessSchoolPublishing,Boston,MA02163,orgoto—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionofHarvardBusinessSchool.JOSHLERNERANNLEAMONANoteonPrivateEquityinDevelopingCountriesThepastseveralyearshaveseenadramaticchangeinprivateequityactivityinthedevelopingworld.Inshort,therehasbeenadramaticincreaseinactivityalongallstagesoftheprivateequitycycle.Moreover,whileChinaandIndiaarenamesonalmosteveryone’slips,evenregionsthatwereformerlyanathematoallbutthemostintrepidinvestorsandlimitedpartners—RussiaandCentral/EasternEurope,Africa,theMiddleEast—havebecomethetargetsnotjustofopportunisticinvestmentsbutevenofspecificfunds.Thesechangeshavebeenfueledbothbyinstitutionalinvestorsbasedindevelopednations,particularlytheUnitedStatesbutalsoCanadaandtheUnitedKingdom,andbyprivateequityfirms.Thisisnotthefirstsurgeofinterestinemergingmarketsprivateequity,butitseemstobethewidest-spread.Anearliersurgeoccurredintheearlyandmid-1990s,fueledbytherapidgrowthofmanydevelopingnationsandtherelaxationofcurbsonforeigninvestmentsinmanyofthem.Thiswascompoundedbytheperceptionamongmanyinstitutionalinvestorsinthemid-1990sthatthereturnsfromprivateequityinvestmentsintheUnitedStateswerelikelytodecrease.Overthelastyearsofthedecade,however,thesetwoperceptionsshifted,andprivateequityfundraisingindevelopingcountriessufferedasaresult,onlytorecoverstartingin2003.Thebaseofthissecondwaveofprivateequitysharessomesimilaritieswiththefirstbutalsodiffersinsomeimportantways.Asoccurredpreviously,theexpectationsofdepressedreturnstotheU.S.(andmostdevelopedcountries)stockmarketssentinstitutionalinvestorsabroadinsearchofbetterresults,butinanewdevelopment,someofthesedevelopingnationsappeartohavereachedrealinflectionpointsintheirgrossdomesticproduct(GDP)growthtrajectories(seeExhibit1).Inthetwolargestcountriesintheworld,IndiaandChina,andtoasmallerextentacrossthedevelopingglobe,aburgeoningmiddleclassisbeingcreatedthat,inthewordsofaventurecapitalistwholedhistop-tierfirmintoIndia,“wants—well,whateveryothermiddleclassconsumerwants.”Governmentsarealsorealizingthatakeytotheirownsurvivalisjobcreation,whichprivateequityhasproventodowithgreatefficiency.11Studieshaveshownthatprivateequity-fundedcompaniestendtocreatemorejobsthandonon-privateequity-fundedoperations.Thesecompanieswerealreadyinoperation,ratherthanstart-ups,sothisdatadidnotstartfromasmallbase.(Formore,seeFlorenceEid,“PrivateEquityFinanceasaGrowthEngine,”BusinessEconomics,41(3),July2006,andNationalVentureCapitalAssociation,“VentureImpact:TheEconomicImpactofVentureCapital,”March2007,’abilitytoattractprivateequity.Some,suchasSouthAmericaandMexico,havetriedtoincreasethetransparencyoftheircorporategovernance.Manyhaveimplementedprotectionforminorityshareholders.ChinainaugurateditsShenzhenexchange,whichwasgenerallyseenasastepforward,althoughtradingonalltheChineseexchangesisconsideredopaque.Manycountries,includingChinaandIndia,haverelaxedcapitalcontrolsandopenedsectorsoftheeconomytoforeigninvestment.InIndia,forinstance,therealestatesectorexplodedovernightwhenitwasopenedtoforeigninvestment,asitisestimatedthatIndiacurrentlyfacesashortageof22.4millionhousingunits.Privateequityinvestmentappearstobeoccurringacrossdifferentstagesofcompanygrowth.Inmanycountries,growthcapitalwasseenasthebestwaytomitigateriskintheearlydaysofprivateequityactivity.Investinginacompanythatalreadyhadamarketandaproductbothavoidedthehands-onsupervisionnecessarywithastart-upandthegovernmentapprovalthatmightberequiredwhenpurchasingalarger,oftenstate-ownedoperation.Ascompetitionheightenedinthemiddlemarket,privateequityfirmsexpandedtotheendsofthespectrum.Astudyofemergingmarket-targetedfundsthatclosedin2006foundthemtofavorbuyouts(35%)andventure-stageinvestments(33%)attheexpenseofgrowth(25%).2Datahasonlyrecentlystartedtobegatheredforprivateequityinvestmentindevelopingcountriesasawhole.Since2003,theamountofmoneyraisedforemergingmarketshasgrowntenfold,from$3.5billionto$33.2billionin2006(seeExhibit2).Inthosefouryears,the“emergingAsia”region(AsiaexcludingJapan,Australia,andNewZealand,primarilyChinaandIndia)wasthetargetof62%ofthefunds,CentralandEasternEuropeandRussia(CEER)11%,LatinAmericaandtheCaribbean9%,sub-SaharanAfrica8%,andtheMiddleEastandN