Don’t Count on First-Mover Advantage in Private Equity

Poor deal making conditions could dampen return opportunities for early entrants into emerging markets, research shows.

At least in private equity, being an early mover may not pay off for investors.

While new markets typically offer “significant growth opportunities” to exploit, providing an advantage to initial entrants, early transactions in emerging private equity markets have underperformed later deals, according to research from the Emlyon Business School in France.

The study, authored by finance professor Alexander Groh, examined 1,157 private equity deals in 86 countries between 1973 and 2009 and found that “waiting and learning pays.”

“Many emerging countries are large in terms of their population and have enormous economic catch up potential,” Groh wrote.

While this could be considered an “optimal environment,” for private equity investors, “sophisticated relationships between investors, general partners, and investee firms require certain legal standards, enforcement opportunities, and a socio-economic development level which might not yet be reached in many emerging countries,” he argued.

Furthermore, the opportunity cost of capital is “usually high” in emerging countries, Groh said, and appropriate buyout candidates are lacking.

“Investors need to gain the local experience and should not expect that the ‘traditional’ private equity deal model they are confident with can be easily transferred to emerging environments,” Groh wrote.

Over time, investors learn and dealmaking conditions improve—but these effects were not proprietary to early movers, the study found, as later entrants also earn higher returns.

“There are no directly measurable first mover advantages,” Groh concluded. “It is preferable for investors to delay their emerging-market private equity allocations until the particular countries are mature enough to establish liquid private equity activity.”

Read the full report, “You Needn’t Be the First Investor There: First-Mover Disadvantages in Emerging Private Equity Markets.”

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