Question

Give your own example of three stages in which the J-Curve effect occurs.

Answer 1

J Curve in Private Equity

In private equity, the J Curve represents the tendency of private equity funds to post negative returns in the initial years and then post increasing returns in later years when the investments mature. The negative returns at the onset of investments may result from investment costs, management fees, an investment portfolio that is yet to mature, and underperforming portfolios that are written off in their early days.

Typically, private equity funds do not take possession of their investor’s funds until they’ve identified profitable investments. The investors just commit to providing funds to the fund manager as needed or upon request. Banks that lend to private equity funds negotiate for a cash flow sweep that requires the fund to pay down its debt with some or all of the excess cash flow generated. In the initial years, the private equity fund generates little or no cash flow for the investors and the initial funds generated are used to reduce the company’s leverage. This concept requires extensive financial modeling and a financial analyst at a PE fund will have to build an LBO model for the deal.

If the fund is well managed, it will begin experiencing unrealized gains followed by events in which the gains are realized. Leveraged IPOs, mergers and acquisitions, and buyouts result in increased returns to the fund, which produce the J Curve shape. With the excess cash and the after the debts are paid, the extra cash will go to the equity investors. The J Curve incline is determined by the returns generated, and how quickly these returns get back to the investors. A steep curve represents a fund that generated the highest returns in the shortest time possible, while a curve with little steepness represents a poorly managed private equity fund that took too long to realize returns and only generated low returns.

J Curve in Economics

In economics, a J Curve refers to a change in the country’s balance of trade, often following a currency devaluation or depreciation. A weak currency means that imports will be costly, while it will be more profitable to export commodities. The imbalance leads to a fall in the current account, hence a smaller surplus or a bigger deficit.

Immediately after the devaluation of a currency, there will be a lag in changing the consumption of imports. The demand for expensive imports and the demand for cheaper exports will be unchanged in the short run, as consumers look for cheaper alternatives.

The long-term implication of currency devaluation or depreciation is that local consumers will switch to comparable locally-produced products. Also, foreign traders will purchase more products that are being exported to their country. The products exported to their country are relatively cheaper due to the weakened currency value. At this stage, the country experiences the desired outcome of improving the current account balance. The J Curve forms when the country’s currency appreciates and the value of exports becomes more expensive than the value of imports.

J-Curve in Business
After continuous failures, when a business makes a remarkable re-entry into the market in a new avatar, it is denoted as J-curve growth in business.  

J-Curve in business is a situation when a business makes a steep upward movement after the persistent downfall.

Let us understand J-curve growth in the business world with the help of some examples.

Instagram

It started as a mobile gaming application named Burbn but failed as it was a heavy application to run on mobile phones.

However, people liked the function of uploading photographs by taking selfies.   

It was re-launched again with the name ’Instagram’ with full features of photo uploading and sharing and it gets J curve in business.

Youube

It started as an online dating site. It failed. It was bought by Google in 2006 and it converted it into a video search engine.

Today, it has become the world’s largest video sharing platform. It gets J curve growth in business.

Flipkart and Amazon
  
They started as small online book stores. After learning from mistakes, they brought extensive changes in their business model and finally, they get J curve in business.

Paytm
  
J-curve effect could well be understood by how Paytm became India’s number 1 payment transfer platform over the night.

It started as a small online mobile recharge website, which was a failure.   

With astounding J-curve growth, it bounced back and became India’s largest online payment platform.