Like public equity, private equity entails the ownership of shares in a company. The key difference is that the shares of private companies are not publicly traded on a stock exchange and are therefore illiquid. To compensate for the illiquidity, private equity is usually traded at a discount to public equity valuations, potentially generating higher returns.
While information on public companies is readily available, private markets are typically opaque and require extensive expertise to unlock value. They are often out of reach to non-institutional investors. Many investors are unfamiliar with the asset class.
This article aims to answer common questions about this asset class and how you can access the exciting opportunities in the space.
A private equity fund starts by raising capital commitments from investors. The fund manager may focus on a specific strategy (e.g. venture capital), a sector (e.g. technology or healthcare), a geographical region (e.g. the U.S. or Asia), or a combination thereof. The fund manager would then call the capital from investors gradually to buy private companies.
The private equity manager scans numerous opportunities and selects the most promising private companies. Before acquisition, extensive due diligence is conducted to ensure the viability of the investment.
After acquisition, the private equity manager works with the management of the private company to create more value by improving revenues and profitability over the holding period (usually three to five years).
After the value creation process is complete, the investment is exited through an IPO or a sale to a strategic buyer or another private equity manager.
Private equity funds require extensive hands-on management at every stage and need larger teams to source transactions, conduct due diligence, work with portfolio companies to improve their operations, and manage the exit.
The process of raising capital, acquiring companies, creating value, and eventually exiting an investment may last 10 years. However, investors would receive proceeds as investments are realized over time, and are likely to recover their invested capital within a shorter period.
It is essential that you invest with trustworthy, competent fund managers. With decades of experience, the financial advisors at The Family Office can guide you to invest with the best managers.
Private equity investments follow three broad strategies.
Buyouts entail the acquisition of a controlling interest in a company. Often, the acquisition is done with a combination of debt and equity, also known as a leveraged buyout (LBO). The use of leverage requires the acquired company to be mature and profitable, generating enough free cash flow to repay the debt.
After acquisition, the private equity manager works with the management of the company to create value by improving revenues and profitability, either organically or through mergers and acquisitions. Once the full value is created, which may take three to five years, the investment would typically be sold through an IPO or to a strategic buyer or another fund manager.
Growth equity strategies involve significant minority positions of fast-growing companies without leverage. With little or no leverage, these companies do not need to be profitable. If they are, profits would be retained for growth.
Growth companies tend to be younger than those acquired in buyouts, with proven business models that need substantial investment to realize their growth potential. Generally, the holding period of a growth equity investment may be shorter (two to four years).
Venture capital involves making modest investments in many companies at a very early stage, often with unproven business models and no revenues. This is the riskiest of the three strategies as most investments tend to fail, but the rare successes create phenomenal returns (up to 100-fold) that compensate for all the failures. The holding period may stretch to eight years.
The business risks do not differ materially between private and public companies. They are subject to the same economic and geo-political dynamics. However, private equity investors receive a “liquidity premium” over their public counterparts to compensate for the lack of liquidity, which could add 3% to the returns.
Private equity managers often unlock more returns from leverage and business improvements as private markets tend to be less efficient than public ones.
Private equity is also less volatile than public equity, as valuations are based on business fundamentals rather than the daily shifts in investor sentiments.
The allocation to private equity should be part of a broader strategy that includes other income-generating alternative investment asset classes, such as private credit, private real estate, etc.
Allocating to alternative investments in your portfolio improves returns through better diversification with strategies that feature different risk-return profiles and uncorrelated or negatively correlated returns. When one asset class declines, the returns from another asset class that is negatively correlated offset the losses.
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For investors who are willing to lock up their capital for up to 10 years, investing in private equity is an attractive way to generate outsized returns.
But private equity also has its drawbacks. It is opaque and requires extensive expertise specific to one location or industry. Through its global network, The Family Office works with top-tier asset managers to get our clients the best deals worldwide.
Private equity funds usually seek commitments between US$5 million and US$25 million. The Family Office allows you invest a much smaller amount by pooling your capital with other investors.
Regardless of its attractive features, we would not recommend concentrating your investments in private equity. But having private equity in your portfolio improves diversification and long-term risk-adjusted returns.
Founded in 2004, The Family Office is an independent wealth management firm that offers customized portfolio solutions across multiple asset classes. Our investment philosophy is more than just buying and selling assets. We believe the key to growing and preserving wealth is to design a robust investment strategy that suits your unique needs, preferences, and lifestyle.
Whether you wish to preserve your legacy, plan for retirement or diversify your investments, our world-class financial advisors with decades of experience are ready to help you construct a bespoke portfolio that will meet your unique needs. Schedule a call with us today.
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