Why Private Equity?
Private equity is medium to long term finance provided in return for an equity stake in established, potentially high growth, private companies.
Private equity funds can invest in companies that are already privately-owned, perhaps by a family or entrepreneur; they can acquire businesses that exist as divisions or subsidiaries of larger companies, or they can acquire publicly-listed companies and take them private.
Private equity managers are extremely selective and spend significant resource assessing the potential of companies, to understand the risks and how to mitigate them.
Private equity managers also take a very active role in the running of the companies they invest in with the aim of increasing their value. Value can be created through organic growth, buy and build, roll-out and internationalisation.
The management teams which are backed have significant equity stakes in their business and are therefore incentivised to perform well over the long term.
Why listed private equity?
The traditional way of investing in private equity is through Limited Partnerships. These vehicles are mainly open to institutions and other larger sophisticated investors. Listed private equity gives the individual investor access to the asset class which they can’t otherwise obtain.
Listed private equity offers investors the following:
- Access – shares in listed private equity companies are easily traded on stock exchanges
- No barrier to entry – listed private equity has very low entry requirements: namely, the price of a share
- Choice – the sector is diverse, offering a wide range of private equity investment, as each listed fund manager has different investment strategies and criteria
- Simplicity – listed vehicles handle the cash management and administration, which can be complex for Limited Partnership interests. All listed private equity investors need to do is monitor the value of their shareholdings in the quoted vehicle itself.
Disadvantages of listed private equity
There are however some disadvantages to be aware of:
- The potential illiquidity of small, closely-held listed private equity vehicles: although technically a holding in a listed private equity company can be bought or sold at any time, there are times when this is difficult to do in practice, especially with large blocks of stock, partly as investors tend to hold on to their shares as a long term investment.
- The underlying exposure of a listed private equity company to private equity investments can vary considerably. Sometimes it may be heavily invested in underlying companies to the point of borrowing to finance some of the portfolio and be subject to the risk of gearing (although prudent use of the opportunity to gear the portfolio can be very advantageous for shareholders). At other times, the listed company may have a great deal of net cash in the portfolio, as a result for example of a number of realisations and a lack of immediate investment opportunities. Surplus cash may act as a drag on performance.
- Shares in listed private equity companies usually trade at a discount or premium to their Net Asset Value (NAV). The NAV is necessarily an estimate of the value of the underlying assets – albeit according to strict valuation guidelines – and these valuations are conducted infrequently and with a lag. Shares can trade at a discount to NAV for long periods, particularly when stock market sentiment is depressed or subdued.
- Listed private equity is best suited to long term holding, not frequent trading.