Overview

Private Equity Overview

The Private Equity Industry Has Seen Significant Growth As An Asset Class

The private equity industry has enjoyed significant growth since the 1970s and over the last two decades the industry has evolved into a global asset class, offering a wide selection of established fund managers with extensive performance track records.

Not only has the private equity industry developed in prominence but assets under managements have also seen substantial growth. 2014 was a record year for the industry with AUM – the sum of dry powder and the net asset value of private equity investments – in excess of USD 3.8 trillion, according to the private equity research firm Preqin.

A staggering $495bn of funds was raised by 994 Private Equity funds over the year. Exits from buyouts exceeded $450 billion, surpassing the all-time high by a wide margin. Owing to robust distributions,  Private Equity continues to attract new capital as 2015 starts the year off with 2,235 funds seeking an aggregate of $793 billion, and with healthy market conditions and cash-rich fund managers, 2015 too is expected to be a successful year.

When properly structured, private equity can be one of the most rewarding asset classes. Research has shown that private equity has consistently outperformed the public equity market. A tailored portfolio that consists of a careful selection of top quartile private equity funds with attractive returns profile can result in even higher premiums.

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Private Equity As An Asset Class

Private equity investors invest primarily in unlisted operating companies held privately. A private equity fund consists of a pool of monies raised from different sources such as corporations, High Net Worth Individuals (HNI) and Family Offices, Insurance Companies and Pension Funds and is managed by specialist managers to invest in private portfolio companies. The objective is to sell the portfolio company at a higher price after a few years of value development, thus generating profits for the fund’s investors.

History of private equity industry

Even though the roots of private equity can be traced back 50 years the private equity industry formally took off in 1970 with the first structured private equity funds in the United States and the United Kingdom. Regulatory changes were the key growth drivers for banks and pension funds that sketched the private equity markets. By 1990, private equity started attracting institutional investors and gained momentum in terms of fund raising and number of deals closed. In the year 2000, private equity reached its peak with $200 billion invested worldwide thus having grown faster and bigger than any other asset class.

Regions

North America is the homeland of private equity activity. North America accounts for the majority of total AUM (57%), followed by Europe (24%), Asia (13%) and Rest of World (6%). This pattern illustrates the varying stages of development of the industry across these regions. However, with the asset class gaining traction in emerging economies and Limited Partners seeking to diversify their portfolio in terms of risks and returns, regions like Asia have increasingly become an integral part of the private equity and venture capital universe.

Classification of Private Equity funds

The Private Equity asset class can be broadly segregated into three categories

Venture

Venture capital funds usually take minority stakes in startup companies, often in high-growth sectors like internet, consumer, biotech, healthcare technologies etc. These companies usually have no to very little revenues. The various stages of VC investment are classified as below:

  • Early Stage capital development that requires seed capital for the early development of companies or to launch businesses that might be generating revenues but may not yet be profitable.
  • Later Stage capital development in which investors bring in capital to finance expansion, or as replacement capital for existing investors.
  • Pre-IPO / Mezzanine capital in which investors bring in capital to meet liquidity requirements prior to an IPO issue
Growth

These investments are made in more mature companies that require capital for the purpose of expanding its proven business model into new territories, restructuring, or making acquisitions without the loss of management control.

Such investments are normally made in private companies but can also be made in public companies through preferential placements (also known as Private Investment in Public Enterprises, or (PIPEs).

Buyouts

Buyout strategy typically consists of acquiring controlling stakes in mature, established and cash-flow-stable companies. These companies are ‘bought-out’ from their owners with the use of financial leverage.

The investment is managed over a period of time and then exited after significant value has been created. Buyout can be further classified into small, mid and large cap buyout transactions.

Family Investment Offices

The Jawa family first set up Starling Holding in 1986 as a Family Office with the mandate to invest and manage the family assets, within the Private Equity asset class, for the benefit of future generations.

Family Investment Offices manage the personal fortunes of very wealthy families. Families who set up such offices are either entrepreneurs who intimately manage their family business or wealthy families who wish to manage their fortune trans-generationally

There are more than a 1000 Family Offices actively investing across the globe, many of which are managing assets in excess of over €1bn in size, diversified over both traditional equities and alternative assets (Private Equity Funds, Hedge Funds, CTAs and Real Estate).

The role of Family Offices as investors in private equity has increased exponentially in recent times. Family Offices are recognized as a well-suited group of investors for the private equity asset class due to its longer term investment approach and highly illiquid characteristics. While the attractive return profile of the private equity sector makes it a compelling choice for investment, Sophisticated Family Offices are also able to assess and understand the risk associated with the illiquidity of this asset class. Sophisticated Family Offices also appreciate the active, hands on role that fund managers play -an important factor that is absent in the public market.