Private Equity widens its appeal

Why high net worth and sophisticated investors are increasingly turning to Private Equity

Mike White
Partner, YFM Equity Partners

For decades institutional investors have been investing in Private Equity because of its attractive long-term performance of double digit returns, low correlation with quoted markets and resilience.  For example, as an asset class Private Equity has delivered average returns of 11.0%[1] over the last ten years, with the small buy-out segment being the best performing sector of the market.

Private Equity should not of course be confused with investments of the type made by “Dragons Den” or venture capital investors.  Whilst it’s true that both investment types are made into private companies, venture capital investments are made into early stage, normally pre-profit and often pre-revenue businesses.  Whilst these businesses have the potential for generating high returns, they also carry a commensurately high risk.  Instead, Private Equity investments are made into pre-existing, often long established companies, usually involving the buy-out of one or more shareholders e.g. the founder of the business wishes to retire and sell the company to his or her second tier management team.

Whilst, for many years, it hasn’t been unusual for institutional investors to allocate 5% or more of their assets to Private Equity, it is only relatively recently that high net worth and sophisticated private investors have been attracted to the asset class.  Just like the institutions they have been attracted to investing in Private Equity as a way of diversifying their portfolios and accessing the potential for strong returns, something particularly relevant in an era of very low interest rates.

I am particularly interested in a specific subset of the high net worth market, the entrepreneur.  Successful entrepreneurs are typically business savvy and highly driven individuals, with a clear vision of what they want to achieve.  But for most entrepreneurs there always comes a time to sell their company, whether it be when all their goals are achieved, they want to retire, or someone just offers them a price that’s too good to refuse.  So what happens next?  Taking a long holiday might come first.  But that’s the easy bit!  When the suntan has faded there is a real job of work to be done; how to invest the £50m, £100m or more they have realised, which is no small task – albeit there are plenty of advisers on hand to help.

Investment in property and a portfolio of stocks and bonds will no doubt form part of the solution.  But entrepreneurs will often also set aside a “play pot” for investing in small businesses, often taking 100% ownership and becoming actively involved as an angel investor.  The problem with this “direct” Private Equity approach is that once you have invested in a few businesses you can soon run out of bandwidth to manage these investments, and you end up with a relatively high concentration of funds invested in perhaps only 3-4 companies.  So I think there are some good reasons for entrepreneurs to invest in a Private Equity fund in addition to or in place of “direct” investing:

  • Diversification, with a typical Private Equity fund investing in 10-15 different businesses, across a broad range of sectors.
  • Access to a much wider level of deal flow than would otherwise be seen with fund managers often seeing dozens of opportunities for each investment chosen.
  • Professional management, with investments made and managed by a team with a demonstrable and consistent track record of making money in their chosen market.
  • Fund managers often offer investors access to co-investment opportunities, so they can “double up” on investments of particular interest.
  • No personal involvement required, but investors may have a role on the funds’ advisory panel.
  • The social value and personal satisfaction of helping put something back into growing British business

Private Equity has long been the preserve of the institutional investor, but the attractive returns Private Equity funds offer have put them firmly on the radar as alternative assets to be considered as part of any high net worth and sophisticated investor’s portfolio.

[1] Source: BVCA Private Equity and Venture Capital Performance Measurement Survey 2016 (10-year returns)

 

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