Ever wondered what Private Equity really is?
Updated: Jun 29, 2022
For a lot of people, the world of Private Equity has the mystique of being a secretive, exclusive and sometimes glamorous club of investors who are collectively deploying trillions of dollars across the globe while each pocketing a small fortune for the pleasure of doing so.
In fact, if you are interested in how much money Private Equity has under management in 2019, on a global basis the number is an eye-watering A$7.4 trillion Australian Dollars and growing with an estimated $2 trillion of that being held as dry powder waiting to be invested into new deals.
So what is Private Equity? Well, Private Equity or “PE” is a general term used to describe a collective industry of specialist fund managers that invest in acquiring equity stakes in businesses, both control and non-control positions.
The "Private" in Private Equity has become synonymous with the type of transaction PE funds are typically involved in, either the investment in private companies or the take private (de-listing) of public companies. However, if we go back to the origins of the early PE funds in the US there is some contention as to whether the Private actually related to the “Private” sources of capital that were used to fund the transactions undertaken by the PE funds. Either way, the outcome is the same and what resulted was the creation of an investment structure that enables PE funds to transact, transform and grow their investments without having to publicly disclose their actions and performance like a listed company does.
There has been a lot of criticism of the opaque nature of the PE industry over the years but the “limited public disclosure regime” that was engineered into the very fabric of the industry in its early days is at the core of its competitive advantage. This means that fund managers can develop an investment strategy and get a long way through executing that strategy before the rest of their competitors work it out. Remember, PE is a very competitive industry because everyone is vying for a slice of the same pool of capital and being benchmarked against their competitors on the quantum and stability of their returns. For that exact reason, it's critical to be able to develop propriety ideas and investment opportunities and protect them until they are locked away.
Additionally, Private Equity is illiquid which can make it difficult to value a fund partway through its life. This is why there are strict guidelines and reporting requirements imposed on all funds by their investors, however the last thing any PE fund manager wants to have to worry about is having their fund regularly priced on a mark-to-market basis by the public markets.
Quite simply, one of the biggest benefits of Private Equity is its ability to change, grow, restructure and transform a business outside the public eye. This is not because the practices of PE are unlawful or unethical, in fact, one could argue that since the introduction of the United Nations Principles for Responsible Investing in 2006 that any fund that is on the wrong side of the ESG continuum is finding it very difficult to raise money and exist in today’s market. Instead, being able to change and transform a business outside the public eye removes a lot of management distraction and allows the business and its investors to take a multi-year view on value creation opposed to the much sorter horizon considered in the public markets.