evcas little book of private equity

7/29/2019 EVCAs Little Book of Private Equity

1/7


2/7

There are several ways thatcompanies can be owned and canraise fresh capital for investment.

Companies can be state-owned.They can be owned by families orbig businessmen and women.

They can be listed on a stockmarket (and so have thousandsor sometimes more than a millionindividual and institutional owners).

And they can be backed byprivate equity.

This little book is about privateequity and how it owns and investsin companies.

3


3/7

Private equity funds are very picky.

They are the talent scouts ofcompany investment. They spendages assessing the potential ofcompanies, to understand their risksand how to mitigate them. They onlyallocate their private equity funds tocompanies with the X factor.

That doesnt mean these companieshave to be the best in their field.

Usually they are not.

Private equity just helpsthem get there.

Companies come in all shapesand sizes.

So do private equity funds.

There are funds that invest inentrepreneurial start-ups that have

just the germ of a business idea.

And there are funds that acquireestablished companies in oldindustries, with the aim of reviving

their fortunes.

But most companies are in betweenthe two extremes these are smalland medium-sized enterprises.Most private equity investments,around 85%, are into SMEs.

In Europe, private equity firms areinvested in 22,000 SMEs. It soundslike a lot. But there are more than 20million European SMEs in total.

So whats different about

the 22,000?

54


4/7

Private equity is invested by fundmanagers. These also come in allshapes and sizes.

Some fund management firmsare made up of just a handful ofpeople, often former entrepreneursthemselves. Others are biginstitutions with a global network ofbusiness contacts and know-how.

But the idea is the same: to invest

in a company and make it morevaluable, over a number of years,before finally selling it to a buyer whoappreciates that lasting value hasbeen created.

These buyers might be largeconglomerates and corporations,larger financial investors or stockmarket investors (through an initialpublic offering or IPO).

If the company is not much morevaluable when it is sold normallyit needs to grow 8% or more everyyear of the investment the fundmanager doesnt get their reward(sometimes called carried interest).

This growth is quite difficult toachieve, and many fund managersdont ever manage it.

Stock market investing is muchbetter known than private equity.But there are important differencesin how private equity governs andcontrols companies.

Since listed companies have somany owners, they cant all beinvolved in the running of thebusiness. So the task is given toexecutives who wield significantpower, with reference to their

disparate owners.

This system of executivestewardship severs the concept ofmanagement of businesses fromtheir ownership (sometimes calledthe agency problem). Even withthe best intentions, the result can

be a misalignment of interest andsometimes excessive personalrewards despite poor performance.

In private equity, companies areowned by a small number ofprofessional investors, through achain of command that directly linksvalue with reward, from companymanagers through to private equityfund managers, and back through tothe fund.

Such clear accountability hasmany benefits. For instance, it givescomfort to potential lenders, allowingprivate equity-backed companiesto attract relatively cheaper debtfinance for their activities, alongsidethe private equity.

6 7


5/7

So whose money isprivate equity?

Its yours.

If you are part of a pension scheme,or if you have an insurance policy, itis very likely that part of that moneyhas been invested into a privateequity fund.

Pension fund managers like

private equity because they onlyhave one objective: to make sureyou have enough money for yourretirement. Like private equity fundmanagers, they dont care aboutshort-term performance.

They recognise that instant accessand the ability to change your mindoften come at a price that is notworth paying.

By pooling their money with anexperienced private equity fundmanager, pension funds andinsurance companies know thatover the long term they are likelyto achieve strong risk-adjustedreturns for their stakeholders

people like you.

The way private equity fundsare structured is the key tounderstanding how they investin companies.Commonly, private equity funds are10-year limited partnerships.

That means the underlying investorsinto funds commit their money fora long time (in practice, well over adecade). They cant trade in and out

easily. Such investments are viewedas illiquid.

That means short-termperformance is irrelevant. Itis irrelevant to the companymanagers, the fund manager andthe underlying investors, sincenone of them get remuneratedfor short-term performance.

Unlike in listed companies,where management-stewardsreceive bonuses based on annualperformance, private equity

rewards only come when anunrelated buyer sees greatervalue in a company than wasoriginally paid for it.

Creating sufficient value typicallytakes up to five, or even 10, years.

98


6/7

ENTERPRISECAPITAL

Like all industries, private equityhas a lot of jargon that canbe confusing.

Actually the reality is simple.

Lets get this out of the way first.

Hedge funds: nothing to do withprivate equity investment. Hedgefunds are liquid (short-term) tradingfunds that can invest in all sorts of

complex financial instruments.

They can invest in companiestoo, but can do so in order to betagainst them.

Venture capital: this is when privateequity is invested into young,entrepreneur-led, high-potentialcompanies that are typically drivenby technological innovation.

Enterprise capital: privateequity investment into moreestablished businesses that want tointernationalise, professionalise ordevelop their products and services.

Buyouts:private equity can beused to acquire (or buy out) allor the majority of an establishedbusiness. After that, the privateequity method of ownership andgovernance kicks in.

Countries and citizensacross the world face difficulteconomic times.

After the financial turmoil of thepast decade, we need better andmore stable mechanisms forachieving prosperity.

By creating lasting valuethroughresponsible company investment,private equity can contribute to

making peoples lives better.

Private equity isa relatively newindustry in muchof the world.

But it can play an

important part inour future.

For more information aboutprivate equity, please contact us.

We would be happy to hearfrom you.

Bastion TowerRue du Champ de Mars 5Brussels B1050

+32 2 290 02 [email protected]

EVCA is the European Private Equity& Venture Capital Association. Itsmission is to create a more favourableenvironment for private equity andventure capital fundraising, investmentand entrepreneurship.

110


7/7

European Private Equity &Venture Capital AssociationBastion TowerRue du Champ de Mars 5

BrusselsB1050

+32 2 290 02 30

[email protected]

Words:RossButler

Design:bladonm

ore.c

om

Illustration:selenacardwell.com

evcas little book of private equity

Documents