11 minute read
private equity
PE: the unseen takeover
As the stock market grabs the headlines of the business pages with billion-dollar valuations, investment scandals and failed IPOs, away from the spotlight – and the volatility – private equity is recording ground-breaking results
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Private equity vs public equity
How private or public ownership shifts the focus for businesses
Private equity
Not obliged to publish information about their stocks
Public equity
Stock and financial information are released for the public
Investors can work on long-term prospects Investors work on short-term prospects because of public pressure
Targeted for individuals with high net worth Targeted for the general public who can buy, sell or trade these shares
May be less regulated by organisations because they do not need to answer to public shareholders
More regulated by government organisations because they disclose their information
Source: https://askanydifference.com/difference-between-private-and-public-equity/
Words:
Marco De Novellis
SOME OF THE figures around private equity (PE) activity are pretty eye-watering. Investments in global PE reached a record $1.1trn last year, according to Bain & Company, and exit value reached $960bn.
To put that into context, the $1.1trn in buyouts doubled 2020’s total of $577bn and smashed the previous record of $804bn set in 2006. Furthermore, the average deal size for major PE funds broke the $1bn mark in 2021 for the first time.
Encouraged by strong returns and new investment vehicles, investors are increasingly deciding to put their money into private companies.
Alex Dean, Head of Private Wealth for the UK at IQ-EQ, says the growth of PE stems from the 2008 global financial crisis. Between 2010 and 2020, private market assets under management increased by $4trn and the number of active PE firms more than doubled.
Much like the pandemic-related stimulus that has supported PE’s expansion over the past year, billions of dollars were pumped into the financial system after the crash, creating a lasting source of accessible and low-cost funds.
The financial crisis also brought about increased regulation over public companies, which drove investors towards privately owned firms.
What most attracts investors to PE, Dean says, are control, flexibility and returns. “PE investors can have a seat on the board of a company, influence and make decisions,” he explains.
“There’s no distraction of daily stock market instability. And as private companies are not as heavily scrutinised or researched, PE offers investors the chance to spot an opportunity including combining a business with another business or transforming a business in ways that others can’t execute.”
Private firms also avoid some of the administrative burden of regular reporting, public annual general meetings and shareholder agreements.
ADDED COMPLEXITY
However, PE investments can be complex. While stocks are traded daily through public market exchanges, PE investments are long term, with capital typically tied up for at least 10 years. It can also be difficult to liquidate or transfer direct PE investment holdings. Yet impressive risk-adjusted returns, Dean says, compensate investors for the fact that their money is less liquid and tied up for a longer period of time.
In the US, PE achieved average annual net returns of more than 10% between 2000 and 2020, according to Cambridge Associates, while the Standard and Poor’s 500 produced returns of less than 6%.
VEHICLES FOR INVESTMENT
With private companies less subject to regulation, critics accuse PE firms of a lack of transparency. According to its harshest portrayals, PE is about stripping assets, loading debt and laying off staff to generate quick returns.
James Fox, a Jersey-based corporate lawyer and Partner in the private equity team at Ogier, says these notions are tired and misleading.
“The whole point of PE is high growth and high return – and the best way to give investors a return on their money is to grow a business. That asset-stripping perception is completely wrong,” he says.
“You’ll also hear that if a company is private, there’s no regulation. But there is regulation at fund or fund manager level. Major PE fund managers, with billions under management, are often regulated in at least one jurisdiction.
“PE investors demand a level of reporting on assets equivalent to any investment. Plus, if PE firms are buying into a regulated business, they need to comply with all the same regulatory approvals as any other buyer would do.”
While major PE firms dominate the market, large family offices are also contributing to its growth.
According to UBS, 80% of family offices are making PE investments in 2022, up from 77% in 2021 and 75% in 2020. And ▼
Private equity trends for 2022
The sector is evolving amid a fastchanging global economic outlook:
Market growth
Inflation and increasing interest rates mean PE may struggle to better 2021’s record-breaking year, yet PE is still outperforming public equity.
ESG centre stage
The majority of firms have implemented ESG policies for PE investments.
Investment across industries
PE investment is flooding into healthcare technology such as medtech and infrastructure projects.
New technologies
PE firms are becoming more flexible and efficient by adopting new tech such as artificial intelligence.
Barbell industry
With multibillion-dollar PE firms at one end of the scale and family offices at the other, there’s a market opportunity for medium-sized PE investors.
family offices are now allocating 21% of their portfolios to PE – an increase of 16% on 2019.
Many of these investments are made via regulated funds or managers, which means groups of investors can take comfort from regulatory oversight at fund level while benefiting from a private company regime at asset level.
Dean also points to hybrid funds, which enable investment in both public and private securities and companies.
“Investors may look for stability in bonds or property investments, but at the same time have the flexibility to invest in listed stocks,” he says.
Meanwhile, club deals, where PE investors jointly acquire a company, are on the increase. Blackstone, The Carlyle Group and Hellman & Friedman acquired healthcare company Medline in a deal worth around $34bn in 2021, although club deals can also involve smaller-scale, individual investors.
Fox sees the PE market as a “barbell model”, with large PE funds raising billions at one end and family offices making smaller deals at the other.
There’s a market opportunity in the middle, he says, where family offices could form their own quasi-PE funds.
FUTURE TRENDS
Despite the eye-watering numbers around the growth of PE, the impact of inflation and rising interest rates means the coming years may be more challenging.
Amid the uncertainty of the pandemic last year, as many business owners looked to exit, PE firms raised investment, made deals and leveraged buyouts, acquiring companies using borrowed money. Interest rates were still low and debt cheap.
Now, in order to control soaring inflation across the eurozone, central banks are raising interest rates for the first time in more than a decade.
These interest rate rises, Fox predicts, will mean less leverage in the future as debt becomes more expensive.
Still, by historical standards, interest rates are relatively low. Fox says PE houses have sophisticated financial models that allow an optimum ratio of equity and debt to be applied to any particular business so that it achieves its full potential.
Industries ripe for PE investment include technology, media, telecoms and life sciences, says Fox, where companies are looking to grow as quickly as possible. Elsewhere, an expanding global population is increasing demand for investment in infrastructure.
New technologies are allowing PE businesses to manage ever more complex investments. Artificial intelligence is making financial data easier to understand and expediting the deal-making process, and reporting is becoming more automated and information more easily accessible for investors.
Family offices now have investments spread across the globe, investing in companies in countries where it wouldn’t have been possible just a few years ago.
Further, a focus on environmental, social and governance (ESG) factors is central to PE investment. Some 70% of limited partners have investment policies that include an ESG approach, according to a survey by Bain and the Institutional Limited Partner Association.
And 85% of those have an ESG policy for PE investments, while 93% would walk away from an investment if it posed an ESG concern.
PE investment in healthcare more than doubled to a record $151bn in 2021, with medtech attracting attention as investors look for ways to relieve pressures on health services.
The storm clouds may be gathering over the global economy, but Dean believes PE firms and investors have long proved their ability to thrive in difficult circumstances.
“PE has a history of investor activism; of people trying to make an impact in companies,” he says. “Investors are excited by the opportunity of finding the next global winner.” n
SEC private fund proposed reforms
Simon Guilbert, Audit Director at KPMG in the Crown Dependencies, examines some of the key takeaways around the Securities and Exchange Commission’s recent proposed rule changes for private fund advisers
IN FEBRUARY, THE Securities and
Exchange Commission (SEC) proposed regulatory reforms that would have a major impact on private fund managers in the US. The proposals represent the most extensive reforms since the passage of the Dodd-Frank Act of 2010 and target a sector that holds more than $18trn in gross assets. The proposals in many cases apply not only to SEC-registered advisers, but also to US and non-US private fund advisers that rely on the SEC’s ‘exempt reporting adviser’ exemptions.
While managers in the UK may not be entirely familiar with the implications of the proposed regulatory reforms, close attention should be paid to the latest developments, which are designed to capture all fund fees and expenses.
KEY POINTS
If implemented, how will this influence the industry? KPMG in the Crown Dependencies has outlined the notable takeaways and how the changes would affect managers and investors. They would: • Require private fund advisers registered with the SEC to provide investors with quarterly statements detailing information about private fund performance, fees and expenses. • Require registered private fund advisers to obtain an annual audit for each private fund and cause the private fund’s auditor to notify the SEC upon certain events. • Require registered private fund advisers, in connection with an adviser-led secondary transaction, to distribute to investors a fairness opinion and a written summary of certain material business relationships between the adviser and the opinion provider. • Prohibit all private fund advisers, including those not registered, from engaging in certain activities and practices that are contrary to the public interest and the protection of investors. • Prohibit all private fund advisers from providing certain types of preferential treatment that negatively affect other investors while prohibiting all other types of preferential treatment unless disclosed to current and prospective investors.
The extent to which the proposals would prohibit all private fund advisers is allencompassing, from engaging in several activities, including seeking reimbursement, indemnification, exculpation or limitation of liability for certain activity, charging certain fees and expenses to a private fund or its portfolio investments.
They would also extend to fee charges or expenses related to a portfolio investment on a non-pro-rata basis and borrowing or receiving an extension of credit from a private fund client.
KNOCK-ON COSTS
The SEC has positioned these reforms as protecting private fund investors. But the content has raised eyebrows in the industry.
If enacted, additional costs will be incurred by private fund advisers and their funds. The requirements for annual audits, quarterly statements and fairness opinions will necessitate the engagement of external providers, the costs of which will ultimately be borne by investors.
There are also likely to be shortfalls in many (notably smaller) private fund advisers’ internal reporting systems and processes that will require investment to remediate. Furthermore, it is possible that the proposed reforms are misguided in seeking to protect private investors, because investors in private funds are typically sophisticated enough and sufficiently resourced to protect their own commercial interests.
Traditional sources of capital in private funds have the means and capability to perform extensive due diligence and negotiate terms with private fund advisers.
Additionally, these proposed rules may have an unintended adverse consequence of discouraging new private advisers, given the additional costs involved and limitations on offering preferential treatment to certain investors via confidential side-letters.
WHY MAKE THE REFORMS
From the vantage point of the SEC, there are compelling reasons for reforms to be proposed to protect investors.
They will provide greater transparency and compel practices that do not incentivise advisers to place their interests ahead of their private funds.
In particular, the requirement for SECregistered advisers to provide standardised reporting to investors detailing compensation, fees and expenses and so on, and mandating uniform definitions of performance metrics such as IRR (internal rate of return) and MOIC (multiple on invested capital), will likely be welcomed by existing and prospective investors.
In addition, annual audits will provide an important check on advisers’ valuations of private fund assets. These often form the basis for the calculation of adviser fees and can be highly subjective and prone to bias.
At the time of publication, the SEC was still in the process of considering public comments received on the proposals. Only time will tell whether these are the right proposals for the industry and if they will prove successful in striking a balance between protecting investors and imposing a regulatory burden on private advisers.
While the reforms are left hanging in the balance, KPMG in the Crown Dependencies is weighing up the proposals’ pros and cons and advising clients to get a transparent understanding of the proposed rules and the overall impact the changes will have on the industry.
KPMG wishes to provide investors with comfort by outlining a concise step forward for when the comment period ends and the rules are finalised. n
FIND OUT MORE
For further advice, contact Simon Guilbert. Email: sguilbert@kpmg.com
ABOUT KPMG
The KPMG firms in the Channel Islands and the Isle of Man have combined to create KPMG in the Crown Dependencies. This creates a professional services business of 460 people, locally owned and dedicated to serving the key industry sectors across the three islands. The KPMG name and logo are trademarks used under licence by the independent member firms of the KPMG global organisation.
