PRIVATE EQUITY

PRIVATE EQUITY

introduction to private equity
https://www.youtube.com/watch?v=kQKPJ_yUwk8

DEFINITION:
Investments in public and non-public companies or assets through privately neogotiated transations.
It is an structure rather than an asset class.

Players
GENERAL PARTNERS (GP)
LIMITED PARTNERS (LP)

HOW DOES PE DRIVE VALUE CREATION?
1) Strong corporate governance model
- More information
- Implied control premium
- Operational improvements
- Vast expertise that drives revenue growth
- Creates alignment of interest
- Operates long-term horizon
- Managers are never forced to sell the company at the wrong time.

MARKET PERFORMANCE (Bloomberg investment returns 10 years ended 31-12-16)
PE outperform other investment alternatives:
Listed equity 7.42%
Fixed income 5.13%
Private equity 10.85%
Real estate 6.86%

INSTITUTIONAL ALLOCATIONS TO PE
US public pensions and university endowments have large proportions of PE.

Institutional investors
Public and private pension funds
Insurance companies
Foreign governments sovereign wealth funds
Fund-of-funds managers
Large family or multifamily offices

TYPICAL PE FUND STRUCTURE

3% to 5% from GP
Typical minimum is 10 Million USD
Typical management fee of 1..25%-2% per annum charged on commited capital
Typical performance fee (known as carried interest) is 20% of profits after fees and expenses charged at the time the investment is sold.

MECHANISM OF PE FUND

1ST YEAR - FUNDRAISING
-GP establishes limited partnership agreement setting forth the funds terms and conditions. LPA is limited partnership agreement.
- LP commit certain amout to the fund upfront during the fundraising period.

4-5TH YEARS INVESTMENT PERIOD (COMPANIES BOUGHT, REQUIRED FOR
When capital is needed for portfolio acquisitions, the GP issues requests for capital from the LP (capital calls).

DIVERSIFICATION, NO 100% OF COMMITMENT GOES INTO ONE COMPANY)

6-10 YEARS HARVEST PERIOD (COMPANIES SOLD)
Companies are sold or go public via an IPO and distributes proceeds back to the LPs.

EXIT STRATEGY
During INVESTMENT, the GP gains controlling investment in a company, the majority of which may be funded with debt.
During IMPROVEMENT, the GP increase the company's financial results and value by impelmentting operations, financial and management changes.
During EXIT, performs cash out of the investment typically through OP, trade sale to antoehr private equity firm, or a recapitalization.

J CURVE
Refers to the J shaped line that represents the cumulative net cash flows of a private equity fund during its life: negative flows during early years due to capital calls. Distributions are made after investments are exited.

PORTFOLIO DIVERSIFICATION

Five main tools:
1.Vintage (first year a PE fund makes a portfolio investment. Affected from broad-based market movements).
2.Industry
3.Geography
5.Manager (GP's expertise and performance) The difference betwween top and bottom quartile investment managers has been 13% over the past ten years.
6. Stage (Stage of maturity)

The video also shows primary, secondary and co-investements.