Private equity is an investment class that encompasses all types of equity investment into unlisted businesses and other special situations where the investment has the character of a private equity transaction. Unlisted businesses generally require access to investment capital to fund growth or to provide liquidity for existing shareholders. More specifically, unlisted companies may require private equity to expand or grow an established business either organically or by acquisition, to facilitate existing management to buy out an existing owner, to facilitate new management to buy into a business, or to allow existing shareholders to make a partial or full sell down of their holdings.
Compared to investments in listed companies, private equity investments are relatively illiquid, offer potentially higher returns and, being unlisted, do not exhibit daily volatility in value as listed companies do. Moreover, private equity funds can negotiate the terms of their investment based on detailed company information and access to key management. The Manager can also become actively involved in the strategy of the investee company through board representation, thereby increasing shareholder value.
Direct Capital’s primary operating space is investments in companies with an enterprise value of between $25 million and $300 million, this space is commonly referred to as the mid-market. These are generally companies at a later stage in their life-cycle, including expansion stage, replacement capital and buy in or buy out transactions.
During the initial stages, investors in a private equity fund are called upon to provide portions of their Committed Capital as and when investments are made. These are known as draw downs or calls. Typically, calls from investors and new investments by the fund will be made over the first five year period of the fund’s life.
As portfolio companies mature and distribute earnings or redeem capital, the fund will begin to make distributions to investors. In general, this will take a few years from the date of first investment and, as with calls, the timing and the amount of distributions to investors will be irregular. Funds generate positive net cashflows from portfolio company earnings and any liquidity events.
As distributions to investors normally commence before the whole commitment has been called, it is unusual for an investor to have the full amount of their committed capital outstanding at any particular time.
The New Zealand private equity industry was established in 1993 with a Government initiative, the Greenstone Fund. Since then the industry has grown to approximately 92 members.
Between 2002 and 2012 local fund managers raised in excess of $1.6 billion in over 24 private equity and venture capital funds.
Private equity and venture capital investment activity in New Zealand is around 80 transactions per year (median) with equity investment of apporximately $260 million per year (median). There are typically 50-70 venture capital transactions per year and 15-25 private equity transactions per year. 1
1 The New Zealand Private Equity Market-An Overview for Institutional Investors July 2013.
The New Zealand market has developed a number of unique and positive characteristics as a result of the local market investor base, including the benefits of a long term investment strategy and investing in portfolio companies which ultimately provide strong investment returns from fully imputed dividends. The Pohutukawa structure also provides investors with the potential to obtain a direct shareholding in listed portfolio companies via the amalgamation of investment entities.
The term "private equity" can be broadly broken into the following categories: Venture Capital; Expansion Capital; Buy Outs/Buy Ins and Special Situations:
Venture Capital is often used to describe the private equity sector as a whole, but more accurately describes investments made at an early stage in a company’s life.
Development / Expansion Capital is financing provided for the growth or expansion of a company that is breaking even or trading profitably.
Buy Outs, Buy Ins are used to refer to different structures in private equity that are applied to established businesses with positive cashflows and profit streams. Private equity managers provide funds to enable current operating management to acquire an existing business (a management buy out) or to enable a manager or group of managers from outside a company to buy into a company (a management buy in).
Special situations - Private Placements, Pre IPO and PIPE's. A private placement is where private equity managers provide liquidity to existing shareholders through the purchase of existing shares. Pre IPO ("Initial Public Offer") investment is where private equity managers support the listing of a business through taking a stake in the business prior to its IPO and then assisting in the IPO process. PIPE’s ("Private Investment in a Public Entity"), as its name suggests, is a private equity investment into a listed company, which typically has the characteristics of a private company. In particular, its shares are thinly traded on the stock market and the company does not have ready access to the capital markets for capital raising.
Market conditions can present a compelling opportunity for private equity investors
In periods of weaker economic conditions and situations such as the credit crisis, there are likely to be private equity investment opportunities. Private companies are likely to raise equity to fund growth and for working capital needs. These factors combined, may lead to greater private equity investment opportunities, with less competitive pressure on investment valuations. Also, businesses with private equity backing and strong balance sheets will be well placed to capitalise on investment opportunities to strengthen their competitive positions.
Long term returns from diversified private equity funds in established markets have been superior to returns from listed equity indices
In the US, UK and Europe, private equity returns have outperformed relevant equity market indices. This out-performance reflects private equity’s ability to perform detailed due diligence on investment targets, influence management and a company’s strategic direction, and provide the company with finance and resources for growth. Management usually has an equity stake in private equity backed companies which is intended to strongly align their interests with private equity investors.
Investing in private equity greatly increases the choice of investment possibilities
The private company market in New Zealand offers a broader reflection of New Zealand’s economy than the listed market. For every listed company in New Zealand there are approximately 180 unlisted businesses with 10 or more employees1. The unlisted business sector is also more diverse in terms of size, stage of development and the industries they operate in.
Succession of privately owned companies presents an opportunity for private equity funds
There is a large number of private companies in New Zealand that will need to address succession concerns in the short to medium term. A significant portion of these private companies see private equity as a potential partner1.
Private equity is becoming an increasingly important asset class for investors. Allocations of 5%-10% in institutional portfolios are commonplace
Increased portfolio diversification and a low correlation between private equity and other asset class returns reduces overall portfolio risk for an investor.
1 Pohutukawa Private Equity II Ltd Prospectus 21 November 2008.