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Debunking myths about private equity

It’s not just for the uber-rich.

Moneyweb sat down with Jacolene Otto, senior manager for private equity and real estate at financial advisory and administration firm Maitland, to discuss some common myths about private equity and real estate funds.

Private equity (PE) funds raise money from investors for the buying and selling of businesses. Investments are typically held for a period five to 12 years, and the private equity fund managers provide some level of active management in these companies with a view to increasing the value of their investments.

Here are some common myths about private equity.

1. PE funds are only accessible to institutional investors or the uber-rich

Not true. Some are listed on the JSE, such as Ethos Capital, Gaia Infrastructure and Sabvest. Then there are scores of 12J investment vehicles (which in terms of Section 12J of the Income Tax Act, allow substantial tax benefits to investors). Private equity funds are also accessible to ordinary investors via the London Stock Exchange and other bourses.

There are far more private equity funds that are not listed on the stock exchange and are therefore not easily accessible by ordinary investors.

“Most of us have exposure to private equity and real estate funds through investments that have been made by our pension funds,” says Otto. “You have to be patient with a private equity or real estate fund and not expect returns in the first year. But over time you would expect private equity funds to pay a higher rate of return than that offered through more conventional investments.”

2. Private equity and venture capital are the same thing

No, venture capital funds are usually invested in newer and smaller businesses, often start-ups or tech companies, while PE funds invest in businesses that are more established, usually with some profit history.

3. The private equity investor wins while the entrepreneur loses

PE investors do take a more hands-on approach to any business they back, and this typically means taking a seat on the board, guiding the strategic direction of the business, and opening up their networks to help expand the business. “Remember, they are looking after investors’ funds, so they will want to keep a close eye on how that money is spent, but they will not generally get involved in day-to-day affairs,” says Otto. “You don’t lose control of your company unless you sell majority control to them. PE investors or managers are generally highly experienced in business, and they are able to tap into sector-specific knowledge, which can be of massive benefit to the investee company.”

4. The only thing that matters when doing a private equity/venture capital deal is the price

Not true. PE and venture capital investors are backing the entrepreneur and their vision and passion. The investors are generally looking for a unique niche where competition is muted. Price is important, but it’s not the only thing that the private equity investor and the entrepreneur should consider. This is a long-term relationship, and just as important as the price the private equity investor is buying at or the entrepreneur is selling at is whether they are strategically aligned and want the same things out of the relationship. 

5. PE investors only invest in companies in distress

Some do specialise in buying distressed companies with a view to turning them around and then on-selling them at a profit. This is more of a hedge fund strategy, but private equity fund managers will look for companies that can be bought at a good price (not necessarily in distress) and where they can add value, such as by mergers or new business ventures.

6. Once a PE investor invests in your fund it is only concerned about the exit strategy

Make no mistake, PE fund managers will always be looking at their exit strategy since this is how they recover their investment. But there is a lot of building that has to happen before then. They are on board for five, seven or even 12 years.

7. PE investors are only interested in impact investing, renewable and clean energy, and infrastructure assets

It’s true that impact investing is becoming a big theme in investment, but unless it turns a decent profit, no one will invest in a business that sets out to make a socio-economic impact. It’s the same with environment, technology or infrastructure. Unless these businesses are profitable, investors will run for the hills. It just so happens that there is a strong demand for solar panel and wind farms, agro-processing, water desalination plants, new technological innovations, roads, highways and dams. There are businesses built around themes that are highly attractive to investors and profitable. That being said, private equity and venture capital investors are involved in every sector of the economy.   

What fund managers need to know about starting a PE Fund

Fund managers are great at sourcing deals and raising capital from investors. But we live in a complex environment, so the manager’s role is only partly done. The fund needs accounting, legal and other skills to set it up, ensure the regulatory compliance issues are attended to, that investors are kept in the loop, and all the other things that come with looking after other people’s money. This includes taking care of fund documentation, with paperwork that is 100% on target.

As a PE investor, do I need an independent valuer or administrator?

Many PE funds have just three or four investments and a handful of investors. Why would they need an administrator or independent valuer? Unless the fund manager has these skills in-house, it is definitely recommended to keep up to speed with all the regulatory and compliance issues that come with money management.

An independent valuation is also recommended since business owners and investors tend to have giddy ideas about the value of their companies.

Otto says Maitland can assist in the setting up of private equity funds in SA, Mauritius, Luxembourg and elsewhere. It takes care of the regulatory work, including the administration of the funds, accounting functions, investor queries, investor statements, payments to investors and so on. This leaves the PE fund managers free to do what they do best: identify, monitor and invest in companies.

“We also provide a second set of eyes to make sure things are done properly, and that funds stick within the rules of the private equity fund,” says Otto. “This provides an extra level of comfort for investors.”

Brought to you by Maitland.

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And if you are the company that is seeking investment from a PE Fund be very careful. Having been through the wringer unsuccessfully with PE funds several times now. Be very wary. You have the following risks as the receiver of the funds.
1. Make sure that when applying for funding you do not spend too much time on the DD and answering questions- you can hurt your business
2. Read the terms of the offer very carefully and do not commit to targets where the PE fund will in all likelihood take 50% of your business
3. If you can grow your business without PE it’s better than having a shareholder that really isn’t aligned with you.
4. They all claim they can add value beyond the money. Interview them and do your own due diligence to determine how other than dumb money are they planning on assisting.
5. Be aware that if you are nimble and agile and can make a quick change in direction as a result of a market shift you will probably be hampered in this after bringing PE on.
6. Dont believe everything they say at the initial termsheet level – trust your own instincts- you have run your own business and if you get into difficulties during the DD they will alter the final termsheet as all they focus on is risk.

End of comments.

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