With the COVID-19 pandemic setting in motion a global recession, there has never been a more important period of Australian history where private equity can assist to create jobs and generate economic growth.
With property prices at all-time highs, interest rates at all-time lows, and the share market providing high levels of volatility for investors, where should investors be focusing for great investment returns for the next 10 years?
Private equity can provide high risk adjusted returns to investors over the long term, provided investors can handle the liquidity dynamics of the investment class and cumbersome investment documentation.
The typical private equity investor is seeking to make a 20% annual return, equating to doubling their investment over a 4 year investment period.
Nash connects high net worth investors (seeking exposure of $250,000+) with exciting private investment opportunities in Australia.
Private Equity Explained
I started my career at a multi-national, moved into a Big 4 accounting firm, and then spent almost 5 years at a leading private equity fund. I have been fortunate to have been exposed to many different perspectives of the business world across my career. What amazes me is the misconceptions about private equity in Australia.
Nash Advisory have been selling companies in the mid-market for many years and we are amazed how often a big corporation misses out on a great acquisition because they can’t get their head around valuation, synergies, cost of capital or because they are unable to move swiftly enough to get the deal done. This is where an opportunity can present itself for savvy investors.
Private Equity is an industry which is demonised by the mainstream media, a magnet for aspirational finance graduates, and is under constant pressure from Superannuation and Pension Funds for the standard 2 and 20 fee regime. So how does it work?
Firstly, Private Equity is a blanket term which refers to a pooled investment fund taking equity investment positions in private companies – in Australia these are Pty Ltd’s. When I speak to small and medium sized business owners their reaction to the term “Private Equity” is usually apprehension as a result of a lack of understanding about the industry.
Public opinion of Private Equity is skewed in the media by the deals undertaken by the large buyout and leverage funds. There is plenty of coverage of deals such as Myer, Nine Entertainment, and Dick Smith. Unfortunately, there is limited coverage of the majority of transactions that occur in Australia which are typically companies of between $50 million to $300million in enterprise value. Private equity firms that target these types of companies are generally characterised as Growth Private Equity. Their primary goal is to grow the business, to generate more jobs for Australians, and to corporatise family run businesses into corporations which could one day become listed on the stock exchange.
The structure of private equity is such that a “Manager” will manage monies on behalf of investors. The Manager will take seats on the Board of a company, become heavily involved with strategy, decision making, acquisitions, and key hires. The Manager is therefore very active, and their goal is to add value to the company over a period of time through their efforts.
Growth Private Equity typically look for the following attributes in an investment:
- A growing industry
- An A Grade management team who are invested heavily in the company
- A competitive advantage such as intellectual property, brand name, or market position
- A clear 3 year business plan with several levers of change
- Potential for acquisitions to supercharge the company’s performance
- A broad range of exit options (buyers and IPO possibility)
Why does private equity out perform other asset classes?
The formula for a great private equity investment is quite simple, but relatively misunderstood by most investors. Great returns are driven by:
- Unique opportunities – private equity funds review and reject 99 opportunities for every 1 transaction that they complete. Finding a great deal is hard, but when they do find a deal it is typically a hidden gem.
- Focus on driving performance and returns – most owners of medium sized businesses tell me “I could grow significantly in the next few years if I wanted, but I’m happy with less stress in my life and the level of profit I am making today”. Private equity funds incentivise executives in the organisation to drive performance on behalf of the founders and investors.
- In some situations, the buy price should be at a valuation which represents a “minority discount”, and the sell price should be at a valuation which represents a “control premium”. According to academic studies, this can represent a 30% uplift in value for an investor.
- Capturing a size premium upon a sale – businesses making e.g. $5m in EBITDA have a limited buyer pool, whereas a business making $10m in EBITDA has significantly more buyers and also the prospect of an IPO. The multiples paid for a business can be significantly different between small, medium and large businesses. In our experience, the size premium can represent at least a 30% uplift in value for an investor.
In summary, a good investment could deliver a 3x return for investors as follows through the multiplication of the above factors:
In our opinion, Private Equity is the most exciting asset class in Australia at present. We are in discussions with a range of companies who are seeking funding from high net worth individuals. In addition, we have many owners who are reviewing their business and are considering Private Equity as a viable business exit plan.
To learn more about whether Private Equity would be good for your business please contact Nash Advisory.
The following two publications are provided as references of private equity returns against other asset class benchmarks