All about Private Equity: definition, advantages and investment strategies

Private Equity (PE) is one of the most popular types of private capital investment. It is a type of private capital investment that invests in private companies, i.e. those that are not listed, such as family or industrial companies, with the aim of boosting their financial performance and growth.

In this post we explain its main characteristics, advantages, risks, types of investment and how you can include it in your portfolio.

Specifically, investing in PE consists of providing financial resources to a company for a given period of time and, in exchange for this investment, receiving a stake from which high growth is expected. PE can offer investors higher returns than stock market investments, but it must be taken into account that it is an investment with a longer time horizon.

Due to the complexity of this type of investment, the best way to invest in this type of company is through funds. The management team (GP) will be in charge of establishing communication with the company, as well as designing or participating in the business plan to promote its growth and development.

When it has achieved its objective, i.e. once the company has increased in value and investors can obtain a good return from its sale, the fund will proceed to divest the company. This exit process can be done in different ways:

• The company goes public through an IPO (initial public offering).
• A fund specialized in other phases of the company's life cycle acquires it.
• The founders themselves or former partners, who want to regain full control over the company, buy back shares. This is known in the industry as an “exit”.

For this reason, Private Equity represents an important means of financing and support for companies seeking to grow and expand, while at the same time it is an attractive option for investors due to the high returns that can be obtained.

But the creation of value in a company of these characteristics is not immediate, so they are long-term investments, the time horizon is usually more than five years. This makes them illiquid investments and they generally have to be held until the divestment process is completed. However, if an investor needs liquidity, he can turn to the secondary market, where he will have the option of selling his assets or finding new opportunities.

By investing in private companies, that is, unlisted companies, we gain access to a large universe of opportunities, both in terms of the volume of companies available (there are many more private than public companies) and the point in their life cycle in which we can gain access. When a company is listed, it has already generated most of its value. Since we can invest in these companies beforehand, we will not miss that stage, so the potential appreciation is much greater.

These advantages are added to others specific to private capital investment, such as diversification and decorrelation with public markets, a greater potential for profitability and the lower volatility it brings to the portfolio.

Its less liquid nature is also an advantage, as it invites investors to take a long-term approach, thus preventing them from making rushed divestment decisions fuelled by emotions. In addition, Private Equity can become a great ally for regular and constant savings.

Through your investment, you can also contribute to growth and job creation. According to a report by SpainCap, an association that groups Venture Capital and Private Equity entities in Spain, the employment in the 3,012 companies invested by private capital entities increased by 6.4% in 2021, generating a surplus of 29,157 jobs and accumulating a total of 481,334 workers. That is a growth of more than two percentage points than that registered in Spain. An achievement you will be part of thanks to your investments with Crescent.

However, like any investment, it entails risks. Especially in terms of illiquidity, with an investment horizon much longer than other types of investments.

Depending on the point in the life cycle of the company in which you want to invest, its business objectives, and the control over the company taken on by the GP, we can differentiate between several types of investment.

Mainly two stand out: growth and buyouts.

Investing in growth involves entering established companies that can continue to grow and expand. Investors acquire small positions and delegate the company's management to the management team, although they contribute with their experience and can advise on strategies.

In the buyout strategy investors acquire major positions in the company and make the strategic decisions for the company, replacing the current shareholders. This position can be adopted through different strategies such as leverage buyouts (LBO) or management buyouts (MBO).

This type of company can be accessed through funds or funds of funds. These vehicles provide a high degree of diversification, as they are able to invest in different companies. This is one of the funds' main advantages, since trying to reach a similar degree on one's own account would be very difficult and entail a very high cost.

In addition, investors will receive professional management, where a management team (GP) will make the investment decisions. The GPs have tools, information and contacts to make the best decisions, that is, resources that can hardly be matched by an individual investor.

Through these vehicles, investors (LP) can access opportunities that they would not be able to when investing as an individual. This is achieved because the funds have a greater negotiating power and a much higher volume of assets, enabling them to access a wide variety of markets and projects.

Author

Sofía Cisneros

Communication and content - Crescenta