Former PE journalist here - as an alternative asset class, I wouldn't allocate more than 10% of your Net Worth to any of that (including hedge funds), but it's legit. Also depends on your style - venture, LBOs, growth capital, or a mix.
Just because of the higher risk? Any other info you can share with the group? I think you’ve probably got the most knowledge in this thread. (Certainly FAR more than me).
Okay - again, for context, this has been years. I joined the financial media outfit just before the great financial crisis, so I know the industry in growth mode and in "oh shit, nobody pick up their phones" mode. My area were European funds, which are generally smaller and had a reputation for being "less aggressive" compared to US funds.
What you're likely going to invest in your case are LBOs (leveraged buyouts), but I'll quickly cover the other investment types as well.
First, it's called "private" equity to separate it from "public" equity, such as listed companies. These are investments in companies that are not publically traded. Often, PE houses use corporate finance suits to source them deals, or they are approached by a "target" or approach it themselves. Some PE firms do invest in the stock markets, but it's kind of rare and considered a "style shift" (definitely undesirable) - because it's hard to outperform the market if you buy
on the market.
VC (venture capital) - invest in young start-ups that ideally have something unique, "advise" the founders and connect them to the rest of the industry (sometimes it is just networking), grow and "nurture" the company and sell when it goes big, is acquired or goes public. The guys I talked to called this the "noble art", and the understanding was that in a portfolio of 10 VC investments, about three companies will break even, one will be a moderate success, one a big success, and five will die on the way. A VC firm might start with a small slice of the company but might end up being the majority holder - as these are often syndicate deals - several VCs pitch in over multiple "funding rounds" - the original owner or funder often only holds only a small slice of the company in the final stage (ie the "exit"). Returns range from literally negative to PayPal.
Growth financing- Mature, profitable company needs money to grow, restructure, develop new products. They might not be willing or able to get more money from banks, so they take in an investor like PE which remains a silent participant - it provides the money, but doesn't run the company. PE might own 25% or so and will "exit" afterwards. Not sure if the terms are pre-agreed, I've heard different things. Ideally, the company is already like a massive niche leader and already excellent. PE financing is used to shore up the equity and/or secure additional loans from the bank.
MBO - Management buyout. Mature privately owned company is being taken over by the management (this is often succession planning when the old CEO/owner wants out). Few CEOs have the money to buy their firms outright, so they team up with PE firms to pay out the old owner and take over. PE capital makes that whole thing possible. The lines to the next one can be blurred - we used MBO in a specific way.
LBO - leveraged buyout. Often considered the "classic". PE firm buys a profitable company using a small slice of their own funds' money, and gets banks (or a syndicate of banks) to lend the rest. Basically like you buy a house with 10% down. Banks are happy because they sell the LBO loans onwards as financial products, so they don't have the risk linger on their balance sheets, and they earn their commissions, the main reason for doing these. PE guys are happy because they only risk 10%. The company pays off the loan, PE firm often "restructures" the firm - making the balance sheet more efficient (ie either pull out the "surplus" equity to pay investors or use that as part of the leverage), often cutting parts of the company that don't make enough money. While they hold the company, they can do any number of things, such as use it as a "buy and build" platform (ie buy smaller companies and attach them to the bigger one to grow it, round out the product portfolio, acquire patents/expertise etc), or do mergers (they might already hold a similar company and combining them might make it more valuable). Worker councils/trade unions hate PE because very often the sale means layoffs as the PE suits pursue returns and easy wins first. The company can be acquired either from a large industrial group (spin-out), or it might be bought on the stock market (a take-private), or it might be bought from a PE firm with a different "style" - so a PE firm might buy a company, restructure it and sell it to a PE firm with stronger "growth" or "buy-and-build" expertise - or simply a larger fund if they've been successful at growing the company. Buying from PE as a PE firm is called a "secondary". Have a chain of three PE owners and it's a "tertiary". I've heard stories that PE firms would by firms from each other as a "favor" when they need a deal for returns/optics, but that might be a rumour.
"Vulture" funds: This is a bit of a nickname, but generally these a PE firms that buy companies for a nominal amount, often just before they go bankrupt ("distressed"), or when the parent company just spins it out because that particular unit/division is just no longer "core" and/or not really profitable ("spin-off/spin-out"). Vulture funds don't need bank loans, but the amount of capital they put in is low or nominal (like a dollar/Euro plus warm promises), or the parent company pays
them to take it off their hands. PE firm then tries to do a turnaround, or pretends to do a turnaround (when asked by the press/workers) and meanwhile sell off all assets and sift through the wreckage, looking for scraps of meat (hence the heart-warming nickname). If the turnaround works, they sell the company "better" and often "slimmer" on or take it public, but at this point they've often already had their pay day. Or they wind it down and workers/the press blame the PE fund, and not the original parent.
Then there are co-investments and infrastructure investments, but I heard guys scoff, "those only make like 10% pa". Growth seems to return about 15-20%, while LBOs are aiming for 25-30%, but sky's the limit, I've seen much higher than that back in my days.
Why I wouldn't put huge amounts of money into it? Well, I saw what happened during the financial crisis, with fund managers literally no longer picking up their phones. Leveraged finance departments at banks just closed down overnight. Several PE guys I knew went back into consulting or retired (there were also rumoured or confirmed suicides - and murder-suicides; one guy offed his whole family). Small funds closed. Because it's such a ... rarefied world, there's a lot of stuff going on that's just not in public perception.
One of the big drawbacks is you lock up your money for 5-10 years and the PE house might not be able to source good deals cheaply to get those outsized returns. I understand there's currently a boom again, and the industry's "war chests" and "firepower" is ample and dry, respectively, so there is likely to be a lot of competition from other PE funds, and since many deals go to auction, there's a real risk they're overpaying for the assets they buy.
The fees and rewards for the funds are steep - definitely do some research, but they usually have a fixed fee to hold your money, and they get a big chunk once they've exceeded the hurdle (targeted return, if I remember right, which I've often seen at like 20%) - but again, it's been a long time so the T&Cs are super hazy in my mind.
Investors are institutional investors (insurance companies, many of which have their own "captive" PE firms), and UHNWIs (ultra high net worth individuals) usually. Sovereign wealth funds can be investors or do their own deals.
I'd definitely want to see how the PE fund has done over the past economic cycle before I'd give them money; ideally, I'd like to see brand name co-investors as well. You *can* also invest in listed PE funds - back then it was hugely controversial that "private equity goes public itself", because PE's argument has always been that its non-public model is superior and then they put themselves at the mercy of the market. And, because things can go wrong and it's an illiquid asset class, I wouldn't sacrifice diversification. If you want to play the PE theme with somewhat less risk, maybe look at a listed PE firm such as KKR (
https://ir.kkr.com/) first. No idea about returns here, and this is very much not a stock recommendation - it's just a large firm that did go public and I remember the surprise/outrage when they did. There are many others.
(Again, my personal opinion based on looking at hundreds of deals and talking to loads of people smarter than me - I might be outdated. Generally, I think the old rule applies to not invest in stuff you don't understand, so I'd still proceed with caution - not because I don't like the industry - many of the guys are super smart and it was truly an interesting experience for me, though the vulture guys I never warmed to.)
