Author Topic: Private Equity - Legit, or not Legit?  (Read 2430 times)

Maturin

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Private Equity - Legit, or not Legit?
« on: April 16, 2021, 07:37:01 PM »
Hello, all:

I searched the forum, but did not find much about private equity. The only thread I did find was mostly hot takes from people who did not have experience with it. So, I am posting this.

What does everyone think of private equity investments? Hot takes are welcome, but Iím especially interested if anyone has actually invested in any private equity funds and what their experiences were.

Is it just a scam that profits salesman at Morgan Stanley/Goldman/etc.? Will the taxes on top of the fees rip your eyeballs out? Or have I finally stumbled across the secret that rich people use to get richer? Something in between?

I have the opportunity to invest in a private equity fund that will begin paying off after 3 years. You get your money back after 5-6, and everything after is profit. They claim theyíve hit 16% and higher returns on past funds.

I understand how they work generally, but thereís obviously lots going on behind the scenes that Iím not privy to.

EDIT: I have the ability to do this with a very low interest rate (like 1.6%) but variable tied to LIBOR. But I could pay it off if rates rise.

Joel

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Re: Private Equity - Legit, or not Legit?
« Reply #1 on: April 16, 2021, 09:10:35 PM »
What kind of private equity investment is this exactly? Will you be an investor in the private equity fund or an owner of a debt instrument that a private equity fund used as leverage to finance their investment? Two very different vehicles. Also, not all private equity groups are created the same. Some are willing to take on more risk (ie leverage) than others.

My experience comes from being a finance executive at multiple companies owned by private equity groups. Itís a fascinating space.

reeshau

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Re: Private Equity - Legit, or not Legit?
« Reply #2 on: April 16, 2021, 09:53:17 PM »
I would also recommend The Little Book of Venture Capital Investing, by Louis Gerken, for some insight into success rates, methods, etc.

MustacheAndaHalf

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Re: Private Equity - Legit, or not Legit?
« Reply #3 on: April 16, 2021, 11:07:57 PM »
Who is pitching a private equity investment to you?  Without knowing that, nobody can tell you if it's a scam or legit.

Private equity is limited to accredited investors, so they might not have to include the SEC warning that past performance does not necessarily indicate future results.  They are also not going to tell you about the high failure rate.

You mentioned a "fund", does that mean a pool of investors pursue a number of private equity deals?  Diversification can spread the risk of investing in a company that goes under.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #4 on: April 17, 2021, 04:56:22 AM »
What kind of private equity investment is this exactly? Will you be an investor in the private equity fund or an owner of a debt instrument that a private equity fund used as leverage to finance their investment? Two very different vehicles. Also, not all private equity groups are created the same. Some are willing to take on more risk (ie leverage) than others.

My experience comes from being a finance executive at multiple companies owned by private equity groups. Itís a fascinating space.

The former, an investor in a private equity fund. Iíd get the loan through the private banking part of the mega bank where the ďadvisorsĒ selling the PE investment happen to be located, I just happen to bank there also. The PE group appears to be quite good, but frankly I donít know what to look for and Iím a skeptical person. Iím worried that the entire space is really just a casino where mostly the house makes money.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #5 on: April 17, 2021, 05:00:04 AM »
Who is pitching a private equity investment to you?  Without knowing that, nobody can tell you if it's a scam or legit.

Private equity is limited to accredited investors, so they might not have to include the SEC warning that past performance does not necessarily indicate future results.  They are also not going to tell you about the high failure rate.

You mentioned a "fund", does that mean a pool of investors pursue a number of private equity deals?  Diversification can spread the risk of investing in a company that goes under.

Yes, I meet the accredited investor definition and I know what itís there for. I take your point, though, itís the Wild West. When I say fund, I mean itís an entity assembled by a PE group that invests in private companies that theyíve researched. They done one per year, each called a ďvintage.Ē The companies are not limited to a certain theme. They say their analysts review hundreds of potential deals and then usually invest only in 20-30 per vintage. Then my understanding is they begin selling out of them after 3-4 years.

bwall

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Re: Private Equity - Legit, or not Legit?
« Reply #6 on: April 17, 2021, 05:43:43 AM »
At the end of the day a lot will depend on the character of the people running the fund.

Will they have the ability to slice off a nice portion of the profit for themselves as additional fees in some way? Or will they let all the profit flow down to the fund where it can then be distributed equally?
From their point of view, investors have accepted 16% as an acceptable target return. Why should investors then get, say, a 30% return? What would prevent them from diverting the additional 14% return (30% - 16%) to their own pockets, while claiming they've 'had an amazing year!

I'm not saying this will happen, but the pieces are in place for it to happen if the people in charge are so inclined and there is no oversight.

As a general rule, I think I'm the best person to manage my own investments. Anytime I think otherwise I watch a few episodes of "American Greed" on CNBC until the feeling goes away. :) 

Anon-E-Mouze

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Re: Private Equity - Legit, or not Legit?
« Reply #7 on: April 18, 2021, 10:25:31 AM »
"Iíd get the loan through the private banking part of the mega bank where the ďadvisorsĒ selling the PE investment happen to be located, I just happen to bank there also."

This conflict of interest would concern me.

MustacheAndaHalf

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Re: Private Equity - Legit, or not Legit?
« Reply #8 on: April 18, 2021, 10:54:19 AM »
Who is pitching a private equity investment to you?  Without knowing that, nobody can tell you if it's a scam or legit.

Private equity is limited to accredited investors, so they might not have to include the SEC warning that past performance does not necessarily indicate future results.  They are also not going to tell you about the high failure rate.

You mentioned a "fund", does that mean a pool of investors pursue a number of private equity deals?  Diversification can spread the risk of investing in a company that goes under.
Yes, I meet the accredited investor definition and I know what itís there for. I take your point, though, itís the Wild West. When I say fund, I mean itís an entity assembled by a PE group that invests in private companies that theyíve researched. They done one per year, each called a ďvintage.Ē The companies are not limited to a certain theme. They say their analysts review hundreds of potential deals and then usually invest only in 20-30 per vintage. Then my understanding is they begin selling out of them after 3-4 years.
Want to hear a joke?  "Credit Suisse Risk Management"

Personally, I would look at the damage each bank took from the Archegos Capital Management collapse.  Better due diligence there suggests an investment bank with better due diligence in general - hopefully for private equity.  Just to warn you, I think that limits it to just two names (Goldman and JP Morgan), both of whom probably charge high fees (I haven't had accounts with either of them).

You could read "Unconventional Success" by David Swensen, who decided to invest part of Yale's Endowment in private equity.  Many university endowments followed his lead for the higher (and riskier) returns.




Michael in ABQ

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Re: Private Equity - Legit, or not Legit?
« Reply #9 on: April 18, 2021, 11:18:24 AM »
Anytime I've looked at investment opportunities that claim returns in excess of an S&P 500 index fund it is always for a relatively short time frame or it's one fund out of dozens.

The risk required to get from a 10-12% annual return (measured over a decade or two) with an S&P 500 index fund to something north of 15% is not worth it in my opinion. Maybe you get lucky and pick the right fund that manages to do so for more than a few years in a row, but odds are against you.


I did a lot of appraisals for commercial real estate that was purchased by closed-end mutual funds (aka privately traded funds). They consistently paid at or above market price, took a bunch of fees off the top, provided a return that was at or below the rest of the market, and had far less liquidity and transparency compared to a publicly traded fund. As an investor I wouldn't touch one with a 10-foot pole.

The more complicated the investment is, the more likely it is to benefit the investment manager - not the investor.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #10 on: April 18, 2021, 12:54:35 PM »
"Iíd get the loan through the private banking part of the mega bank where the ďadvisorsĒ selling the PE investment happen to be located, I just happen to bank there also."

This conflict of interest would concern me.

Whatís the conflict? Either way, I bear the risk that the investment goes bad and am on the hook for my principal. If I take out the loan, I pay the lender a small bit of interest as well, but donít have to pull cash from existing investments (index funds) to buy in.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #11 on: April 18, 2021, 12:56:42 PM »
Anytime I've looked at investment opportunities that claim returns in excess of an S&P 500 index fund it is always for a relatively short time frame or it's one fund out of dozens.

The risk required to get from a 10-12% annual return (measured over a decade or two) with an S&P 500 index fund to something north of 15% is not worth it in my opinion. Maybe you get lucky and pick the right fund that manages to do so for more than a few years in a row, but odds are against you.


I did a lot of appraisals for commercial real estate that was purchased by closed-end mutual funds (aka privately traded funds). They consistently paid at or above market price, took a bunch of fees off the top, provided a return that was at or below the rest of the market, and had far less liquidity and transparency compared to a publicly traded fund. As an investor I wouldn't touch one with a 10-foot pole.

The more complicated the investment is, the more likely it is to benefit the investment manager - not the investor.

Your first two paragraphs (and last) are kind of my gut reaction. Interesting insight from your experience as well, I appreciate it.

theolympians

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Re: Private Equity - Legit, or not Legit?
« Reply #12 on: April 18, 2021, 09:24:33 PM »
For curiosity's sake, how much are you thinking of investing in this? If it is a little, no big deal. Or are we talking serious, you could buy a house , money?

BicycleB

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Re: Private Equity - Legit, or not Legit?
« Reply #13 on: April 18, 2021, 09:42:33 PM »
From casual reading (intermittent business articles 25 years, noting trends, etc) I'm guessing the odds for you are better staying away. Not an expert in the space though.

PTF, mostly for education.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #14 on: April 19, 2021, 07:20:36 PM »
For curiosity's sake, how much are you thinking of investing in this? If it is a little, no big deal. Or are we talking serious, you could buy a house , money?

Thereís a $100k minimum investment 0_o

For what itís worth, thatís actually fairly low and is one of the selling point so this fund. Usually itís $250k minimum. Money is tied up for 7-10 years.

Abe

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Re: Private Equity - Legit, or not Legit?
« Reply #15 on: April 19, 2021, 08:34:23 PM »
Yeah unless youíve got at least a few million saved Iím not sure this is worth the risk. Regarding conflict of interest: the people loaning you money to invest are (corporate-wise) the same people who are telling you to invest? Why are they then having you borrow their money to invest in their fund? Itís to guarantee a rate of return for themselves (the interest you pay on the loan). So you have a guaranteed expense for a non-guaranteed gain that is opaquely managed by a private fund without SEC filing requirements?

Other thoughts: what are their fees as a % of total investment? Are fees expected regardless of performance, or tied to performance?

Lastly: Do you have proof of prior returns, and how confident are you that this isnít a Ponzi scheme? Thatíd be my attitude on investing with someone I donít know at all.

vand

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Re: Private Equity - Legit, or not Legit?
« Reply #16 on: April 20, 2021, 03:26:16 AM »
PE is absolutely legit, but its generally considered higher risk thank public stocks.
Pick 100 companies, expect 80 of them to lose money, 10 to be mildly profitable, 7 or 8 to be very profitable, and hope 1 or 2 return 50-100 times your initial investment.

Oh yeah, there's no indexing available.

So yeah, not for Bogleheads.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #17 on: April 20, 2021, 10:05:26 AM »
Yeah unless youíve got at least a few million saved Iím not sure this is worth the risk. Regarding conflict of interest: the people loaning you money to invest are (corporate-wise) the same people who are telling you to invest? Why are they then having you borrow their money to invest in their fund? Itís to guarantee a rate of return for themselves (the interest you pay on the loan). So you have a guaranteed expense for a non-guaranteed gain that is opaquely managed by a private fund without SEC filing requirements?

Other thoughts: what are their fees as a % of total investment? Are fees expected regardless of performance, or tied to performance?

Lastly: Do you have proof of prior returns, and how confident are you that this isnít a Ponzi scheme? Thatíd be my attitude on investing with someone I donít know at all.

As to the loan - they didnít offer it or mention it, I just knew I had access to it and asked them about it. They said essentially that ďyea, some people choose to do it that way, others donít.Ē The ďadvisorsĒ (hah) selling the PE investments donít get any benefit if I use borrowed funds for my buy in and havenít pushed me one way or the other. And itís a very low rate right now that can be paid off any time if rates rise.

Their fees are high, like rip your eyeballs out high. There several layers of people who get paid on this before me. The first layer is tied to performance but the others who are selling get the same fee even if your investment goes bad. But the data they send on past funds discloses all of that and shows the return net of fees. So itís like a 16% return net of fees, for example, but in some funds it was much higher. This particular group that these guys are selling investments in hasnít had any bad years recently, but Iím sure these same ďadvisorsĒ (salesman) have also placed people in losing funds before.

Itís definitely not a Ponzi scheme. I know these people by reputation and am confident that itís not an outright scam. But it is definitely a higher risk investment than an index fund, no doubt. With that being said, the worst case isnít that you lose your entire principal (usually). Itís that you get a garbage or somewhat negative return and your money is tied up for ten years so thereís a huge opportunity cost if that happens. So not great, but not as bad as with stock options that expire worthless or something.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #18 on: April 20, 2021, 10:07:46 AM »
PE is absolutely legit, but its generally considered higher risk thank public stocks.
Pick 100 companies, expect 80 of them to lose money, 10 to be mildly profitable, 7 or 8 to be very profitable, and hope 1 or 2 return 50-100 times your initial investment.

Oh yeah, there's no indexing available.

So yeah, not for Bogleheads.

Yea, I guess the real question is whether Iím a Boglehead. I just donít know, and the salesman selling these loans sure arenít going to tell me.

BicycleB

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Re: Private Equity - Legit, or not Legit?
« Reply #19 on: April 20, 2021, 03:25:56 PM »
From background reading, there have been eras when private equity as a sector in the US had returns that exceeded returns on publicly traded equities (listed stocks). But not always.

I recall reading an article a couple of years ago where the author claimed to summarize data showing that, at that point, an era of higher-than-public returns had more recently been followed by one where private equity as a sector lagged public equities. I believe the author's opinion at the time was that it was unclear whether enough correction had occurred that private equity was likely to provide value. The author's conclusion was that since public equities are far more liquid and transparent, it wasn't worth pursuing for the time being.

If I understand correctly what private equity means, private equity funds aren't limited to equity investments only; they could be holding cash or bonds sometimes while looking for other investments, and in many cases aren't limited to just financial investments anyway - some of them could buy land or art or other things that are not traded in stock exchanges. Therefore I may misunderstand or mis-state what the author above was comparing to, though I know his/her point at the time was an assertion that there wasn't a value available to make up for the lack of liquidity.

Not sure if that helped any. :)

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #20 on: April 20, 2021, 07:00:22 PM »
From background reading, there have been eras when private equity as a sector in the US had returns that exceeded returns on publicly traded equities (listed stocks). But not always.

I recall reading an article a couple of years ago where the author claimed to summarize data showing that, at that point, an era of higher-than-public returns had more recently been followed by one where private equity as a sector lagged public equities. I believe the author's opinion at the time was that it was unclear whether enough correction had occurred that private equity was likely to provide value. The author's conclusion was that since public equities are far more liquid and transparent, it wasn't worth pursuing for the time being.

If I understand correctly what private equity means, private equity funds aren't limited to equity investments only; they could be holding cash or bonds sometimes while looking for other investments, and in many cases aren't limited to just financial investments anyway - some of them could buy land or art or other things that are not traded in stock exchanges. Therefore I may misunderstand or mis-state what the author above was comparing to, though I know his/her point at the time was an assertion that there wasn't a value available to make up for the lack of liquidity.

Not sure if that helped any. :)

Super interesting actually, thank you.

Joel

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Re: Private Equity - Legit, or not Legit?
« Reply #21 on: April 20, 2021, 08:13:31 PM »
What kind of leverage ratio does this fund target operating with? Higher risk, higher reward.

Vashy

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Re: Private Equity - Legit, or not Legit?
« Reply #22 on: April 21, 2021, 04:50:22 AM »
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.

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #23 on: April 21, 2021, 09:19:44 AM »
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 youíve probably got the most knowledge in this thread. (Certainly FAR more than me).

Vashy

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Re: Private Equity - Legit, or not Legit?
« Reply #24 on: April 21, 2021, 01:24:05 PM »
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 youíve 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.)
« Last Edit: April 21, 2021, 01:43:18 PM by Vashy »

Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #25 on: April 21, 2021, 08:12:19 PM »
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 youíve probably got the most knowledge in this thread. (Certainly FAR more than me).

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.


Thatís what this one isóand they do 30 or so companies per ďvintage,Ē and if I remember right they are doing it with a brand name coinvestor that handles part of the deal. So that all actually sounds pretty good based on what youíre saying, I think.

Really really appreciate this, very helpful information thanks so much for taking the time to type it out for everyone.

Vashy

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Re: Private Equity - Legit, or not Legit?
« Reply #26 on: April 22, 2021, 02:03:39 AM »
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 youíve probably got the most knowledge in this thread. (Certainly FAR more than me).

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.


Thatís what this one isóand they do 30 or so companies per ďvintage,Ē and if I remember right they are doing it with a brand name coinvestor that handles part of the deal. So that all actually sounds pretty good based on what youíre saying, I think.

Really really appreciate this, very helpful information thanks so much for taking the time to type it out for everyone.

I'm glad it's helpful, and good luck. :)

habanero

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Re: Private Equity - Legit, or not Legit?
« Reply #27 on: April 22, 2021, 02:08:55 AM »
Private Equity is to a large extent a new and fancier-sounding term for "leveraged buyout".

chasesfish

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Re: Private Equity - Legit, or not Legit?
« Reply #28 on: April 22, 2021, 03:40:48 PM »
The most basic explanation is you should earn a premium return over a market investment for taking on added illiquidity risk.

As with any investment, the operator and fees matter.  You either do your own due diligence or if you don't know how to, pay for a consultation or buy it through a professional allocator who takes an asset under management fee.

I've done consultations/deal evaluations for people looking into a private equity investment.  It's been a fun hobby since reaching FI and planning on doing more.

BicycleB

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Re: Private Equity - Legit, or not Legit?
« Reply #29 on: April 22, 2021, 05:55:29 PM »
The most basic explanation is you should earn a premium return over a market investment for taking on added illiquidity risk.

As with any investment, the operator and fees matter.  You either do your own due diligence or if you don't know how to, pay for a consultation or buy it through a professional allocator who takes an asset under management fee.

I've done consultations/deal evaluations for people looking into a private equity investment.  It's been a fun hobby since reaching FI and planning on doing more.

Fwiw, @Maturin, chasesfish is a retired banker who is probably good at this stuff because he did it for a living before retiring on his investments at 35 or so. He's a legitimate "vendor" for this type of service, I would think. Just FYI.

chasesfish

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Re: Private Equity - Legit, or not Legit?
« Reply #30 on: April 23, 2021, 04:54:45 AM »
@Maturin

I've reread the thread...

This sounds like a straight forward middle market private equity fund.  Buy businesses from entrepreneurs, professionalize and scale them, then exit those investments.  There are literally thousands of these funds chasing businesses trying to exit.

I would have a ton of due diligence questions, but mainly focused around the track record of management and (today) what exactly are they are doing differently to get deal flow?  Personally I would only invest my money with a team that has a track record of directly sourcing deals given the amount of money competing for companies in this space.   Secondly, what is their track record of professionalizing operations.  Are the partners of the firm people who used to operate businesses of similar size or are they all finance junkies and former investment bankers who live by excel models?  The funds make their money one of two ways:  Sourcing deals below market value and improving operations.

At a six figure investment and depending on the size of the fund, you should get a telephone call to ask due diligence questions.  From the sound of it, you may be buying this through an allocator who's already done some of this.  It's up to you if you want to outsource your due diligence in that way.

I don't quite understand the fee comments, I'd just need to know more. 

The "borrow money" part may or may not be concerning to me depending on your level of wealth.  If you already have a $400,000 + taxable investment portfolio with a lot of underlying gains and includes some treasury bonds, borrowing 25% of that amount and using the portfolio as collateral is probably prudent.  That's been a strategy of the wealthy for decades and will be for decades in the future.  If that's not the loan structure you're considering, then it's an entirely different discussion about risk/reward.

Happy to answer more general questions.


Maturin

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Re: Private Equity - Legit, or not Legit?
« Reply #31 on: April 27, 2021, 04:40:58 AM »
@Maturin

I've reread the thread...

This sounds like a straight forward middle market private equity fund.  Buy businesses from entrepreneurs, professionalize and scale them, then exit those investments.  There are literally thousands of these funds chasing businesses trying to exit.

I would have a ton of due diligence questions, but mainly focused around the track record of management and (today) what exactly are they are doing differently to get deal flow?  Personally I would only invest my money with a team that has a track record of directly sourcing deals given the amount of money competing for companies in this space.   Secondly, what is their track record of professionalizing operations.  Are the partners of the firm people who used to operate businesses of similar size or are they all finance junkies and former investment bankers who live by excel models?  The funds make their money one of two ways:  Sourcing deals below market value and improving operations.

At a six figure investment and depending on the size of the fund, you should get a telephone call to ask due diligence questions.  From the sound of it, you may be buying this through an allocator who's already done some of this.  It's up to you if you want to outsource your due diligence in that way.

I don't quite understand the fee comments, I'd just need to know more. 

The "borrow money" part may or may not be concerning to me depending on your level of wealth.  If you already have a $400,000 + taxable investment portfolio with a lot of underlying gains and includes some treasury bonds, borrowing 25% of that amount and using the portfolio as collateral is probably prudent.  That's been a strategy of the wealthy for decades and will be for decades in the future.  If that's not the loan structure you're considering, then it's an entirely different discussion about risk/reward.

Happy to answer more general questions.

I should be ok to borrow. As to your other question, yes, Iíd be buying through an allocater. Theyíre the guys Iíve been talking to, I just didnít know the term for them. Theyíre just salesman essentially, which is why there are multiple levels of fees. I pay them and the actual PE managers. Iíd have to go back in look, but the managers themselves had two layers of fees, I think. But Iím looking at profits to the clients of these salesman from past years net of fees.

So basically, yes Iíd be outsourcing the diligence to a group of people that are well known to the working rich and mega rich in my city and by all accounts have a good track record of matching investors with PE groups. They have three that they like that operate differently, and Iím interested in one that invests in companies of the size you describe. I donít think they actively manage the companies, though. (So, sitting here now, I think it may be that they just let existing management run the company and theyíre just providing growth equity financing??).

Oh, Iím now remembering that the second layer of fees is to pay a coinvestor, a much larger PE group, that the smaller one that Iíd be investing with partners with. Iíd have to go back and look at why they do that.

chasesfish

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Re: Private Equity - Legit, or not Legit?
« Reply #32 on: April 27, 2021, 07:03:26 AM »
Thanks for the reply.

So you've checked the box on due diligence and being with a credible private equity firm.

Now the only question is are you okay with the 5-10 years of illiquidity in exchange for the probability of a 1-4% higher return than what the market will generate over that same period.

Given how you're investing and the professionals you're using, it's unlikely the investment will be a home run.  There are too many people protecting their career risk and ability to make money.  They won't be "swinging for the fences" and instead trying to hit a bunch of singles and doubles.

I *do* think the investment thesis makes sense.   We have a generational issue going on of more businesses that will be for sale than operators that can run them.  This is a 20 year process of consolidation, professionalization, and integrating technology into smaller companies and aggregating them together.   So I'm supportive of the space and supportive of how you're going about the due diligence process. 

Now it's just a question of is the liquidity lockup worth the additional return to you?   If you don't have any major liquidity needs coming up and have cash flow that's stable in other places, go for it.


vand

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Re: Private Equity - Legit, or not Legit?
« Reply #33 on: April 27, 2021, 08:07:17 AM »
Personally I get private company exposure via a a few (UK listed) publically traded Investment Trusts that I hold, RIT Capital
(RCP.L) & Caledonia Investment Trust (CLDN.L). 

Obviously with this porttion of the trusts being private the NAVs are not updated daily, only monthly at best, but it's an easy way to get access to private companies through publically traded instruments. I also trust the management of these funds as much as I trust any actively managed money.

 

Wow, a phone plan for fifteen bucks!