A Short Overview of Private Equity
In Australia, there is some $77bn in private markets, with private equity & venture capital funds raising more than $5.6bn in 2020. Since 2010, assets under management in private equity in Australia have almost doubled, from just over $20bn to just under $40bn (Preqin, 2021).
The rise of private equity follows a global trend of wealth flowing into private markets. At the end of 2020, private markets grew to more than US$7.4tn, with private equity accounting for nearly half of the total assets.
Given the huge amount of wealth flowing into private equity, what is it and where did it come from?
What is "private equity"?
At a high level, private equity is an umbrella term that covers a number of strategies, but is essentially about the use of a fund to buy private companies and help them improve their performance.
When people use the term ‘private equity’ they typically mean one of two popular strategies: leveraged buy-outs (LBO) or venture capital (VC).
In a LBO, the investment manager will typically acquire a majority stake in a number of private businesses. These businesses are often thematically linked and are mature and stable, with a track record of free cash flows. What makes it a ‘leveraged’ buy-out is that the fund not only buys the companies with the money provided by the investors (i.e. the limited partners), but also borrows money (i.e. uses debt or ‘leverage’). Once the company is acquired, the investment manager will use its skills and expertise to help optimise the performance of the company. This may occur by changing the financials, governance or operating structure of the company. These changes take time to implement and even longer for the results to be seen. Therefore, a fund may run for up to ten years to allow sufficient time to see if the investment thesis employed by the investment manager was successful.
Quite simply, the core theme of an LBO is to improve an existing private company’s operations, from both revenue and profitability perspective and sell the company at a higher valuation in a 3 - 5 year period. The more successful the investment manager is, the higher the return for investors.
Venture Capital is more widely known. A venture capital firm or fund invests in start-ups, early stage or emerging companies and, in return, receives an equity stake in the company (i.e. part ownership). They do so because they believe, or they are shown, that the company has high growth potential (i.e. the potential to become very successful). In essence, a venture capital firm is looking to invest in the next Facebook or Google. Unlike an LBO, the venture capital firm or fund typically does not take a majority equity stake in the company. They want the founders to be motivated to deliver the potential. In addition to cash, the VC firm may also provide advice and guidance to the company to help them along the way. This is less about optimising an existing company, but finding a valuable idea and providing the founders the resources to bring it about or scale.
Short history of how private equity started and how it has grown
While there has always been wealthy families providing capital to companies and partnerships going back hundreds of years, the modern private equity industry really only started after the end of World War II in the United States.
In the 1950s, under President Eisenhower, the passage of the Small Business Act represented a turning point. This provided government loans to venture capital firms, allowing them in turn to make more substantial loans to new businesses. This was perhaps the first formal steps towards the concept of leverage. Soon after, other firms followed. Kohlberg Kravis Roberts & Co (KKR) arguably made the world’s first leveraged buy-out in 1964, with the purchase of Orkin Exterminating Co., which as the name sounds, dealt with pest control (Loosvelt, 2010).
During 1980s, Congress in the United States relaxed restrictions for investments by pension funds, and thus large amounts of capital started to flow into private equity funds and the industry took off. During this period, many of the best-known private equity funds were born like The Carlyle Group, Bain Capital, and The Blackstone Group.
It wasn’t until the mid-1980s and into the 1990s that private equity in Australia really got underway. Bill Ferris and Joe Skrzynski created Australia’s first venture capital firm in the mid-1980s. The VC industry was given a boost when the Government opened the Innovation Fund, which offered a matching scheme for investment in venture capital firms. Again, in the 1990s, Bill Ferris was at the forefront of private equity in Australia when, in partnership with a New York-based private equity firm, he set up Australia’s first buy-out fund, which saw remarkable success (Norton Rose, 2021).
Australia has now become home to many globally recognised names, including KKR, Blackstone, Carlyle, PGIM who all have offices here.
How’s the Australian private equity investment been shaping up?
The interest in private equity is increasing year-on-year within Australia and New Zealand. In the first nine months of 2021, a number of record deals have been struck, which in value terms exceeded the combined activity of 2019 and 2020.
The Australian market continues to attract significant interest from investors overseas. Of 200+ transactions announced in third quarter of 2021, foreign bidders were involved in more than 33% of such deals with 30 deals coming from US investors, followed by the United Kingdom (11) and Sweden (8). In fact, one of the biggest transaction of 2021 was the acquisition of Afterpay Limited, an Australian FinTech company which was acquired by US based Square Inc. at US$26.6bn (Preqin, 2021).
The below chart shows how Australia’s private equity assets has been growing year-on-year.
Australia-Focused private capital assets under Management by Asset Class, 2010 - 2020
Source: Preqin, 2021
If we assume private equity to be a sector on its own in Australia, its income would exceed the insurance or the coal mining sector. In fact, the number of people, they would employ would be more than banking or automotive industry (Prequin, 2021).
Our vision at Reach
At Reach Alternative Investments, our vision is to enable Australian sophisticated investors exclusive and unprecedented access to institutional-grade private equity opportunities offered by the world’s leading asset managers. We are committed to bringing this market out of the shadows and supporting a community of both investors, and their advisors, to invest in this space effectively.
However, while there is rightfully a growing interest around the world in relation to private equity, particularly as companies delay their initial public offering (meaning they are taking longer to list on the stock exchange), we think caution needs to be exercised. Historical performance is not an indicator of future performance and you may lose money. Before making any financial decision, you should consider the information memorandum and your own circumstances to consider whether it is right for you. If you need advice, we strongly encourage you to speak with a licensed financial adviser / planner.
Financial Times (FT), Robin Wigglesworth “Private capital industry soars beyond $7tn” (11 June 2021) https://www.ft.com/content/4d0e6f18-2d56-4175-98c5-e13559bdbc25
Ibis World, Industry Statistics, Australia https://www.ibisworld.com/au/market-size/private-equity/ 29 May 2021
Loosvelt, Derek “A Brief History of Private Equity” (10March 2009) https://firsthand.co/blogs/in-the-black-vaults-finance-careers-blog/a-brief-history-of-private-equity
Norton Rose Fulbright “Deals Down Under – Australia in the sights of Global Private Equity” (January 2021) https://www.nortonrosefulbright.com/en/knowledge/publications/25883ab4/deals-down-under-australia-in-the-sights-of-global-private-equity
The information in this article has been compiled from sources we believe are reliable. We make no warranty, express or implied, regarding accuracy, adequacy or the completeness of the information in this report. We provide this information on an ‘as is’ basis. This disclaimer applies to isolated and aggregate uses of the information. Information can also become out of date fairly quickly. If you have obtained this information from a source, other than from Reach Alternative Investments, please consider it carefully as electronic data can be altered subsequent to original distribution. Please contact us immediately if you think that may be the case.Always remember that all investments carry risk. You may lose or gain money. Past performance is also not indicative of future performance. Before making a financial decision, you should read the relevant Information Memorandum.
The information in this article is prepared by WeReach Alternatives Pty Ltd (ACN 652 305 658 AR 001 293 245), trading as Reach Alternative Investments, who is an authorised representative of Cache Investment Management Pty Ltd (ACN 624 306 430 AFSL 514 360) (Cache). Any financial products described in this email will be issued by Melbourne Securities Corporation Limited (ACN 160 326 545 AFSL 428 289), as disclosed in the relevant Information Memorandum. All information is general information only and does not take into account your personal circumstances, financial situation or needs. Before making a financial decision, you should read the relevant Information Memorandum and consider whether the product is right for you and whether you should obtain advice from a professional financial adviser