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Have you ever taken an ancestry test with Ancestry.com? Have you ever visited Sea World or Movie World in Queensland? Have you ever shopped at Toys “R” Us? Have you flown with Virgin Australia? Although seemingly very different, the brands mentioned above have one crucial thing in common: they are all owned by private equity (PE) firms.

What is private equity?

Private equity is a form of investment partnership in which the private equity firm, as the general partner (GP), provides capital to unlisted companies using a private equity fund as an investment vehicle. Private Equity funds typically receive an ownership stake in the investee company in return for the capital, and this can be controlling or non-controlling, depending on the goals of the investment.

Where do private equity firms receive their funding from?

A private equity fund’s core source is its investors/clients. These limited partners (LPs) investors are usually high-net-worth individuals, family offices, or large financial institutions such as superannuation funds, sovereign wealth funds, and other private equity firms.

Private equity fund managers, or GPs, operate the fund to pursue investment opportunities and complete transactions on behalf of their investors/clients.

Private equity sources of funding

How does Private Equity create value?

Private equity funds are designed to create significant value for all parties involved in a PE transaction through screening investment opportunities that meet its criteria.

PE firms provide large sums of capital to the investee company. Investee companies typically utilise the capital supplied by Private Equity firms to capitalise on unique growth opportunities in the global economy. This may involve the sourcing of potential acquisitions for private companies where the target company may bring additional operational capabilities or enhance revenue and cost synergies. PE firms also provide strategy consulting to the management team of the investee companies within its portfolio. The advice provided by the fund is designed to improve profitability and accelerate growth within the investee company.

Private Equity managers possess Merger & Acquisition (M&A) expertise and resources that PE investors typically need to have. For instance, private equity funds can collect larger pools of capital than individual investors, including a mix of equity capital and debt financing. This capital raised allows capital partners to make larger acquisitions and investments than individual private equity investors. Furthermore, PE firms can use this capital to make a more significant number of investments. It allows capital partners to diversify their portfolios across multiple sectors and businesses. This diversity protects the PE firms’ portfolio against the poor performance of an individual company or sector.

Graph - how does private equity create value?

How do funds receive a return on investment?

Funds commonly profit from their investment through two forms of return. Firstly, through dividends generated from profitable investments. Secondly, by increasing the value of the acquired company and realise a return through a sale or initial public offering.

Private equity is classified as an alternative investment. Private equity and other investments are considered higher risk than traditional asset classes, such as stocks and bonds. As a result, firms require a higher investment return to compensate for the risk assumed.

Graph - private equity index vs S&P500 index

Source: Moonfare – Private Equity Basics in 6 Charts

To ensure adequate returns are achieved, Private Equity funds often take an active management role in their investee companies – or hire a team of professionals who work closely with senior management teams to help improve profitability and accelerate growth.

As a result, some private equity funds focus on specific sectors or themes where fund managers have expertise. For example, Carlyle Group focuses on investments in the aerospace, defence, and government services sectors, whereas Blackstone leans toward investments in real estate, infrastructure, insurance, and credit.

Private Equity investment strategies

Private Equity firms often employ a mix of investment strategies to achieve risk-adjusted returns, with each strategy varying according to the target company’s stage of the corporate lifecycle.

Company stages of the corporate lifecycle.

While large leveraged buyouts continue to increase, non-buyout private investing in venture capital and growth equity has also seen increased activity. This overall growth shows investors’ increasing sentiment toward diversification across the private equity spectrum.

Global buyout, growth equity, and venture capital AUM

Source: Bain&Co., Preqin

Leveraged Buyouts (LBOs)

LBOs fall under the broader “Private Equity Buyouts” umbrella, whereby a Private Equity fund acquires a controlling stake in a private company. In the case of an LBO, the Private Equity fund secures debt to acquire the controlling stake to improve the company’s operations and financial performance and resell the company at a higher value. A simplified example of using debt financing would be taking out a mortgage, where the return on equity would increase by the degree of leverage.

Leveraged Buyouts - A simplified example of using debt financing would be taking out a mortgage, where the return on equity would increase by the degree of leverage.

Growth Equity

Growth equity is a form of investment in which private equity firms provide capital to an already profitable company to accelerate growth or expand operations into new markets. This typically sits in the grey area between VC and PE investment, aiding smaller companies in expanding as they traverse their life cycle while allowing them to raise capital without losing a controlling ownership stake.

Venture Capital

Venture Capital firms invest in early-stage businesses with high growth potential. Venture capital funds are a form of private equity focused on investing in small start-ups with high growth potential. However, these investments require a more significant risk tolerance.

Venture Capital firms invest in early-stage businesses with high growth potential.

Turnaround Investing

Private equity funds acquire underperforming businesses to make operational improvements as well as improve allocating capital, reselling them at a higher price in the future. With this strategy, a private equity firm would typically purchase equity in a company at the start of a bankruptcy procedure.

Private equity funds acquire underperforming businesses to improve operational efficiency and allocate capital more efficiently

Distressed Investing

The private equity fund invests in a company facing bankruptcy, intending to return the business to profitability. As companies invest in turnaround companies, distressed businesses do not have the cash flow to service debts and involve greater risks, which also means they can offer higher returns.

The private equity fund invests in a company facing bankruptcy, intending to return the business to profitability.

General Partner (GP) Stakes

A Private Equity firm takes a minority, non-controlling stake in another Private Equity firm. Typically, the acquiring firm’s position is non-strategic and passive. This investment strategy is gaining traction across private equity investments at the moment.

Investing in an industry peer allows the firm to gain exposure to the investee’s entire balance sheet instead of an individual investment or fund. The investor is granted access to the investee’s revenue generated from management fees as opposed to the returns generated by the appreciation of an individual fund. The added level of diversification ultimately makes this strategy attractive to the investor fund. It exposes them to a broader portfolio of companies, industries, themes, and even investment strategies than what would be available in an individual fund. This strategy also benefits the investee firm, as the acquisition capital provides liquidity, allowing the investee to fund new initiatives.

Types of Private Equity Buyouts

Platform buyouts are a common choice within growth equity, involving acquiring a foundational company as a core for future acquisitions which could be accomplished through an add-on, otherwise referred to as the “buy-and-build” strategy. According to Bain & Co., frequent acquirers have had a 130% advantage in shareholder returns over non-acquirers over the past decade compared to 57% in 2000–2010.

Add-on acquisitions can be made, typically referring to the acquisition of smaller companies with little financial and administrative infrastructure, though it can also refer to large companies. In 2024, add-on transactions now make up around half of the global total, compared to 30% in 2019, also according to Bain & Co. This would provide further services, technology or expansion into a specific geography and can entail different degrees of integration.

Bolt-on acquisitions would be partially integrated into the platform company, as this would be motivated by strategic reasons and not necessarily for revenue. While these acquisitions involve companies that may not be as large as the platform, they would typically be able to maintain some of their infrastructure and identity. Tuck-in acquisitions, on the other hand, would be completely integrated, with little infrastructure and run by owners and this method would be driven by revenue or geography reasons more than strategic reasons, given that the target company would lose its identity and fold its infrastructure.

Buy-and-build strategies focus on enhancing organisational capabilities.

Key statistics

According to the Australian Investment Council yearbook, in 2022, the private equity industry remained Australia’s dominant private capital market (including Private Debt, Real Estate, etc.) with $42.2 billion in assets under management. It represents approximately one-third of total private capital markets. Over the past five years, the private equity market in Australia has grown, on average, at 11% annually. The aggregate deal value reached $20.1 billion in 2022 (an increase of 32% on the prior year).

Global private capital dry powder, by fund type ($T)

Source: Bain & Co., Preqin

Private Equity “dry powder” (cash or liquid securities held in reserve and ready to be deployed) is estimated to stand at $10 billion (as of September 2021), which is 11% lower than the prior year. This trend often indicates that private equity firms have sufficient avenues to invest in.

The largest Australia-focused fund raised in recent years (from 2016-2022) was raised by BGH Capital (BGH Capital Fund II), which raised $3.6 billion in March of 2022.

In recent years, the largest completed Australian buyout was a public-to-private purchase of Vocus Communications (a fibre and network solutions provider). The acquisition was made by a consortium consisting of Macquarie Infrastructure and Real Assets and superfund Aware Super for $3.5 billion in February of 2021. International private equity firms have also completed notable buyouts of local businesses recently, including KKR’s buyout of Probe Group for $1.1 billion and Blackstone’s all-cash takeover of Crown Resorts for $6.3 billion in February of 2022.

Case study: Myer

One of the more famous private equity case studies is that of Myer. Established in 1900, Myer became one of Australia’s largest department stores. In 1985, Myer and Coles completed a $1 billion merger in the largest deal in Australian history (at the time).

By 2006, Myer had begun to struggle financially due to a lack of investment in technology and systems, combined with slow decision-making management, and increasing competition from brick-and-mortar specialty retailers and online retailers.

In 2006, Coles Myer Ltd sold its stores to a consortium of US Private Equity firm TPG and its associates Blum Capital and the Myer Family for $1.4 billion. The consortium’s capital financed only $450 million of the $1.4 billion Myer price tag. The remainder was financed by debt.

TPG purchased Myer in a bid to turn the department store around. TPG quickly hired Bernie Brooks, Woolworths’ marketing guru, as CEO, began clearing inventory of old stock, and invested in new technology and systems. The consortium also began shutting down underperforming stores and sold its flagship Melbourne store (which it later leased back).

In 2009, three years after the purchase, TPG and the consortium sold Myer, which was relisted on the ASX. The consortium netted around $2 billion from their initial investment of $450 million.

Lessons from the Myer case study

The case study of Myer, TPG and its consortium displays the “Turnaround Investing” private equity investment strategy whereby TPG seeks to purchase an underappreciated business at an attractive price to improve operations and increase the value of its investment.

Myer announces opening date for all of its Australian stores, including Karrinyup | PerthNow

Q&A

Who funds private equity firms?

Private equity firms, receive capital from LPs that would typically include wealthy individuals, institutional investors and pension funds, which include superannuation funds and foreign institutions. Notably, AustralianSuper, Australia’s largest pension fund, plans to double its private equity assets to 9% of its portfolio over the next four years, approximately by $35bn. The Corporations Act 2001 distinguishes between retail, wholesale, sophisticated and retail investors. Certain investments are not accessible by everyday retail investors as they may require greater financial capability or literacy.

Why invest with private equity firms?

Private equity investors invest with PE firms to generate a higher return than what can be achieved in public markets. PE funds are also considered portfolio companies. Portfolio companies hold an interest in several businesses, providing private equity investors with a diversified approach to private markets. Further, PE firm fund managers allocate capital on behalf of private equity investors.

What is the average private equity fund return?

According to the Australian Investment Council, private equity and venture capital funds have returned 15.1% to investors over the 5 years ending 2021 (net of fees). The ASX300 and ASX Small Ords have yielded 10.6% and 11.3%, respectively.

Over the ten years ending 2021, PE and VC funds generated 14.5% in returns. Over the same period, the ASX300 and ASX Small Ords yielded 7.8% and 3.3%, respectively.

Finally, over the 20 years ending 2021, PE and VC funds generated 12.9% returns, against the ASX300 and ASX Small Ords’ 7% and 4.3% (respectively).

What is the difference between private equity funds and hedge funds?

Hedge funds and PE funds are alternative investments that pool funds from various investors. PE funds invest directly in private businesses, whereas hedge funds use a variety of strategies and techniques (including derivatives) to generate returns. These strategies are applied to both private markets and public companies. Hedge funds typically abide by the 2-20 rule: the hedge fund charges a 2% management fee to its investors and a 20% performance fee for investments that realise their upside.

Who regulates private equity firms?

In Australia, PE firms are regulated by the Australian Securities and Investments Commission (ASIC). ASIC oversee Australian public companies, financial markets (including the ASX) and services (including banks, insurers and superannuation funds), and financial professionals (including those that advise on investments).

What are the key risks of private equity?

The key risks of private equity are:

  • Illiquidity – Investments often include lock-up periods in which investors cannot exit their positions without penalty. Lock-up periods can be uncomfortable for investors who wish to exit their positions or need access to capital quickly.
  • High leverage – buyouts funded partially by debt increase the risk associated with the transaction as it quickly becomes expensive if interest rates rise above expectations.
  • Conflicts of interest – private equity managers may pursue deals that benefit their interests more than those of shareholders.

37.4

Average return
since inception

55

Portfolio value
as at Jun-23
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