Private equity has made the news recently with groups of professionals calling for pension funds to invest more heavily in this asset class. Like any investment, there are many risks associated with this particular asset class and the benefits accrue to a select few who are able to execute successfully. Before we delve into the pros and cons and whether or not this is a viable way to solve the problems facing Jamaican’s pension funds – today we will simply try to understand, what is “private equity”?
Most people who own their own business are invested in “private equity” or engage in “private equity type” activities. If you own a shop and you are trying to get better pricing from your suppliers or you are trying to increase sales – you are actively engaged in some of the critical components of a private equity investment strategy. Private equity investors typically buy a business and seek to maximize value in a variety of different ways, many of which you probably employ in your own business. This applies across all businesses from road-side shops to large supermarket chains; from small “partner loan groups” to larger microfinance operations; from independent nail technicians to large salon chains. The point is, private equity investors and small business operators are very often trying to solve the same problems or achieve the same goals – usually at different scales and varying levels of complexity.
At the risk of oversimplification, the private equity investment strategy aims to purchase an ownership stake in a target company, increase the value of the company, and then realize that value through a variety of different mechanisms, most often through the sale of its shareholding. Usually, target companies are either underperforming, distressed or in need of capital. Upon acquisition, the private equity firm tries to execute a well- defined turnaround strategy to create a more valuable entity. However, there are also instances in which the private equity firm may assume a more passive operational role. In these instances the target company may be a start-up or in the early stages of its life cycle. The private equity firm would provide the capital and oversight needed to fuel the growth of the business. These are particularly common in the technology industry.
What does this look like in real life? Locally we have seen it. For example, the change of ownership at companies such as Supreme Ventures and Barita – new investors hoping to extract more value by creating efficiencies or changing business strategies. GraceKennedy’s purchase of Key Insurance could be interpreted as a purchase of a challenged asset with the goal of trying to turn it around. Alignvest’s purchase of Sagicor Financial is another popular reference point. These investors are hoping that their new strategies will increase shareholder value. Private equity investors quite often use very creative and lucrative financing and ownership structures to increase the size and probability of positive returns.
Why would someone go into private equity? The risk is very high but on the occasions that the investments are successful, the returns are outsized. “The winners pay for the losers” is a common saying among the seasoned private equity firms overseas.
Marian Ross is a Vice President of Trading & Investments at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: [email protected]