The investment world has many well-known and lesser-known terms. Think of stocks, bonds, options, futures, or swaps. In a special series, we explain the characteristics and history of the various investment categories. In this episode, Greg Jania, global co-head of private equity at APG in New York, discusses the characteristics of private equity.
Private equity summarized
What is it?
Private equity stands for investments in unlisted companies. Investors pool together to buy companies that can grow or make acquisitions with the extra capital. In return, investors receive a return on the capital when the companies are sold.
When did it originate?
At the same time as the rapid growth of private companies in the 1970s, the role of private equity also increased. There are (large) investors and private equity funds that only invest in private equity. A share of 10-20 percent is not unusual in investment portfolios. At APG, six percent of the total invested capital is private equity, approximately fifty billion euros. Private equity is expected to continue to grow strongly.
What else is involved?
Compared to listed companies, there are a multitude of private companies active. Because there are not many liquid assets available, investing in private equity is popular. For the investors themselves, the returns are on average higher than the average returns on the stock markets. Furthermore, private equity is a means of making the portfolio more diverse and therefore less vulnerable. However, there are also disadvantages associated with the investments. The costs are higher, and sometimes so are the risks. For the receiving companies, shareholders want a say and are involved in the strategy.
What is it?
When a private investor participates in a company, he becomes a shareholder. The aim is to make the company more profitable through growth or acquisition of other companies. After a number of years, the shareholders can sell the interest to another public or private firm or another private equity firm. “A company can of course go public to raise capital and later issue additional shares,” explains Jania. “But an initial public offering (IPO) is complicated and a listing on the stock exchange is subject to many rules. As a company, selling shares directly to private parties is often easier and you can decide who you partner with.”
Different shapes
Private equity has been controversial. Some funds are often seen as 'locusts' that quickly want to make big profits. According to Greg Jania, that is an oversimplified view. “Capital is simply necessary for companies to develop. You can distinguish different shapes. Capital to facilitate management buyouts, takeover by the existing management, to guarantee the continuity of a company. Sometimes even to be able to leave the stock market. Also venture capital and seed capital are needed to bring inventions to the market, which means financing with some risks. This is often done with private capital.”
Are there any other benefits for the recipient companies? “Private investors often bring knowledge and skills. Because they like to invest in a company with which they have an affinity. In the field of sustainability, for example, or circularity, current themes.
Pitfalls
That all sounds good. Are there any hidden pitfalls? Of course, says Greg Jania, who has been active for APG in New York since 2013. “First of all, the degree of control. As a company, do you want the new shareholder to help decide on the strategy? On takeovers? On certain investments? If proper agreements have not been made, this can lead to conflicts and a lack of flexibility. Another pitfall is having too high expectations. Investors often invest in startups or scaleups with promising ideas. But these are not always fulfilled. There is always a risk that something will not work out. With listed companies you can simply exit by selling the shares, but that is a lot more complicated with private companies.”
And then there are the high costs. "Indeed. At APG, we currently have around 50 billion euros outstanding with more than 3,000 companies. That is six percent of our total invested capital. By comparison: we invest ~30 percent of our assets in public stock exchange funds. But there are many more private companies than public companies. We make well-considered choices with private equity, investing mainly in companies with social impact that meet certain ESG objectives. Companies that innovate with sustainable energy, circularity. We screen every manager. Quite labor intensive and that does not stop after signing the deal. Our team monitors performance, informs the organization and clients of any incidents and takes action if something threatens to go wrong. We are among the global top ten investors in private equity and we set an example. This means that we closely monitor 'our' companies and must know the markets. And yes, that is expensive. Our team of over 50 specialists is working on it full-time.”
When did it originate?
In the 1970s and 1980s, private equity emerged as a serious form of investment. Investors started to experiment with funds that raised capital to invest directly in private companies. The founding of Kohlberg Kravis Roberts & Co. (KKR) in 1976 is considered an important milestone. Since then, private equity has grown into a major force in the financial world. In addition to KKR, major players include Blackstone, TPG Capital, EQT, and CVC Capital.
What else is involved?
The costs are no reason for APG to temper investments in private equity. “On the contrary,” continues Greg Jania. “The returns are higher on average. Moreover, we carefully spread our portfolio across different sectors worldwide. From small startups to very large companies. Portfolio diversification is essential for every professional investor. Especially for a pension investor who is responsible, on behalf of its pension fund clients, for the income of millions of people.”