Interview : what is Private Equity?
EXPERT’S VOICE: QUESTIONS TO RAJAA MEKOUAR-SCHNEIDER – CEO LPEA
“The industry of Private Equity is growing very fast and it calls for more attention and more oversight on behalf of the investors and the regulator's.”
Text version of the interview:
1/ Could you define what Private Equity is?
Private equity is an investment asset class that typically is defined as alternative investment. I don't like the alternative mention of it because private equity represents a very wide range of the industry in the financial sector. It consists in investing in privately as private says companies ie there are not listed on the stock markets. That's the main generic definition that separates it from stocks that are listed on the equity markets. It typically involves a wide range of stages, from very early-stage investments in very small companies or as we call them seed or even pre-seed, all the way to distressed companies and in the middle you have all kinds of stages that I can delve into a little bit more but it encompasses a wide range of the economy. It concerns all kinds of companies that a private equity investor will invest in with private money as opposed to by buying a stock listed on the stock market.
2/ What are the major differences between Venture Capital and Leverage Buyout?
The difference between leveraged buyout and venture capital has to do with the stage of maturity of the company that is being purchased. Venture capital is typically more early-stage less mature companies that may not have revenues or profitability yet. Whereas buyouts are going to be later stage more established companies that typically will generate positive cash flows and have a bigger size. The second key difference between venture capital and leveraged buyouts is the type of structure when it comes to financing the acquisition. Typically a venture company will only receive equity funding whereas the leveraged buyout will include some sort of leverage. Typically 50% of the acquisition could be financed by debt. The reason is that the company cash flows can justify such leverage and it enhances returns and also reduces the tax bill.
3/ What are the main risks related to these two types of investments?
Private equity as a whole is called a risky asset class for two reasons : the first one is it's illiquid. So compared to a stock that you buy on the stock market you cannot sell it every day. The value creation will happen over time typically three to four years and that's what we call risk. I like to think of risk premium because private equity is very focused on its investments and as a result you justifies an illiquidity premium, which means the investor will get a higher return for the risk that he takes. The risk being again related to this illiquidity. Other than that I think that the risk will be attached to the fact that if you invest in a fund you don't have any influence, you are a passive investor. But if you invest directly in a company you have more control over what's going on in it, the risk will be more related to the fact that it's illiquid compared to a liquid asset class.
4/ What explains the attraction of investors to this type of investment?
Private equity has been even more attractive since the financial crisis. The simple fact that he has performed very well, better than the stock markets with less volatility and more consistency in its performance. As a result of course as the interest rates have been gradually going down and the yields have come down across many other asset classes private equity has attracted more interest. It has performed very well and continues to do so despite the financial crisis
5/ What are the current market developments for Private Equity?
Private equity in Luxembourg has been growing steadily just like the rest of the market. What we've seen, with the advent of more regulation, is the move towards more front office functions and beefing up the teams of the private equity firms that have been present here traditionally. Which helps us a lot because it creates jobs and also requires more sophisticated skills. More generally as the industry is growing very fast it calls for more attention and more oversight on behalf of the investors and the regulator's. We have to keep up with the success and make sure that it continues whatever happens on the macro level in the economy. Another major trend affecting private equity in Luxembourg positively is the advent of new types of investors as democratization is happening and private equity is available to a broader range of investors. I would like also to mention private banks who are very present here as well as family offices were increasingly present and important for the asset class. These trends are very important for the future.