Private Capital: An Investment Strategy for a Volatile Market
Amid uncertain equities markets, there is an investing strategy that makes some of the potential advantages of traditional private equity available to individual investors.
Nov. 14, 2024 – Publicly traded markets have been setting new record highs and just hit its two-year bull market anniversary.1 Many investors may be wondering if this can continue and if they should diversify their portfolios. Traditional private equity (PE) is one possible option, but it often feels like an exclusive club that most people can’t join. In the past, only institutions and accredited investors, like high-net-worth individuals, could access the category. That’s understandable — traditional PE is a complex category, and it can entail additional risks. But PE has performed well over the past 15 years. These strong returns — and improving economic conditions — have attracted more capital. A 2024 Nuveen Global Institutional Investor Survey found that 81% of institutional investors plan to increase or maintain private equity allocations in the coming year.2
If your clients are individual investors, they may feel as if they’re missing out. And if they’re only investing in public companies, they are missing out. To help put this into perspective, as of 2023, there were approximately 4,300 listed companies in the U.S., compared with more than 370,000 private companies.3,4 You can read more about it in previous blog post.
However, there are differentiated private equity strategies that provide this access to everyday investors.
The Basics of Traditional Private Equity
Because traditional PE has been difficult for most individual investors to access, many aren’t up to speed on the basics of the asset class. (Why would they be?) But as new options emerge, it’s worth discussing how traditional PE works.
Big picture, private equity is the investment of capital into a private business in exchange for ownership of that business. Typically, those investors’ positions are bundled together in a fund, which is run by a private equity firm.
The goal of most traditional PE firms is to buy companies, make improvements to increase the value of those companies, and then sell them in typically seven to ten years. Private equity strategies come in many forms, but broadly, there are three main types of strategies that are associated with traditional private equity:
Venture Capital – Venture capital (VC) typically focuses on companies in the very early stages of their life cycles, or “start-ups,” with the hopes of long-term growth. Companies at this stage may have shown initial promise but may not be as established and are usually seeking substantial dollars for the first time. In many cases, they tend to have a narrower focus, with portfolios concentrated in one industry, such as technology.
Leveraged Buyouts – Leveraged buyout strategies (LBOs), which are the most synonymous with the term PE, rely heavily on debt to acquire controlling stakes in a company. Typically, the debt component of an LBO will be 70% to 90% of the purchase price.5 While leverage can increase gains, it can also increase risks, particularly during a downturn. And many LBOs focus on turnarounds to reorient a struggling business.
Growth Equity – Growth equity is typically viewed as a “bridge” fund between venture capital and leveraged buyouts. It looks to acquire growth-stage businesses — with more historical financials than a VC, but less than LBOs. It will seek either a minority or majority ownership across a variety of industries and leverage amounts.
For individual investors, traditional private equity has downsides as well. Risk levels can be high, and funds often don’t start generating income or making distribution payments for several years after investors commit their funds. Additionally, investors typically pay management fees on the full capital amount committed starting on day one, even if the fund only invests a portion of the capital in the first year (resulting in a phenomenon known as the J-curve). And fees can be steep.
For individual investors, these risks are why traditional private equity has been limited to accredited investors, who must meet certain criteria in terms of their income level, net worth, or financial expertise.
Private Capital
- Private capital includes both debt and equity, so it offers the potential for income and growth. (Traditional private equity, in contrast, doesn’t deliver returns until the portfolio companies are sold and the investors are paid off. Additionally, there is no income component.)
- Private capital focuses on established, durable companies that are growing rather than trying to execute turnarounds on struggling firms. It seeks majority control (which means the fund’s managers can make the changes needed to improve performance) without taking on excessive leverage (so that companies aren’t burdened by excessive debt loads).
- The companies’ management teams remain in place and have skin in the game, so their interests are aligned with those of the private capital managers.
- Finally, there are lower minimum investment amounts and greater transparency. To be clear, while private capital may be lower risk than traditional private equity, it is still considered higher risk than stocks and bonds.
1 Nicole Goodkind, “Wall Street’s been on a two-year tear. Can the party last?” CNN, Oct. 15, 2024.
2 Equilibrium: 2024 Global Institutional Investor Survey, Nuveen. Results based on survey of over 800 institutional investors, conducted in October – November 2023. Institutional investors invest with strategies, terms and conditions different from those of individual investors, who typically have a shorter investment time horizon, possess lower risk capacity, have greater liquidity needs and pay higher fees and expenses for retail offerings.
3 “Private, U.S. parent companies,” Dun & Bradstreet. Data as of Nov. 9, 2023.
4 “Listed Domestic Companies, Total,” World Federation of Exchanges, 2023.
5 “What Is a Leveraged Buyout?” Shopify, Nov. 2, 2022.
Represents CNL’s view of the current market environment as of the date appearing in this material only. There can be no assurance that any CNL investment will achieve its objectives or avoid substantial losses. Diversification does not guarantee a profit nor protect against losses.
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