Private equity, like other alternative investments, has historically been associated with institutional investors and ultra-high-net-worth individuals. But like so many things, as we near the end of the second decade of the 21st century, private equity as an asset class is rapidly evolving. Products and platforms in today’s capital markets can offer retail investors cost-effective, transparent access to institutional-quality, income-producing private equity alternative investments.
Furthermore, this new frontier is opening just when the market downturn we experienced in early February reminds retail investors of the importance of diversifying their portfolios with alternative investments that can help them weather market volatility. While traded equities have enjoyed outsized performance the last few years, private equity have produced higher returns in the long term. Over the 10, 15 and 20-year periods ending September 30, 2017, the Cambridge Associates U.S. Private Equity Index, a benchmark measuring U.S. private equity performance, achieved higher annualized returns than certain major indices such as the S&P 500 Index, DJIA, Nasdaq Composite Index among others according to Cambridge Associates data.
This is good news for retail investors, but like any new frontier, careful planning, leadership teams, and due diligence are required in order to avoid potential pitfalls as investors explore private equity opportunities. Different types of private equity investments carry varying levels of risk. Today’s retail investors are presented with private equity opportunities from a broad array of firms in the marketplace, including alternative asset managers, holding companies, and managers that focus solely on private companies and private debt strategies.
When investors and their investment advisors are inundated with opportunities and proposals, it can be tricky to identify the most promising and least risky investments before them. Below are some suggested best practices and due diligence tips that retail investors and their advisors can keep in mind when considering whether or not to invest in private equity, either through direct investments in a company or through products tied to private equity funds.
- Income-Producing Companies are Less Risky than Startups: If a company seeking private equity capital is already past the startup and research-and-development (R&D) stages of development and already produces a current and sustainable yield, then investors are more likely to begin receiving steady income as a return on their investment right away. Startup companies, and those still stuck in the R&D phase, by definition haven’t proven themselves capable of producing income or achieving their goals for growth. Investors may have to wait years before a startup or R&D company begins generating income and delivering distributions.
When considering an investment in a more mature company that already produces income, investors and their investment advisors should think about the company’s susceptibility to industry disruption and market downturns. If a growth-oriented, income-producing company offers necessities such as waste management or healthcare treatments, then the company is less likely to suffer during recessions. Also, if the industry in which it operates has high barriers to entry, then the company is less likely to be disrupted by up-and-coming competitors.
- Capital Should Be Put To Use: Investors and their investment advisors should ask how fast any investment they make will be put to use. The faster that private equity capital is invested in an income-producing company, the faster investors may begin receiving distributions—and, potentially, the faster the investment target’s cash flow can increase which could lead to higher returns. Of course, there are risks with any investment and no guarantees of profit or distributions; and there are diversification risks associated with making your investments during any one time period.
- Make Sure a Company’s Management Team/Operating Partners Will Remain Post-Acquisition: No company can grow into a successful, income-producing business ready for more growth without the expertise and leadership teams of competent managers or operating partners. If a company with a growth strategy will wind up losing the management team or operating partners who helped position it for growth in the first place, then questions could be raised about its future prospects. Steady leadership by executives intimately familiar with a company’s business, mission, and operations is key to the business’s continued success. Therefore, retail investors and advisors should find out whether or not a company’s management team and/or operating partners will stay on, or maintain a minority ownership stake, following an injection of capital from a private equity firm/fund.
- Seek Out Transparent Reporting: Investors and advisors evaluating private equity opportunities should conduct due diligence on alternative asset managers offering to facilitate the investments. As part of this due diligence, they should make sure that they will be able to keep tabs on their portfolio through frequent reports from the asset manager. These online or print reports should provide a complete picture of the company’s business operations, cash flow, and revenue as well as performance.
- Remember to Conduct Due Diligence on Third-Party Service Providers: Due diligence on companies seeking private equity capital, and asset managers offering access to private equity investment strategies isn’t enough to protect investors. Third-party service providers to the company and the asset manager should also undergo due diligence to ensure they are taking care of and comply with industry regulations and adhere to cybersecurity protocols. Even the slightest regulatory or cybersecurity breach at a third-party provider connected with an acquisition target or asset manager can put an investor’s confidential information, as well as their investment portfolio, at risk.
Private equity investment strategies can potentially bring retail investors consistent and risk-adjusted returns over the long term and also help protect their portfolios during downturns. As long as retail investors and their advisors conduct the same level of rigorous due diligence on private equity investments/acquisitions as they do on other prospective investments and strategies, they have the possibility to enjoy the benefits of cost-effective, transparent access to additional income and diversification while also giving American companies the support they need to expand.
Jeffry Schneider is a Strategic Advisor of GPB Capital, a New York-based alternative asset management firm focusing on acquiring income-producing private companies. GPB Capital provides their portfolio companies with the strategic planning, leadership teams, managerial insight, and capital needed to enable strong businesses to work towards the next level of growth and profitability. As Strategic Advisor to GPB Capital, Jeffry Schneider works with GPB Capital’s leadership teams to guide and improve the organization’s worldwide marketing and distribution strategies. Jeffry Schneider is also the CEO of Ascendant Capital, LLC, a branch office of Ascendant Alternative Strategies, LLC (“AAS”), member FINRA/SIPC. AAS is the exclusive distribution partner for, and an affiliate of, GPB Capital Holdings, LLC (“GPB Capital”).