Lance Jenkins: Private equity investing offers rich return
Capital and support important given the large proportion of unlisted firms in NZ, writes Lance Jenkins.
As a private equity (private company) investor there are three questions I regularly get asked - what is private equity? Do we need private equity in New Zealand? And for an investor, how does it actually work?
What is it?
Private equity simply means the investment of equity capital in companies which are not listed on a public stock exchange.
Private equity investors, however, provide more than just capital, they also support a company's management team in developing and executing growth strategies over an extended period of time. We are, in essence, long-term investors and partners in private businesses.
Before any investment is made, private equity investors spend a large amount of time upfront working with management and owners to understand what they do, the industry dynamics and how value can be created for all partners.
Every investment made is based on a belief in the management team and a clear understanding of how our complementary skills can help them deliver on and execute their growth plans.
Research published last year by GE identified about 34,000 "mid-market" private businesses in New Zealand. Over two-thirds of these businesses saw growth as a key area of focus, but they also identified two hurdles to achieving and implementing those growth plans.
Succession planning, or having the capital to buy out retiring owners, before taking the business to its next stage of growth, was seen as a hurdle.
I would add to this hurdle that access to equity growth capital in general can be an issue for private companies. But regardless of whether a business is dealing with a succession issue, or looking for new equity to fund a growth opportunity, equity capital matters for private businesses. Private company investors such as Waterman Capital fill this need in the marketplace.
Another issue highlighted by a number of those companies was a concern that they may not have the internal resource or capability to execute on their growth plans.
Private equity investors offer "hands on help" to a company in complementary areas such as acquisitions and strategic planning which are clearly important to a growing business.
A key focus for us at Waterman is to work closely with the companies we are invested in. Unlike a public company investor, we can't just sell our shares in an open market.
We are partnering with management and owners to achieve the common goals of growth and value creation. Through equity investment, we share an alignment of interests that goes to the heart of success in private equity investing.
As partners, our job is to contribute to what a business is doing, in a supportive and value adding way. In addition to providing capital, we become another resource to help grow and develop the business.
Do we need private equity in NZ?
There are two perspectives to this question. Firstly the private company's perspective looking for capital and value add, and secondly from the perspective of the investor, who is looking at private equity as an investment opportunity.
In New Zealand, private equity has an important role to play in providing both equity capital and hands on help. The important point is that here in New Zealand we are different, because private companies make up a larger proportion of our economic and business landscape than in most other developed countries.
While the NZX has done a laudable job attracting quality companies to list, there is still a large under- representation of New Zealand's underlying economy in the public markets. It is for that reason that private companies matter more here in New Zealand than elsewhere and why private equity has a large role to play.
We are fortunate that our two largest institutions, the New Zealand Superannuation Fund and the Accident Compensation Corporation, have recognised both the need for capital in the private company space and the higher returns available to investors.
They have invested in NZ private equity and this funding allows firms such as Waterman to provide growth and succession capital to our private companies.
Having local private equity funds also gives New Zealanders the ability to invest in an asset class that is often difficult to access. For investors with longer time frames, it can be a rewarding experience.
The Australian/New Zealand returns data from industry benchmarking specialists Cambridge recently highlighted that over a 10- year period, private equity funds gave investors (on average) a return of 12.3 per cent per year, versus the NZX and ASX equivalents at 7.2 per cent and 6.6 per cent respectively. Interestingly, if you backed a private equity manager that ranked in the top half of its peers, then the return would have been over 26 per cent per year, or almost four times the listed market equivalent.
So how does it work for investors?
One of the unique aspects of investing in private equity funds is the "commitment" nature of the investment. Unlike buying shares, where you invest $10,000 in a company and pay the $10,000 at the time of purchase, when you invest in a private equity fund you make a commitment to that fund.
That commitment is called down (a "call" is a request for payment) over time by the manager as required, primarily when it finds a business to invest into.
By way of example, if you made a $10,000 commitment and the fund invested that money evenly over the next five years, you would be asked to put in about $2000 a year to fund that commitment.
As the 10-year Cambridge data highlighted, with private equity returns at almost twice that of publicly listed equities, it can be a very rewarding experience for investors.
So in summary, to answer our three questions.
Private equity exists to fulfil a need for both the equity capital required and the hands-on help needed in executing the growth plans of private companies.
This need is particularly relevant in a New Zealand context given the importance and dominance of private companies.
And finally, for investors with longer time frames, the returns can well be worth the wait.