Are you invested in private equity? If the answer is ‘no’, then you are probably forgetting about your life savings.
Quietly, private equity has spent 40 years transforming from the corporate raider image, embodied by the fictional Gordon Gekko into a trusted longterm investment manager, attracting sovereign wealth funds and pension money. Today, pension funds are among the leading investors in privately-owned companies. A trend dubbed the democratisation of private equity – we are all invested now.
Since the 1980s the number of publicly listed companies has decreased by half, while the number of private privately-owned companies have increased dramatically, overtaking listed in 2007.
This is because many executives opt to avoid the arduous and expensive task of running a publicly listed company. Companies these days also spend far longer growing before they list. For example, before Google listed on the public market back in 2004, it received just US$40 million (£31.2 million) from venture funds and other private backers. In contrast, today, companies like Airbnb and Uber receive billions of dollars from these private markets before listing.
Eli Talmor, Professor of Accounting and founder of Private Equity at LBS, (main image, left) has had a ringside seat during the growth and professionalisation of private equity. He sees the subject area as a complete business education, that draws together a number of core skills combined with active leadership and deal making.
Together with Florin Vasvari, (main image, right) Professor of Accounting and Chair of the Accounting Faculty, they have condensed their wisdom on this central tale of capitalism into Private Capital – Private Equity and Beyond. Under the banner of ‘Private Capital’ they have drawn together all the ways a company can find private backing before it goes public including angel investing and crowd funding.
They spoke to Think at London Business School about how the industry has evolved and what they hope to achieve with the new double volume.
Is the story of private capital all about superior fund performance?
Florin Vasvari (FV): I think it is both performance and diversification. Certainly performance historically has been superior, but when people are looking at their portfolio it is not just about performance, but also diversification. The extent to which the returns on private equity investments are correlated or not to the returns of other asset classes is as important.
Eli Talmor (ET): Private capital is about tapping the private sector - the biggest part of the universe. Private capital is about diversification, performance in contrarian times and it is about better governance. So, the arguments are, actually, way beyond fund performance.
How have private markets grown?
FV: Private equity has two beginnings. One was the venture capital industry that created Silicon Valley, and the other branch, which was born on Wall Street. This was the opportunistic branch that started, in the early 80s, to take over companies using a lot of debt that was available. That's why the buyout side of the industry had earned a bad reputation by the late 80s. They were the Barbarians at the Gate that made excessive use of debt to acquire companies.
They called it multiple arbitrage, buy low, sell high. There was a lot of excess, but lenders are much more regulated now. You won’t see structures where 90% is financed with debt and the rest is from a buyout fund. Today it is usually 50:50, if not less, in fact, in emerging markets few use debt at all.
Asset managers are expected to diversify their capital across many asset classes. Private capital is one of those asset classes and private capital provides many sub-strategies. It’s private equity, it's real estate, it's infrastructure. So, there are many ways of diversifying even within the private capital market.
At the very basic level, if you are a big manager investing a pension, you want exposure to public markets, but also to the private economy, and sometimes the only way you can achieve that is by investing in private capital funds.
Private equity funds, in particular, have become so big and so influential, that they had been delaying the listing of a lot of companies. These funds allow the entrepreneurs to stay private and not worry about compliance risks, liability risks, analyst expectations and short term expectations. This is a massive trend, not just in the US, but globally.
Having said that it is important to put private capital in perspective. BlackRock is the largest asset manager in the world. At the moment, they manage close to US$7.2 trillion. Now, if you look at private equity, which is within the private capital market, it manages just US$3.6 trillion. The entire global private equity industry, including its dry powder (unallocated cash), is half the size of the largest public fund manager in the world.
Should the public care about what goes on in private markets?
ET: We are all exposed to private capital. If you have a pension or life insurance, you are exposed. Some call it the democratisation of private capital.
FV: The biggest investors in private capital funds or global alternative asset managers as they are now known are the pension funds and sovereign wealth funds, and this is a change which has come about in the past 10 years.
Instead of buying mature companies via private equity funds, they started to (1) buy real estate and infrastructure assets via dedicated private capital funds that focus on these types of assets or (2)lend to private companies via private debt funds. So we have infrastructure private equity funds, real estate private equity funds, natural resource funds as well as credit funds. The common denominator in all of these private capital funds is that they are closed-end funds that lock investors’ capital for long periods of time, usually 10 years.
How much has changed because of the 2008 crisis?
FV: On the private credit market side, everything. Private debt funds have grown three times since the credit crisis, because they have been replacing the banks. Banks are not incentivised to lend to private companies anymore due to regulatory pressures. If a small private company takes a loan of US$100 from a bank, then the bank needs to set aside reserve capital for that loan in case it underperforms. Therefore, bank lending locks in a lot of capital,making it unprofitable to lend to small companies.