Private assets

Private equity and venture capital: a growing sector

January 30, 2025 - 5 min read

Private equity is a form of investment that has been around for over a century, originating from the industrial revolution. Initially, wealthy families contributed funds to transportation projects, but today, the sector has expanded to encompass a wide array of investment types, with total assets under management surpassing $4 trillion globally.

What is private equity?

Private equity refers to capital invested in private companies in exchange for equity or ownership stakes. Unlike publicly traded companies, these businesses are not accessible to the general public. Private equity capital primarily comes from institutional and accredited investors who adopt a long-term and often illiquid approach. The most active investors in this domain include pension funds, endowment plans, and family offices.

Private equity vs. venture capital

While private equity investments typically target larger, more mature businesses with established financial records, venture capital focuses on early-stage companies with significant growth potential. Venture Capital (VC) investments are characterised by iterative rounds of financing, whereas private equity firms usually acquire controlling stakes and employ financial engineering strategies to enhance value.

The history of private equity

The history of private equity is rich and varied. It can be traced back to the dawn of the industrial revolution, when wealthy individuals financed railroads and industrial ventures. The first major buyout transaction is widely considered to be J. Pierpont Morgan's acquisition of Carnegie Steel Company in 1901. The industry saw the establishment of the first venture capital firms in the 1940s, and the 1980s marked a significant era of leveraged buyouts. However, the junk bond crash in 1989 led to regulatory changes to curb risky practices. The post-financial crisis period starting in 2008 has seen a resurgence in private equity, driven by investor demand for higher returns.

Private equity investment strategies

Private equity encompasses a variety of investment strategies, each tailored to different types of companies and investment goals. Here are the main strategies employed in the private equity sector, along with their respective risk and return profiles:

Buyouts
In a buyout, an investor or a group of investors acquires a majority or complete ownership of a company. This often involves leveraging debt to finance the acquisition, allowing investors to maximise their returns on equity. Buyout firms typically seek to implement operational improvements, streamline management, and enhance financial performance. The investor often takes an active role in the company's operations, sometimes replacing the existing management team. Buyouts represent the largest segment of private equity, significantly impacting the overall performance of the asset class.
Risk/return profile: Buyout funds have generated strong and steady returns in recent years, with smaller buyout funds often posting the highest returns due to lower initial purchase prices.
Growth capital
Growth capital investments target relatively mature companies that are looking to expand but may not yet be ready for a buyout. These companies usually have established business models and a proven track record but require additional capital for development initiatives, market expansion, or product launches. Unlike buyouts, growth capital investments typically involve acquiring a minority stake in the company, allowing existing management to retain control. Investors focus on supporting growth strategies without taking an active operational role.
Risk/return profile: Growth capital investments carry moderate risk, with returns generally lower than buyouts but higher than public market investments, reflecting the potential for growth.
Turnaround investments
Turnaround investments are aimed at companies that are underperforming or facing financial difficulties. The strategy involves acquiring these distressed companies at a lower price and implementing changes to improve their operations and profitability. Investors in turnaround situations often bring in experienced management teams or consultants to help restructure the business, reduce costs, and revitalise the company.
Risk/return profile: Turnaround investments can be highly rewarding if successful, but they also carry significant risk due to the uncertainty of turning around a struggling business.
Funds of funds
Funds of funds are investment vehicles that pool capital from investors to invest in other private equity funds. This strategy provides diversification by giving investors access to a range of underlying funds and investment strategies without needing to conduct extensive due diligence on individual funds.
Risk/return profile: While this approach reduces the risk associated with investing in a single fund, it typically involves higher fees and results in lower overall returns due to the double-layered fee structure.
Secondary investments
Secondary investments involve purchasing existing stakes in private equity funds from other investors. This strategy allows investors to gain exposure to private equity without committing capital to new funds. Secondary investments can provide liquidity to original investors looking to exit their positions before the fund's maturity.
Risk/return profile: These investments tend to carry lower risk as they are based on established performance records of the underlying funds, but returns can vary significantly depending on market conditions at the time of purchase.
Venture capital
While often considered a separate category, venture capital is a key strategy within the broader private equity landscape. Venture capital focuses on investing in early-stage companies with high growth potential. These investments are typically characterised by multiple rounds of financing as the company progresses through various growth stages.
Risk/return profile: Venture capital offers one of the highest potential rates of return, particularly for early-stage investments, but it also carries a high level of risk, as many startups may fail.

Each of these strategies carries different levels of risk and potential return, making them suitable for various investor profiles. Understanding these strategies is crucial for investors looking to allocate capital in the private equity space, as they can tailor their investments according to their risk tolerance and desired outcomes.

Why invest in private equity?

Investing in private equity offers several compelling advantages. First, it has the potential for high absolute returns, as investors aim to buy low and sell high by improving the value of acquired businesses. Second, private equity provides portfolio diversification, with exposure to unlisted companies that typically exhibit low correlation with public markets. This characteristic is increasingly attractive to investors seeking to enhance returns while managing risk.

In conclusion, private equity has evolved into a crucial component of institutional investment portfolios, appealing to those looking for significant returns and effective risk diversification in a dynamic economic landscape. As the sector continues to grow, it is also currently opening to retail investors, as favourable regulations across the world are pushing to inject some degree of private assets into wholesale and retail portfolios to help finance the real economy while offering diversification and attractive returns to investors. This trend, know as the democratisation or retailisation of private assets – is expected to further boost the development of this asset class.

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