Private equity fund of funds are investment vehicles that pool investors’ money to invest in private equity funds. A fund of funds manager is, of course, important for the success of the fund of funds, therefore selecting a qualified fund of funds manager should be considered thoroughly.
There are three major qualifications to look at when selecting your manager: performance, management team, and the strategies and deal funds.
Performance Unlike traditional financial markets, the performance of private equity fund of funds is more difficult to analyze. This is because in private equity the investor must consider four elements: the internal rate of return (IRR), multiples, timing and return of cash. These all must be taken into consideration and weighted more or less equally when examining a manager’s global performance. Additionally, the private equity manager should have a proven long-term record, showing that he is capable of surviving good and bad financial cycles.
Management Team When performing due diligence on a fund of funds you should follow the basics that apply to other funds, and a consistent focus is on the management team and operations. This is a critical point for selecting a manager, while he is the head manager, his management team often decides the success of the fund. ‘Back office’ operations should be a big concern for investors, and as private equity evolves a greater transparency in the ‘back office’ is expected by investors. Overall, you should look for a coherent and competent team standing behind the manager.
Strategy In terms of strategy, many managers differ but the quality to look for here is clarity. A good manager can clearly and expertly explain his strategy to the investors. Specifically in the area of private equity fund of funds, a manager should have prior experience in private equity that has constructed his strategy.
Experience The popularity of fund of funds has led to the emergence of many “me too” funds that have little to no prior experience in private equity or managing a fund of funds. Proven experience in private equity or managing a fund is a big factor to consider when selecting a manager. Seniority often makes for a more knowledgeable and competent manager–although there are also very successful rookie fund managers–but also an experienced manager usually brings a strong staff that has confidence in the manager.
These are just some major points to consider when selecting a private equity fund of funds manager, but extensive interviews and research will ultimately weed out the less qualified managers and hopefully lead the fund of funds to success.
Tags: Private Equity Fund of funds, private equity funds, private equity funds of funds manager, private equity fund of funds management, selecting a fund of funds manager, private equity fund of funds selection
I’ve noticed in the private equity forum and from e-mail questions I have received, that there is a lot of interest on private equity in India. This is certainly warranted, as private equity in India has grown enormously in over the last few years. To address this I am first going to publish a list of private equity funds located in India, courtesy of AltAssets. Tomorrow, I will write an introductory guide to private equity investment in India.
Here is the list of private equity funds in India from AltAssets:
Tags: Private Equity India, Private Equity, Private Equity Investment in India, Private Equity Funds List, List of Private Equity Funds in India, Private Equity Funds List in India, India Private Equity Funds
A management buyout is when a company’s existing managers purchase a large or majority share in the company. This form of acquisition requires the managers of the firm to use a large amount of money, often this capital comes from private equity investors. In return for providing the capital, private equity investors receive shares of the company which will hopefully increase in value under the management buyout. Managers will take the company private to realize the company’s potential performance and possibly attract public investors later.
This buyout may be leveraged using debt or directly through the investors’ capital. The managers contribute too. Although they do not have the means that investors have, managers invest what they can to purchase a small share of the company. The terms of the contract varies between buyouts but the investors usually develop an exit strategy of 3-5 years. The primary goal is the same for managers and investors: to increase profitability. Management buyouts can be risky for investors and the managers too but if it is successful both parties often net huge gains.
Africa is developing good governance and bolstering financial institutions to attract private equity investment.
There are obvious problems preventing private equity in Africa most importantly stability. However, private investment has increased especially this decade with Asian investment strengthening the continent’s economy. Until Africa can modernize its financial sectors with heightened regulation and political reform, private equity investment will realize its potential. The following two part video explains the developments that are taking place in Africa and what to expect in the future:
Carried interest is the percentage of profits that the general partners of a private equity fund receive as an incentive for good performance. The carried interest compensation typically ranges from 20-30% of profits which is a substantial amount of money for the fund’s investors.
Private Equity Carried Interest
A private equity fund is a partnership created to obtain a significant (often majority) stake in an expanding or underperforming company. Outside investors, the limited partners, provide most of the funding capital typically 90-97%. The remaining funding of 3-10% is provided by the general partners of the fund who in turn receive management fees. The typical compensation set up for private equity fund managers is 1-2% of the total fund assets and the carried interest. This arrangement is often very beneficial for the manager and serves as a method for investors to motivate and reward good performance by the general partners.
Carried Interest Tax
There is a large amount of controversy surrounding the taxation of private equity carried interest. Currently, carried interest is taxed as long-term capital gains but advocates for private equity tax reform would like carried interest to be taxed as ordinary income. The change would raise taxes for carried interest from the current 15% to as high as 35%. The most recent attempt to alter the taxation of carried interest was proposed by Republican Senator Charles Grassley but private equity advocates challenged the proposal and it is unlikely that private equity tax reform will occur anytime soon.
Private equity and hedge funds have developed a strong relationship benefiting both partners. Private equity groups own many hedge funds and make long-term investments in hedge funds. Hedge funds have entered the private equity world too, joining with major players in the private equity industry to make large buyout deals. The attraction for hedge funds is the large amount of capital flowing into private equity from institutional investors and the hope that hedge funds can boost performance through buyouts. In 2006, the average hedge fund returned 13.9%, while the average buyout fund returned 25%.
Hedge funds aren’t limited to big buyouts, they have started lending capital to smaller startups and middle-market firms. The move to private equity is logical, hedge funds have always tried to capitalize on often risky opportunities to make money. However, the risk may be too great for hedge funds in private equity, because hedge funds are known for making short investments. Private equity buyouts and even smaller venture capital investments are typically longer investments. Another risk is the illiquidity in private equity, which may be a problem for hedge funds if investors want to cash out their investment. Hedge funds are not afraid of risk so the relationship between private equity and hedge funds will probably only grow stronger in the future.
The incredible economic growth in Asia has attracted many private equity investors, hoping to diversify their portfolio while taking advantage of the vast investment opportunities that the region offers. The boom is led by the emerging economies of China who the IMF predicts to have a 10-11% growth rate and India expected to grow at 8-9%. While both countries have some political restraints, reform is in process and investment has opened up considerably in recent years.
The primary draw for private equity investment in Asia is the impressive returns many private equity funds have enjoyed recently. In 2007, private equity funds in Asia received three times the capital invested. The struggling U.S. economy has inevitably marked a decline in Asian private equity investment for 2008. Despite this, the Asian markets remain strong ensuring that the region will be a critical location for private equity.
China has become the new frontier for private equity investors or private equity funds hoping to attract Chinese investors, also venture capitalists are staking their claim there. With a thriving economy and a booming financial expansion–thanks to a reformation of laws governing private investment–Americans in private equity hurrying to China is akin to miners in the Gold Rush. Today, I will look at some of the differences between China’s private equity and U.S. private equity.
Difference of Private Equity in China Whereas American funds tend to invest in middle-market or big businesses, China’s private equity funds are more like late-stage venture capital investors. Chinese funds look for proven businesses with established positions in the market, eliminating as much risk as possible before investing. Also, while American funds typically avoid the technology sector, China’s private equity funds strongly invest in tech areas like pharmaceuticals, agriculture and energy.
Instead of the big takeovers that America’s private equity is known for, most funds in China purchase only a minority stake in companies. This is because China’s entrepreneurs especially distrust investors and are unwilling to give up a majority share to outside investors. The size of investments tend to be smaller in China because the cost for expanding and operating a business is significantly less.
Tax and regulation reform have led China’s financial growth, and more changes for China’s private equity sector are in the works, making China a crucial area for American private equity investors.
Mezzanine financing refers to a combination of debt and equity financing. Mezzanine financing is typically used by expanding companies that need money but don’t want to go public and risk losing ownership of the company. Mezzanine lenders offer the company the desired funds and do not require collateral. However, mezzanine lenders charge unusually high interest rates (often 20-30%) because the risk for the mezzanine lender is very high.
In addition to high interest rates, mezzanine lenders can convert their loan to equity or ownership if the company defaults on the loan. So, although there is a major risk that the lender may lose a lot of money on the loan, the borrower also faces significant risk. Mezzanine financing particularly attracts privately-owned companies, because it is a way to secure funds from lenders that have no active interest in the company. The dual risks to the mezzanine lender and the borrowing company make the exchange much more involved and lasting. Thus, the mezzanine lender carefully looks to reduce risk by investing in an established, promising business. Companies hoping to attract mezzanine funding usually submit detailed proposals that assure the lender that the investment will be profitable.
Private equity firms will soon have to add another measure hoping to improve disclosure in the industry.
On December 1, the S & P will introduce a public ratings system for the companies that private equity firms buy, and the debt they use to finance the buyouts. Deals with debt between € 500 million to € 1 billion will have a private rating only available to the investors involved in the deal. This marks another in recent attempts to increase transparency in the industry. The private equity industry has responded by encouraging more openness among members.
U.S. private equity firms held strong in the first two quarters of 2008, only 3% behind last year’s performance.
Down 14 firms from this point last year, the 185 U.S. private equity firms managed to raise $132.7 billion in the first six months of 2008. Although the industry is declining, the number shows that private equity is still a large part of the economy.
Leveraged buyout fund-raising fell 20% compared to last year, but venture capital and mezzanine funds have countered big buyout’s weak performance. Venture capital fundraising increased 15% and mezzanine funds set a first half record of $24 billion (almost entirely from Goldman Sachs Capital Partners’ $20 billion fund).
European private equity also had a fortunate first half of the year, increasing %15 from this time last year.
The Private Equity Analyst is a comprehensive monthly print newsletter that provides news and information about all areas of private equity from venture capital to mezzanine financing. Started in 1988, the Private Equity Analyst has built a reputation as a top news source for private equity firms. Just one catch, a one year subscription is $1495!
Similar to an index fund, an exchange-traded fund follows an index or a commodity, but it is traded like a stock. The exchange-traded fund’s price varies throughout the day, and does not have a net asset value calculated at the end of each trading day. Most ETFs have been passively managed, but recently the SEC authorized actively managed ETFs. Benefits of an Exchange-Traded Fund
An exchange-traded fund is traded like a stock, so the investor can buy on margin or sell short. Plus there is no minimum investment required, so an investor can own as little as one share in the fund.
Like an index fund, many exchange-traded funds are passively managed, which reduces management expenses considerably.
Many investors love the diversification that an exchange-traded fund offers.
A private equity fund of funds pools capital from investors and invests in private equity limited partnerships.
Benefits of a Fund of Funds
Private equity investing is typically reserved to wealthy individuals with substantial money for investing, usually more than $250,000. Fund of funds require smaller investments and so present an alternative for smaller private equity investors.
Fund of funds offer the benefit of diversification by investing in a variety of different funds, and even different industries.
Disadvantage of a Fund of Funds
A fund of funds charge an additional layer of fees for the fund of funds manager.
The minimum requirement is still substantial and may be too much of a commitment for some investors.
A recent report on private equity revealed the most pessimistic outlook in five years.
Of 100 private equity executives Grant Thorton surveyed, 85% predicted deals would be smaller in the coming year. The majority of those executives also expect the number of deals to drop. Industry experts believe that this slump is a reflection of the credit crunch and declining economy.
The report was not all bad news, at least for the private equity-owned companies. 84% of the surveyed executives expect their portfolio to grow in the next 12 months, 34% predict major growth. Employees for private equity-owned companies also have some good news, only 2% of those PE executives plan to reduce portfolio company staff, rather the majority plan to increase staff.
With the crunch expected to last at least a year, private equity executives are taking a longterm view.
Private equity investors are a great source of capital for companies, here’s a profile of private equity investors.
Private equity investors are generally wealthy individuals who commit large sums of money to start-up businesses. Many private equity investors are successful entrepreneurs who offer small businesses helpful advice, experience, contacts and of course, money. Private equity investors search for companies with high-growth potential, hoping for high returns of their investments. A private investor is usually easier to attract than a venture capital fund. This is not to say that private investors will throw away their money, but with a good business proposal and some luck many small businesses have secured large investments this way. For small businesses raising capital, private equity investors can be a great alternative to larger venture capital and private equity funds
A leveraged buyout (LBO) is a hallmark of private equity firms, here is an explanation of what a leveraged buyout is.
A leveraged buyout occurs when a company acquires another company using a significant amount of borrowed money. The purpose of leveraged buyouts is that it allows companies to make major acquisitions without having to commit major capital. The company making the leveraged buyout will sometimes use assets from the acquired company as additional collateral on the loan. The rationale for a leveraged buyout is that financing a buyout through leverage creates potentially higher returns. Also, because income flowing to equity is taxed but interest payment toward debt are not taxed, the company making the buyout is able to pay a higher price.
There are some qualities that make a company more prone to a leveraged buyout:
Hard assets (used as collateral)
Minimal existing debt loans
Good history of consistent cash flows
Prime opportunities for increasing cash flows from operational changes
A private equity fund is a pooled investment vehicle that invests in unregistered equity securities. A private equity fund is managed by a private equity firm. The fund invests directly in a private company or “buys out” a public company resulting in a delisting of public equity. Capital investments from the fund are used to strengthen and expand a healthy business, or restructure the operations of an underperforming business. Private equity investors make a long-term commitment hoping for a reversal of a distressed company or an event that results in a liquidation of assets like the a big company purchasing the company or an Initial Public Offering.
Entities that buy illiquid stakes in privately held companies, sometimes by participating in leveraged buyouts. Like hedge funds, the vehicles are structured as private investment partnerships in which only qualified investors may participate. Such funds typically charge a management fee of 1.5% to 2.5%, as well as an incentive fee of 25% to 30%. Most private-equity funds employ lock-up periods of five to ten years, longer than those of hedge fundsDefinition Source: Hedgeco
Private equity fund of funds are investment vehicles that pool investors’ money to invest in private equity funds. A fund of funds manager is, of course, important for the success of the fund of funds, therefore selecting a qualified fund of funds manager should be considered thoroughly.
