Whether you are just getting started or are a seasoned investor, this guide offers deeper insight into the current private equity investment landscape, looking at global and South African trends and offering tips on how to find a firm you can trust.
Whether you’re a beginner or seasoned investor, you may be looking for that next opportunity to diversify and grow your assets. For many, that next step involves private equity investing and partnering with a trusted management firm. Private equity firms like IFSA serve as a trusted intermediary for investors looking for high returns with low market volatility. While not without risk, private equity can create unique value for investors that differ from traditional investments like publicly traded stocks, bonds and other funds. In this article, you will gain deeper insight into private equity investing and uncover top tips for partnering with the right firm.
What Is Private Equity?
Private equity is simply the ownership of a company that does not publicly offer its equity (does not offer its shares on a listed exchange). In exchange for capital, you receive a percentage of ownership interest in the business – usually through the purchase of shares in a private equity firm’s fund. For example, IFSA offers and manages two funds for potential investors. One fund prioritises businesses within South Africa and the other focuses on global markets. Naturally, private equity has a broad range of investment opportunities because of unique industry attributes and the different growth stages of target companies. You could have private equity in an established business with a long history of cash flow or in a more recently established entity looking for capital and rapid growth in an emerging market.The many types of private equity investments offer investors diversification opportunities – especially when working with a trusted firm to research and manage assets. Want to learn more about IFSA’s funds?Read our blog
How Does Private Equity Differ From Other Types of Investments?
Compared to standard investments in publicly traded funds, private equity stands out in the following ways:
- Longer investment timeline
- More direct control over the asset
- Heightened risk/reward structure
Private Equity Requires a Long Investment Timeline
Purchasing all or part of a small to medium-sized company is not a short-term investment. Most private equity deals operate on a five-to-seven-year investment return horizon. The reason being that the potential value from a private equity deal requires time to materialise. Interests in private companies are not as liquid as other investments because of the significant transaction costs and more limited market participants. The commitment and energy of the managing firm and other interested parties create the value of the company for future sale to another private party or public company. Their connections, knowledge and ability to originate a transaction lead to an eventual return on your investment.
An Opportunity for Personal and Direct Involvement with the Asset Company
Investments in public stocks and retirement pensions are truly passive, which means your involvement is often limited. Aside from the research and purchase of the asset, you have little interaction with the company. The relationships in private equity are different. You can have a more active role in the company (or at least have a more direct line of communication with those who have an active role in the company’s decision-making). For example, the managers at IFSA make a point of sitting on the boards of the companies within their funds. Another feature of private equity is that small companies have fewer employees and management. This translates to opportunities for more control over the direction of the company, which is why finding a trusted firm is paramount.
A Chance for Greater Returns with Added Risks
No investment is without risk, and the idea of a guaranteed return is nonexistent. Private equity deals are no exception. Several factors can influence the future success of small and medium-sized businesses. While analysts do their best to evaluate a company’s prospects during due diligence, they can’t predict the future. However, the upside of private equity investments is you can diversify into new markets and purchase a stake in companies with dynamic growth potential. You can also mitigate some of the risk in smaller companies by working with funds that prioritise low volatility and reasonable growth.
How Do Private Equity Investors Make Money?
They do so by selling their ownership interest in various SMMEs for a higher price than they paid for them. After the private equity firm receives its cut, the investors receive a share of the profits in accordance with the terms of their agreement. Most private equity investment agreements have a preferred return provision known as a waterfall.
Who Is Investing in Private Equity?
Private equity investments often require substantial capital. This means private equity investors are usually high-net-worth individuals, financial institutions, pension funds, and other organisations with extensive resources. These organisations also pool the resources of high net-worth individuals to attract deals that would otherwise be unfeasible as individuals. A recent article from Ventureburn shed some light on who has private equity investments in South Africa. The article referenced a survey on venture capital showing that most of the R1.23 billion invested in local startups during 2019 came from investors based in Cape Town. Additionally, the data shows the public sector holds a large position of active portfolios in South Africa (a total of 28.1 percent of portfolios, with deals valued at R1.75 billion).
How Popular Is Private Equity in South Africa?
The demand for private equity in South Africa and other African countries continues to increase. According to the global law firm White & Case, private equity in Africa saw record-breaking numbers in 2019 at the peak of an upward trend. Most of those investments were in companies focused on infrastructure (for example, utilities, transportation, healthcare, agribusiness and fintech). Combined, Nigeria, South Africa, Egypt and Kenya received 85 percent of private equity funding in the African region (equating to $1.7 billion). The Africa Report also published some data on the 2021 private equity landscape in Africa. That research showed a total of 600 firms are tied to investments on the continent. Of those 600, South Africa is home to 174 firm headquarters and regional offices. Regarding the amount of desired investment, the bulk of surveyed investors have shown a preference for deals in the ranges of $1 to 5 million, $5 to 10 million, and $10 to 25 million.
How to Choose a Private Equity Firm?
With 174 firms in South Africa, you may feel overwhelmed in reviewing and identifying your best fit.
Consider Your Portfolio Goals
The first step in selecting a private equity firm is to carefully evaluate your current holdings, your interest in private equity, and what you hope to accomplish. In most cases, every investment choice centres around the following objectives:
- Risk: The potential for your investment not to realise its anticipated gains through a future sale.
- Volatility: The day-to-day and year-to-year changes in the value of the investment.
- Return: The compared rate of return with alternative investment options. Are the firm’s investments your best bet?
- Liquidity: How fast can you sell your position if necessary (as mentioned above, private equity is a highly illiquid investment category).
- Taxes: Finding investments with varying timelines for tax events to reduce your overall tax liability.
No private equity investment will equally cater to all five objectives. The challenge becomes prioritising these goals for yourself in line with your current investments and financial needs. Informed by prior experience with investors, IFSA chooses to build its funds with assets centred on low volatility and reasonable returns. We do this by avoiding investments in risky startups. Instead, we carefully monitor the market for more established SMMEs that are beyond their initial growth phase. Our record shows that businesses in this position with strong leadership and positive results are ready for that next infusion of capital.
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Always consider your portfolio goals before choosing which private equity firm to work with. Look for Private Equity Firms with a Strong Reputation and Track RecordAfter identifying your wish list in a private equity firm, find a firm that has proven its ability to check off every item on that list. A strong reputation and proven track record are key. IFSA has continued to enjoy successes in South Africa’s private equity space thanks to the knowledge and experience of its managing directors. Each SMME presents its own challenge for taking that next step in its growth. At IFSA, we take ownership of that challenge by sitting on the board of directors of its investments and being a part of the solution. How do you know you can trust IFSA as your private equity investors?Read our blog
We serve on the board of directors of the businesses we invest in. This gives us a far greater ability to control outcomes.
We are active investors in our own funds. Without exception, we believe in putting our money where our words are.
We are people-focused. It gives us great satisfaction knowing that the value we add is changing people’s lives for the better.
We have found that the best way to mitigate challenges is to chase down the issue at hand and deal with it in the most direct way possible.
Invest in Private Equity Through IFSABy reading this article, you’ve taken a strong first step in understanding the rewarding world of private equity investing. The next step is to schedule a free consultation to further evaluate how our approach meshes with your objectives. We always welcome the chance to meet with investors looking for their next opportunity. IFSA (Pty) Ltd Registration No. 2000/005153/07 An Authorised Financial Services Provider Licence No. 43337