Understanding Private Equity and Alternative Investments

By FBNQuest

Although there are a variety of options for raising capital and attracting investors, equity is one of the two most sought-after options.

It allows a company to give a share of ownership of its business to an investor in expectation of a return as the business grows. Unlike public equity (stock market) with ownership of shares in a public company, private equity (PE) simply means ownership of shares in a private company.

Private equity is a type of capital investment (asset or security) made to (target) companies that are not publicly traded on a stock exchange.

As an alternative form of private financing, private equity allows investors directly invest in companies through which such investors gain an ownership stake in the companies. Investors seek PE funds to earn returns that are considered to be better than those from the public equity markets.

To avoid debt, companies can sell their stocks to raise money that can be used to fund new technology, make acquisitions, expand working capital, and fund projects geared towards business growth.

Usually, the financial information on stocks of such a company is not disclosed to the public, rather, an investor can only speculate on the asset worth of the intending company.

Private equity involves three parties: the investors who supply the capital, the private equity firm that manages and invests the money on behalf of the investor via a private equity fund, and the company (known as Portfolio Company) that the private equity firm invests in.

A private equity firm’s ultimate goal is to sell or exit portfolio companies to deliver superior returns (above the benchmark return also referred to as Internal Rate of Return (IRR) to earn carried interests).

The most widely adopted investment strategies by PE investments are leveraged buyouts (LBOs) and venture capital (VC) investments.

In LBOs, a PE firm will raise debt from institutional investors on the back of a target company and assume control of the target company, while using the cash flows of the target company to pay the acquisition capital. Whereas, the VC makes investment in young and fast-growing companies in an industry that has the potential for exponential growth while adding value to the firm being taken up. In some cases, PE firms grow and improve a middle-market company with the aim to sell or exit to a mature company within a specified period.

Generally, private equity firms are active investors who are involved in the board level and monitor the financial and operating performance of portfolio companies.

However, some private equity firms are involved in the day-to-day operations of portfolio companies and may take C-level positions such as CEO, CFO, CIO  and  COO  to ensure that value creation initiatives are implemented in the portfolio companies to ensure that increase in revenue, improvement of operational efficiency and corporate governance.

A private equity fund is typically opened to institutional and accredited (individual or business entity) investors who invest large sums of money for a long period.

Institutional investors are companies or organisations like endowment funds, commercial banks, hedge funds, mutual fund managers, and insurance companies that invest money on behalf of other people.

Accredited investors on the other hand are individuals or a business entity that invest based on their income, net worth, asset size, governance status, or professional experience. The reason is that private equity as an asset class is generally illiquid and has a long lock-up period and only ideal for investors with a large asset size (or AuM).

Other alternative investments include infrastructure assets, art, antique furniture, automobiles, real estate, commodities, exchange-traded funds, and hedge funds.

The market performance of traditional investments and alternative investments are independent of each other, hence, the inclusion of alternative investments in a portfolio can reduce its risk through diversification.

Before the coronavirus outbreak, PE investments in Nigeria have been flourishing and as a result, in 2019, Nigeria was described by the African Private Equity and Venture Capital Association (AVCA) as one of the most attractive destinations for PE investments. Between January and February 2019, PE in Nigeria recorded investments worth N277.64 billion ($767 million), an improvement of 345 per cent compared to   N62.37 billion  ($172 million) worth of deals closed during the corresponding period in 2018.

The deals within the first two months of 2019 included the 100 per cent acquisition of Chi Ltd by Coca-Cola Company for the sum of $500 million, which accounted for 65 per cent of the total private equity investments within that period.

Other notable deals included Access Bank Plc’s acquisition of Diamond Bank Plc, the Partech- led Series A funding of Kudi, a financial services provider, and the acquisition of Wakanow, a travel agency, by the Carlyle Group valued at $40 million, to mention a few.

Why invest in private equity?

Private equity firms have grown over the years to become attractive investment vehicles for wealthy individuals and institutions who manage large pools of capital.

PE often guarantees better returns compared to other investments, with some private equity managers outperforming the public markets.

To diversify holdings, investors turn to private equity for higher returns than do public market. Specifically, such investments are for investors who can afford to have capital locked up for long periods.

Investors in private equity funds are called limited partners. As a limited partner, you get a return on your investment when the private equity firm sells the company it purchases while the private equity firm (also called general partners) takes some percentage as profit.

In Nigeria, different PE firms like FBNQuest Funds have their specific deal sizes, investment horizons, sector focus, fundraising timelines, and exit strategies.

As one of the leading alternative investments managers in Nigeria, FBNQuest Funds has been in operations for over 17 years and has invested in over 70 private companies through direct investing and their expertise and exposure to PE and VC Funds. Domiciled in Nigeria, the firm has investments in companies in Nigeria and other countries within the Sub-Saharan Africa region.