Introduction to Private Equity: definition, main strategies, pros and cons

Investment in PE (Private Equity) consists in temporarily purchasing a stake in a company, that is, purchasing the total or partial stake in a company for a period of more or less three to five years and then divesting it.

In this journey, obviously, the aim is to generate value for the shareholder: buy at a value and end up selling at a higher value for investors to obtain that return.

The medium/large market is more habitual, traditionally Private Equity was mainly aimed to large companies, but in recent years there have been certain funds that are focusing on smaller companies and end up covering a range of different sizes. Now, there are funds that invest in companies with a turnover of €10 million and others that invest in companies with a turnover of €10,000; the range is immense.

For example, the purchase of MásMóvil by a syndicate of funds or, right now, there is a tender offer for A+ by another group of funds. The reason is that funds have increasingly raised more money, investors have gained a lot with Private Equity funds and further funds are being raised and ending up in very large companies. Any or almost any company, of any size, at the top and the bottom, can be potentially purchased by a Private Equity fund.

Private Equity is special; it is the great unknown in the world of investment. Everyone sees the option of investing in construction or the stock market. However, when you see the long-term returns, and you compare the profitability between the stock market and private equity, the latter has always obtained higher returns.

It has a major advantage: it is the asset with the best risk-return balance. But it has two problems: access and investment time horizons.

As regards the first, whereas investing in the stock market is as easy as going to the bank and purchasing, for example, Telefónica shares, investing in private capital has not been so easy. Although platforms like Crescenta resolve this.

The second issue is that it is a longer-term investment, that is, it is an investment with a time horizon of "X" years, so it is an illiquidinvestment. It is true that it can be sold in secondary markets, but that is an option that is something that has happened more in recent years, so people see it more as an illiquid asset.

Reality is that it is currently a much more profitable asset than others, and it solves the two issues it had. Illiquidity is resolved with secondary markets, and access is resolved using platforms such as Crescenta.

In fact, large institutional investors such as the universities of Harvard, Yale, etc., which are the investors that obtain the highest returns in the world, have a considerable part of their investments in private capital, in both PE and VC (Venture Capital)… Therefore, there appears to be a clear correlation between investors that achieve the highest returns and those that invest in private capital.

Yes. Private Equity, due to its illiquid nature, can be employed as a long-term savings tool, but you have to consider your investment strategies and somehow separate the concept of investment from expense.

If you are a disciplined investor, what you should do is invest part of your assets in the long term, with very high returns, in private equity. On the other hand, you should invest in shorter term investments, that is, liquid assets such as fixed income or equity, which will have lower returns, but provide the liquidity you need. A disciplined investor should structure their investment portfolio with a part of illiquid investments in the long term and another part of liquid investments in the short term.

However, truth is that in Spain many people do not follow this strategy; the financial culture in Spain is not as developed as in other countries, and I believe that platforms like Crescenta help people gain access to this long-term strategy.

In Spain, the long-term investment strategy is in real estate, but it has pros and cons.Ideally, you would build a portfolio with real estate, private capital and stock investments, a diversified portfolio in which each asset has its pros and cons.

It seems simple, but it is actually more complicated: it is buying something that is cheaper than when you are going to end up selling. So what is the secret? Obviously, everyone tries to buy as cheap as possible and sell as expensive as possible, but the real secret is in creating value.

How is value created? There are several levers. One is that the company continues to do what it is already doing, but better. For example, you get involved in a medium-sized enterprise that has not implemented best practices and starts to operate. The fund will bring discipline, thanks to its experience.

Another lever is creating value by getting involved in new businesses. For example, you get involved in a wholesale distribution business and the fund's strategy is to get into retail distribution. You enter a new business, create a lot of value and the company that invoiced 30 with this strategy now invoices 60.

Another lever, which is quite typical, is internationalisation. Often companies tend to remain in their markets. However, funds have the mindset of saying “Hey, if you have a fantastic product, why not go to Germany, Switzerland or the United States”. This creates a lot of value, because if you are in a local market and invoice 10, when you enter the global market, you will enter another world.

The fourth is acquisitions, the “buy and build” strategy. It consists in, for example, a sector where there are several small companies and we initiate a concentration process to build a larger company. There are many examples of very beautiful projects. Funds work hard to identify fragmented sectors to initiate a value creation strategy and create a larger company that is obviously worth more than a group of small companies.

If you are going to buy a company that costs €200 million, the logical way of investing is with relatively low tickets through a fund. In a fund there are investors (LP) that invest in the fund and there is a manager called GP that manages the fund.

It is a mixed structure, where there is a manager and the money, although the managers usually also invest their money. This is why when we see in the news that an American fund has bought a company, it is the fund's manager who makes the decisions, with the money contributed by investors. When the company is sold, the investors are returned their money.

Of course, the manager will charge their success fees based on the success of the transaction. The investor's return is also very much related to the managers' returns, that is, all parties are incentivised to make projects perform well, and there is an alignment of interests that is a key factor in this business.

This content is merely indicative. This content is merely financial training offered to you by Crescenta, without the intention of giving any type of personalised investment recommendation.

It is neither any type of advertising of financial instruments nor a recommendation or purchase offer.