The new face of private equity

From a misunderstood outlier to a key pillar of the business world, private equity has come a long way, writes Eli Talmor, professor and founder of the Private Equity Institute at London Business School.

Private equity has transitioned from being first described in the US as an industry of asset strippers and corporate raiders in the 80s and 90s to being labelled a locust and clumsy trick in Europe a decade later. This image changed during the global financial crisis when private equity and sovereign wealth funds were viewed as the only non-governmental pivotal forces if needed as investors of last resort.

Its expansion has been astounding; from $30 billion in 1992, the industry has grown approximately 200x in less than quarter of a century, and is estimated to triple further over the next 10 years. From being a small blip on the outskirts of alternatives, private equity has moved to centre stage of capital markets. With its long-term record of success and the unprecedented increase in allocation by institutional investors, the private equity model has earned an eminent standing.

In order to achieve its new status, private equity had to complete a transition from a modus operandi that focuses on financial repackaging to proclaiming growth and operational value creation as its core competence. New investment strategies have become more sophisticated, such as co-operation with strategic buyers through minority stake investments. Venture capital has also seen a rebound in activity with eye-popping valuations and the proliferation of unicorns around the world.

There has also been a massive expansion of private equity beyond its traditional domains of buyouts and growth capital to new types of assets. In particular, with the increasing limitations on loans by banks, private equity has strongly expanded into credit. In the new regulatory environment following the crisis banks have been unable to extend much of the corporate and transactional credits they used to serve. The huge void is being replaced with non-bank credit in which private equity firms play a key role. The overall growth into new sectors has reached such a magnitude that it now requires rebranding the industry from private equity to private capital to better capture this expansion.

The introduction of secondary transactions in private equity funds, with over $100 billion raised between 2013 and 2015 by secondary funds, has dispelled the perceived barrier to investing in the asset class, namely its illiquid nature. Furthermore, direct investing by in-house teams of institutional investors, the disintermediation and non-traditional structures, the so-called shadow capital and in particular co-investing, means private equity is already of a far greater scale than the $4 trillion oft referred to.

Private equity has become increasingly transparent, a blessed coming of age for the industry. This was initially aided by the granular disclosure by public pension investors and in recent years through an explosion of data provided by aggregators, integral analytic software systems and the prolific academic activity in the space. The Institutional Limited Partners Association released a disclosure guideline in 2016 on how fees and expenses should be reported, which is being fast adopted by the titan trendsetters of the industry. There has been a drive by the SEC to “spread sunshine in private equity” and we see far more regulation around the world – a trend that needs to be managed with caution and co-ordinated on a global level.

Is there a supremacy of private equity over its more mature sibling of listed companies? There is no real danger to the stock market. For all its hands-on engagement, in governance and operation, private equity is an expensive source of funding and as such should be transitional capital. The private and the public models will live side by side whereby companies occasionally migrate from one side of the pool to the other through buyouts, takeovers or IPOs. However, the powers are more balanced now.

Professor Eli Talmor will be speaking at the annual International Private Equity Market in Cannes, 25-27 January 2017.