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STRUCTURAL ADVANTAGES OF PRIVATE EQUITY VERSUS PUBLIC EQUITY

STRUCTURAL DIFFERENCE BETWEEN PRIVATE EQUITY AND PUBLIC EQUITY

WHAT IS PRIVATE EQUITY?

Private Equity (PE) is another source of investment capital that invests in the equity capital of privately held companies, I.e. companies that are not publically traded.  The term “private equity” denotes shares of owner‑ ship in companies that are not (or not yet) listed on a stock exchange. Private Equity actually derives from high net worth individuals and institutional investors that acquire equity shares of privately held companies or acquire a controlling stake in publically traded companies to make them private, eventually becoming delisted from public stock exchanges. These companies are not listed or traded on any stock exchanges. The PE capital can be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Now private equity has gained a great amount of influence in today’s financial marketplace.

What Is Public Equity?

Public equity meaning essentially refers to shares or ownership of a public company, i.e., a company that is listed on a public stock exchange. When a company goes public it essentially allows the public to buy ownership rights in their business. assets which can be traded in seconds as and when needed. The shares of a public company can be bought and sold at any time via a stock exchange. Public equity has great potential for garnering good gains in investments over time. Daily stock values may fluctuate, but the stock market value tends to go up over time. Thus if a stock you bought appreciates over time, you can be said to have made ‘capital-gains’.

ADVANTAGES OF PRIVATE EQUITY OVER PUBLIC EQUITY (DIFFERENCE BETWEEN PRIVATE EQUITY AND PUBLIC EQUITY)

Private equity investments are distinct from public equities along a number of dimensions, many of which are arguably drivers of enhanced private equity returns. Investors in privately held companies might benefit from conducting detailed due diligence, entering at more attractive valuations, obtaining active management or control of the investment taking a long-term view of investing and using leverage efficiently.

CONSIDERATION PRIVATE EQUITY PUBLIC EQUITY
Due diligence Access to proprietary information Access to public filings
Control of investment Typically full control or significant influence; hands-on, activist investing, heavy board involvement Proxy voting
Investor value-added capabilities Access to resources such as capital markets expertise, industry contacts, senior management recruiting and growth capital Typically passive investing, although larger institutional shareholders can exert influence
Time horizon Commitment to long-term value creation, no public market pressure Short-term pressure to meet quarterly earnings can compromise long-term goals
Exit options IPO, M&A, dividend recapitalization, secondary (fund-to-fund) transactions Sell at market
 
1. IN-DEPTH DUE DILIGENCE

Determining the value potential of a private equity investment is a critical process for investors, and can take months or even years. During the due diligence period, a private equity manager often has broad access to a company’s financial records, strategies and management team. This level of detail and access to information is not typically available to public market investors. In addition, a private equity manager often employs the expertise of accounting and consulting firms to evaluate target companies. This process often includes intensive interaction with customers, suppliers and management. The level of due diligence in a private equity investment often cannot be replicated by public market investors, who typically do not have the time, resources or access rights to obtain similar information. Such rigorous discipline enhances the chances for successful investment decisions.

2. INFLUENTIAL HANDS-ON INVESTING

Most private equity investors are highly involved with the companies in their portfolios, and often have significant influence, if not full control, over the operations and finances of their portfolio companies. They often assert their control through board seats and senior management appointments. In some cases they may even act as a company’s CEO or chairman. Private equity investors can also provide capital markets and industry expertise. Finally, private equity managers seek to maximize investment value by controlling exits and determining the appropriate timing and structure of liquidity events.

3. MANAGING FOR LONG-TERM VALUE CREATION

Private equity-backed companies enjoy the benefit of being able to adopt a long-term view of managing their business versus meeting quarterly earnings expectations set by the Wall Street community- a pressure that might drive public companies to focus on short-term objectives at the potential cost of long-term goals. This is especially relevant in today’s environment of increased regulation and growing demands from activist investors such as hedge funds. Likewise, private equity-backed companies can often avoid the increased costs and complications of the regulatory compliance, focusing instead on long-term growth.

4. PROPERLY “INCENTIVIZED” MANAGEMENT TEAMS

To create optimal value in the underlying portfolio companies, it is essential that the interests of the private equity manager and the company management are aligned. To promote such alignment, private equity firms often provide financial incentives to the portfolio company’s senior management team through stock ownership and by tying compensation to performance. The senior management team of a private equity portfolio company typically will own anywhere from 5-10% of the company. This can translate into a substantial wealth creation opportunity for management, but only if management increases the value of the portfolio company.

5. OPTIMAL CAPITAL STRUCTURES

Private equity firms may also be able to use leverage more effectively than public companies. Private companies have more flexibility to change their capital structures (e.g., the mix of debt and equity securities to finance a company), as public companies often have to conform to what the public markets consider generally acceptable in terms of the amount and structure of leverage.

6. MULTIPLE EXIT OPTIONS

Private equity funds can “realize” or “exit” (i.e., monetize or liquidate) their investments through a variety of means. IPOs, strategic sales, sales to other financial sponsors or dividend recapitalizations are some of the more common methods. Having multiple exit options gives private equity funds a choice of means by which they seek to maximize value. Multiple exit options also help when certain parts of the capital markets become difficult to access. For example, private equity investors may seek liquidity through a dividend recapitalization when IPO markets are weak. By contrast, investors in public securities typically have only one option to realize their investment: selling at the prevailing market price.

RECOMMENDED READINGS

About the author

Dileep K Nair

Mr Dileep is currently the managing partner of Unifinn Capital Global and an advisor to the investment banking and corporate finance world. He is a mentor, entrepreneur and business advisor with an overall 19 years of experience in investment banking, retail banking and corporate finance, with relevant experience in handling private equity transactions, private debt, venture capital, angel investing, M&A, and other growth capital and real estate financing transactions.

dileep.nair@unifinn.com

https://unifinn.com

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