Market Advantages Driving Performance

Private equity markets have a number of natural advantages over the public equity markets that can lead to stronger financial performance. These advantages work in favour of the investor when the initial investment is made, and throughout the period when the investment is held. In addition, certain disadvantages experienced by companies in public markets can be avoided when companies are privately held.

Advantages During Investment Selection and Evaluation

Less Competition for Investments: Private equity markets are significantly less competitive than public markets. By their very nature, private markets are private; when investment opportunities are not advertised, investors must rely on proprietary deal flow. Although the number of higher profile transactions going to auction is increasing and the competitive pressures are growing for private capital, the real-time price competition of the public markets remains largely absent. Skilled investment managers can leverage private market inefficiencies into superior financial returns.

Due Diligence: Successful private equity managers conduct an extensive due diligence review prior to every investment. The majority of potential transactions do not pass this filter and are rejected. The ability to review confidential internal documents and plans, interview employees, customers and suppliers, and develop a real business relationship with management prior to the initial investment decision can allow a private equity investor to increase its chances of generating a sound investment decision, as compared to merely reviewing publicly-filed reports.

Negotiated Terms: Private equity investments are typically negotiated extensively by investors seeking to maximize their financial return while minimizing financial risk. Many techniques are well established in these markets for optimizing the investor’s financial position, and new structures are continuously being developed. Financial engineering cannot save a poor investment, but it can reduce risk and enhance returns, well beyond the “take-it-or-leave-it” common share structures of publicly-traded investments.

Advantages During the Life of the Investment

Alignment of Interests: Private equity investments are typically structured to provide senior management of the portfolio company with a strong personal financial incentive to create shareholder value. It is not uncommon for the senior management team to own a significant portion of the company’s equity, with the opportunity to create substantial personal wealth if the company succeeds. This alignment of interests between shareholders and management is designed to ensure that the company’s leadership performs at the highest levels for the benefit of the investors, and to minimize the potential for conflicts of interest between the personal interests of the business executives and the direct financial interests of shareholders.

Board Representation and Control: Many private equity investments carry the opportunity for ongoing board representation for the investor (or its co investor partners). As a director, the investor can obtain continuous access to management and company data, and naturally becomes an active participant in all major business decisions. In most cases, a private equity investor (either alone or as part of an investment consortium) will hold sufficient control of the portfolio company to take action quickly where required, including by replacing ineffective management if necessary. Successful private investors will help to drive corporate strategy, develop key relationships and engineer favourable exit transactions.

Advantages of Avoiding the Public Markets

Limited Disclosure: The business costs of public market disclosure can be very high. Most publicly-traded companies must make financial statement disclosure every quarter, together with disclosure of every material transaction or event affecting the business as soon as it occurs. It is increasingly difficult to develop new business or financial strategies without alerting competitors and affecting relationships with customers, suppliers, employees and other interested parties. In many cases, the pressures of continuous financial disclosure and the need to meet analyst earnings estimates can push longer term growth opportunities aside.

Public Market Regulation: The actual compliance costs of public market regulation has grown substantially in the past few years. The introduction of Sarbanes-Oxley and similar new corporate governance legislation has increased the expense of regulatory compliance significantly. In general, the executive and board level time spent on compliance has also grown dramatically, reducing the available resources for business development.

Other Public Market Distractions: Major events in a publicly-traded company often trigger a corporate governance response, in addition to the normal business response. A typical process may include a special board committee as well as additional lawyers, accountants and financial advisors. Significant time and expense can be directed at compliance with these required or expected corporate governance activities, instead of directing resources to the business of the company. In addition, many public companies are stalked by short-sellers, certain types of aggressive hedge funds and other public market investors whose interests are fundamentally not aligned with the growth and success of the business.

When all of these advantages are combined, the case for the private markets becomes compelling for investors and for many business managers. The resulting growth in private equity investment has led to a parallel growth in going private transactions, as boards and management of public companies recognize the benefits of the operating environment of private capital.

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