Private Equity Sectors

There are a variety of sectors within the private equity industry. Some private equity funds focus on specific industries, such as high technology, telecommunications, oil & gas, mining or the retail sector. Other private equity funds are focused on a specific type of investment, such as venture capital, mezzanine or distressed debt or buyouts. As part of its investment strategy, Kensington seeks to diversify its portfolio into various investment sectors, principally the buyout, venture capital and mezzanine debt sectors.

Buyouts

In the context of a private equity fund, a buyout, leveraged buyout or management buyout refers to a transaction initiated by a private equity buyout fund manager, usually referred to as a financial sponsor, in which control of a majority of a target company’s equity is acquired. The acquisition is often leveraged through debt financing, with the amount of equity funding dependent upon the ability of the company to service that debt with its own cash flows. The financial sponsor generally requires management to invest a meaningful portion of their net worth in the equity of the company on the same terms as the sponsor’s equity. This ensures alignment of interests between the financial sponsor and the management of the company. Most private equity capital is invested in the buyout sector.

Leveraged buyout firms seek to generate returns by focusing their efforts on improving the core areas of company operations, which affects the company’s growth, productivity and capital structure. Returns are often enhanced over time through the expansion of trading multiples. That expansion is achieved by making sure that the activities of the company are focused on building the value of the equity. When the company is sold into the public markets or to a strategic or other private buyer, the combination of enhanced growth prospects, proven management, optimized capital structure, and elimination of non-core activities, can lead to a higher multiple of cash flow and earnings upon the sale than at the time of acquisition. Some private equity investors pursue a similar strategy by providing growth capital, which is used to expand a portfolio company’s business, in exchange for a minority shareholding position. In such cases, it is important to ensure that the financial sponsor has the ability to control the timing and form of the sale of the business, and has sufficient control over the operations of the company to ensure that its investment return objectives are achieved.

Venture Capital

Venture capital refers to investing in start-up and early stage companies with a business model based on new technologies or other innovations. Successful venture capital investing offers the prospect for significantly higher returns, but carries an increased level of risk because the companies in the portfolio are less established companies whose business models depend on unproven technologies or developing markets. The ultimate goal is to build the company and position it for an appropriately timed exit opportunity, usually through a public offering or by the sale of the business to a strategic investor, such as a larger company in the same industry.

Mezzanine Debt

Mezzanine debt financing is typically used as one element in the capital structure, for expansion, to finance leveraged buyouts or for recapitalizations. Mezzanine financing is often used as a means of bridging the gap between private equity and senior debt in buyout structures. A typical mezzanine loan is structured as subordinated debt with yield enhancements related to the value of the equity or to the cash flow growth of the business. Mezzanine investors typically benefit from a combination of current cash flow from interest payments and a potential increase in the value of their equity. In Kensington’s investment portfolios, mezzanine fund investments are used to provide steady and early returns, and to provide additional diversification.

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