CONTRIBUTORS
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
Priya Thakur, CFA
Analyst
Franklin Templeton Institute
Key points
- Private equity can be classified by various stages (venture capital, growth equity, and buyout)
- Private equity has historically delivered an “illiquidity premium,” which represents the excess return received for locking up capital for 7–10 years
- Private equity has historically delivered attractive risk-adjusted returns relative to public market equivalents
- Secondaries have become a vital cog in the private equity ecosystem
- Product innovation has helped bring these once elusive investments to a broader group of investors
We often think about initial public offerings (IPO) as a part of the so-called “American Dream,” taking an idea and turning it into a successful company. These companies typically need help along the way, whether it is capital to start the business and hire employees, guidance assessing the viability of the new idea in the marketplace, or making strategic investments. This help often comes in the form of private equity. Private equity represents a vital cog in the US economy, fueling much of the growth and innovation across America. Private equity firms helped entrepreneurs build such companies as Google, Apple, Facebook (Meta), Uber and Tesla—among others.
In addition to providing capital to startups, at the other end of the spectrum are buyouts, where private equity firms take over and restructure troubled companies. Buyouts garner a lot of attention; for example, Kohlberg Kravis Roberts & Co.’s leveraged buyout of RJR Nabisco, which was ultimately turned into a book and then movie—Barbarians at the Gates.
While this story painted a less-flattering picture of private equity and the excess use of debt, buyouts today typically do not resemble that type of transaction.
Private equity often gets a bad rap in the media, where pundits may criticize fund managers’ fees, or the potential oversized returns available exclusively to institutions and well-heeled investors. But in fact, private equity funds can unlock considerable value in private companies which potentially leads to strong investment returns. These strong returns can help retirees invested in pension plans. Endowments and foundations may also benefit from private equity strong returns as they are able to fund activities due to the growth in the underlying portfolios. For example, universities can create scholarships, and foundations can fund causes they view as contributing to society. In addition, sovereign wealth funds invest heavily in private markets because that is where they see the most attractive opportunities.
As discussed earlier, private equity firms are critical partners for entrepreneurs and startup companies. They can provide seed capital, can leverage their network to identify opportunities, and can provide human capital as businesses mature. Early investors in these startup companies can reap large rewards if the company goes public.
In this paper, we delve into private equity and cover the following issues:
- What are the stages of private equity?
- What is the appeal of private equity?
- What are secondary investments?
- How has product innovation evolved to meet the needs of high-net worth (HNW) investors?
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
To the extent a fund invests in alternative strategies, it may be exposed to potentially significant fluctuations in value.
Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity. Diversification does not guarantee a profit or protect against a loss.
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.