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Active ownership model generating outperformance through cycles.
Long term view
Private equity is a long term ownership model. There is less short term performance pressure on private equity owned companies than in the public markets. This long-term view allows private equity managers to set ambitious medium to long term goals for management, making it possible to prioritise fundamental value creation over short term profit targets and thereby build an attractive business for future acquirers.
Alignment of interest
To ensure close alignment of interests between investors and management teams, remuneration structures prioritise equity incentivisation, aligning the business teams with the private equity managers and ultimately those managers’ underlying investors. The same is true between the private equity managers and their respective investors (such as ICG Enterprise Trust): performance fees are only paid once the respective fund has returned 100% of capital, plus a hurdle (typically 8% p.a.). After that, gains are typically split 80% to the investor and 20% to the private equity manager; this performance fee is called carried interest or carry.
Significant due diligence and risk mitigation
The long term focus of private equity and the illiquid nature of any investment in private companies means that significant due diligence is undertaken prior to any investment. Private equity managers will typically only invest after a long period of deep investigation, often over several months and sometimes even years, and in most cases alongside management. Private equity managers are typically sector focused and will have detailed knowledge of potential investee companies’ competitive landscape. This not only plays an integral part in the due diligence process but also informs the investment thesis and strategy for the business, should it be acquired.
Strategic and operational change
Private equity is an active ownership model with managers providing focused strategic and operational guidance to the companies in their portfolio. This can include expansion into new markets or business lines or growing companies through acquisition. Operationally, private equity managers work with management teams to maximise efficiencies within the business, and importantly the close lines of communication mean that any under-performance can be identified early, with the skills on hand to address issues quickly.
Financial expertise and discipline
Private equity managers bring significant financial and capital markets expertise to the businesses they invest in, encouraging financial discipline and ensuring that the business has access to competitive financing solutions. Most private equity managers use leverage prudently, with a clear focus on free cash flow generation and interest cover, ensuring the business has the right capital structure to withstand any economic or end market uncertainty.
Ultimately, all private equity backed businesses are for sale, and when companies are ready for disposal, they may be sold to trade buyers, or to financial buyers (including other private equity funds). Alternatively, they may float on a stock market in an initial public offering (IPO). Once an investment is sold the net proceeds are returned to the private equity manager’s investors. In the case of ICG Enterprise Trust, these proceeds are recycled into new investments or returned to shareholders through dividends.