The formulas, tricks and trade secrets of Private Equity

Not Private Equit

Sample Chapter

Have you ever asked yourself what qualifies and what does not qualify as private equity? I certainly haven’t been ordained to make a claim either way, and it’s not as if it really matters what you label an investment, but let’s try to make a distinction for the same reason Hillary climbed Everest… because we can.

By way of its namesake, private equity should be “private” and involve “equity”. But, what does that mean? The word “private” could refer to the source of capital, the ownership of the investment or the publishing of financial reports. If you put the words “private” and “equity” together, then you’d imagine that the “private” refers to equity from private sources. However, that would rule out listed private equity (LPE) as genuine private equity, which I don’t agree with (see this post for my LPE discussion).

I’ve previously said that I prefer to think of private equity as a methodology rather than a class of capital. So, this makes me think of the “private” in private equity as referring to privately held investees (or very soon to be private, in the case of Public-to-Private buyouts). Of course, this rules out PIPES (Private Investments into Public EquitieS), but I’m okay with that because PIPES don’t adhere to my idea of the private equity methodology.

But, private equity is more than just an investment into a private company; we’re still left with the word “equity”. Well, I’m a big believer in private equity being about investments as equity or any instrument with unlimited upside potential. Sure, some funds invest through mezzanine debt and preferred stock with liquidation caps, but for me, real private equity has full access to the upside. That’s not to say I think firms shouldn’t have any other exposure, just that most of it should be via real equity with real upside.

Just to summarise, I believe genuine private equity refers to equity investments into private companies. However, that’s still too broad; any old investment fund or wealthy individual could fit into that definition. To wrap up my definition of private equity, the investor has to be active in the business and add strategic value to the business; they must be professional investors and business people. They must act as directors, managers, staff, investors, stakeholders, and value creators. For me, this is the essence of private equity.

As for what I think doesn’t qualify as private equity; any minority investment into a public company, any investment as a passive investor, or any investment that doesn’t give the investor enough influence to make a difference. I certainly don’t buy the idea that you’re only private equity if you’re registered with your local PE or VC association; if anything, it’s more nobel to be an active, long-term, private portfolio investor without the penchant to be called “private equity” (think Buffett and Branson… before they listed).

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