Learning how to invest in private equity markets

  • TangoWhiskey

    Status: Forum Member

    Posts: 307
    Joined: 26 Aug 2010

    There has been some mention here of the private equity markets and how you essentially are buying an income stream from a stock for 3-5 times earnings vs 10 + times earnings in the public markets. You lose whatever protection you had from fraud and other risks that comes with the higher due diligence, compliance and regulation of the public market (if those things in fact confer any added protection!), but like real estate I'd rather do my own due diligence anyway. How does one learn to invest in the private equity market - are there any books that are recommended? 
  • CurtisSvidal

    Status: Forum Member

    Posts: 24
    Joined: 28 May 2012
    From: Edmonton

    I'm guessing that you are referring to income trusts..."private equity" often refers to hedge funds which are a very different concept.
    I suggest you look up income trusts on wikipedia to confirm that is what you have in mind. If so, a google search may provide some references.
  • ThomasBeyer

    Status: REIN™ Member

    Posts: 10,195
    Joined: 30 Aug 2007
    From: Alberta and BC - The Top 2 Places on the Planet to live and invest !

    Private Equity is in essence non-publicly traded equity.

    This is a wide space, from a JV in a real estate, to a co-investment in a restaurant or franchise as a passive investor with 2 buddies, to private software/manufacturing/oil/mining/real estate firms, with 12 investors or 2500.

    In Canada this market comes in two forms: with a prospectus or without one. The latter is also referred to as the 'Exempt market" as the issuer is exempt from issuing a prospectus. A prospectus is a financial and disclosure document that has to be approved by the security commission of the issuing province. An exempt product has a very similar, albeit somewhat less complex financial and disclosure document called an offering memorandum (OM. An OM follows certain detailed 60+ page long formats but that does not have to be approved by the security commission of the issuing province. It is signed by the issuer's executives as to "It does not contain a misrepresentation."

    Disclosure 1: The firm I manage is an exempt market product issuer in the real estate space.

    Disclosure 2: This is an educational piece, not a promotional one nor advice.

    Exempt products are sold in two ways:
    a) by the issuer, without commissions, usually to friends and family members, close business associates, accredited investors or those that invest $150,000 or more.
    b) by Exempt Market Dealers (EMDs), usually with commission of 4-12% depending on the OM, usually to eligible investors (those that are not in the group of friends and family members, close business associates, accredited investors or those that invest $150,000 or more)

    Ontario right now does not allow sales to eligible investors, but that restriction is being reviewed right now.

    The OM lays out the business structure in some depth, such as who are the lead executives, their background, the intended venture in broad form, the fees, the equity split between investors and the issuers (also often referred to as the syndicator), the risk, the restrictions etc. Such as document costs about $25,000 to $40,000 to produce, and as such is usually only useful for raises over $1M.

    What do you look for in a private equity deal:

    First of all, ask yourself: does it make sense in a broad format, given the fees or commissions or equity split described.

    Then ask yourself if the anticipated or advertised returns are indeed achievable.

    Then ask if the issuer and his/her team has experience in the space.

    Then look at the described and the real likely or possible risks, within a realistic range. Life is risky. Driving a car is risk. Flying an airplane is risky. Yet millions do it annually. The OM is akin to the fine print of the airplane ticket which states that the plane might be late, or might not fly at all, or might blow up, or might fly into buildings or might be crashed by an incompetent pilot .. all of which has happened, of course, yet people are still willing to fly airplanes.

    Then look at exit options, i.e. liquidity. Most PE deals have a minimum timeline given the nature of the underlying asset class or business venture. So if you invest in a mining company, look at the drilling results and the location and the funding requirements and the track record of the operating team, and ideally you understand the lingo of the industry and how long it would take to get a mine open and operational, as an example. It might be 2-3 years .. or a decade. Ditto in an oil or gas firm, know the difference between proven reserves and proved reserves. Ditto in a real estate firms, where I have extensively operated in and written about, for example here on myreinspace on mistakes to avoid. Many of the arguments can be transferred to other business, say oil & gas, restaurant, software technology, manufacturing, transportation or mining but I am not a domain expert there.

    Some PE deals are brand new, i.e. the opening balance sheet has almost no cash, whereas others raise money in addition to existing ventures. Thus, some are mainly promises and some are based on years or months of operating.

    Many PE deals make a lot of sense and I have invested in at least 8 different firm, but many are not. Some I invested in also did not perform as intended during the 2008-2010 recession or take far longer to achieve target returns or at least return of capital.

    80%+ of my personal networth is in PE deals as I do not understand the public market well enough to ever having made any significant money in it, in fact I am probably negative all in over a 15+ year horizon. Unlike PE, where I have lost some but mainly gained handsomely over the years, including many deals I am in control of, or at least part of a controlling group.

    I spend a lot of time with the lead executives and understand their financials, their business plan, their growth projections and their assumptions about the market and the risks. Our OM, for example, has 4 pages of risk disclosure ranging from interest rates to general market risks to natural catastrophies to building implosions to natural disasters.

    EMDs or their reps are supposed to steer you away from certain asset allocations % and now also do a fair amount of vetting before they take on an issuer, making entry into this market more difficult than prior to 2010. Investors have fill out detailed networth statements and forward that to the EMD rep called a Know Your Client (KYC) form. Then you have to sign a risk disclosure form in addition to the fairly lengthy subscription forms. The forms in essence say that you can lose all your money and that the investments are very risky, even if the issuer syndicated a government bond or bought an apartment building with no mortgage. Therefore, you really have to look at the prospectus or OM carefully and look at overall common sense factors as in the end you trust some people with your money and they have a fairly wide degree of freedom what to do with it, such as borrow money at 28% or hire consultants for $250,000 or drill dry holes or buy overpriced land parcels or commercial properties in bad locations and manage them poorly.

    Thus, proceed with caution, but do proceed and consider it as one of your investment options.

    Again, this is not advice, but my opinion. I am not licensed to give advice.
    Thomas Beyer, Honorary REIN Member & Member REIN Advisory Board
    President, Prestigious Properties [@facebook .. @twitter]
    T: 403-678-3330 E: tbeyer at prestprop dot com - www.prestprop.com

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  • TangoWhiskey

    Status: Forum Member

    Posts: 307
    Joined: 26 Aug 2010

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