Important Questions Investors Should Ask Before Making a DDQ Private Equity Investment.

Private Equity Investment is an investment class wherein the capital isn’t listed on the public exchange. It comprises funds and investors who directly invest in private companies. The assets under management (AUM) by private equity firms globally crossed an astounding $ 4 trillion in 2019.  Investing in private equity can be advantageous as well as it may have some disadvantages.

Advantages:

•       A study conducted by Boston Consulting Group showed that two-thirds of private equity deals resulted in at least 20 percent annual growth for the purchased company. Hence, private equity companies are adept at creating value.

•       Investing in private equity opens up opportunities for an investor to generate higher absolute returns while improving the investor’s portfolio diversification.

Disadvantages:

• The initial returns are not so attractive and it might take several months to get significantly healthy returns.

• Private equity firms usually ask for a majority stake, and the investor might be left with little or nothing of his savings or capital.

Questions Investors Should keep in mind Before Making a Private Equity Investment:

·         What is my timeline?

Investing is a private equity investment is an excruciating process when it comes to time. A Private equity investment takes years to mature. Identifying the right deals and sourcing them with improving the underlying investment is all and all a lengthy process. Hence, investors looking for short-term investment should not invest in private equity. On the other side investors aiming for long-term investments shall find these attractive. This should be included by a company while making a DDQ for private equity investment.

·         Am I okay with the fees?

Private equity firms usually charge two types of fees, Management Fee and Performance Fee. They usually charge a management fee of 2% of the committed capital of the fund. Carried Interest is a type of performance fee. A significant difference between public funds and private equity is that private equity includes carrier interest as well, which is typically 20% of the fund’s profit.

·         What is my tolerance towards illiquidity?

Private equity investments are difficult to buy as well as sell. As the timeline for these investments is longer it might enhance the potential for return but this might not be favorable for investors who cannot tolerate illiquidity. An investor who doesn’t have enough cash to lock for a longer span of time or to tolerate some situations that may require liquidity should go for public markets as you can get in and out very easily. This is one of the most important points to be included in a DDQ for private equity investments.

·         Where does the investment stand on my current Portfolio?

Some of the investors may invest in private equity as it delivers exceptional returns while some of them may invest in them to counterbalance their publicly traded investments. Hence, an investor should monitor the investment and its role in the portfolio.

·         Would I be okay with lower transparency?

Unlike public markets, an investor won’t get regular updates or performance reports in the case of public equity. Private equity managers send reports to their investors on a quarterly basis. Hence, less visibility and transparency is offered in the case of private equity. The investors have to trust the managers that they will create value over a longer period of time. This is considered as a very important reason why thorough due diligence is really necessary before investing.

·         How does post-investment reporting work?

As mentioned previously, managers report to the investors on a quarterly basis. In the quarterly report the manager includes the following points:

1.      IRR (Internal Rate of Return)

2.      Total Value to Paid-In Capital (TVPI)

3.      Distributed to Paid-In Capital (DPI)

4.      Residual Value to Paid-In Capital (RVPI).

An investor should consider these points while investing in a private equity firm. As mentioned the wide dispersion of the returns and the long time horizon thorough due diligence is necessary. For an equipped investor with a longer investment time, required assets, tolerance towards illiquidity, and risk tolerance shall get huge benefits. An investment in private equity not only adds diversification to the portfolio but also huge returns. Going firmly through the DDQ before investing is really necessary before investing.