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January 25 2016


Considerations When Evaluating Equity finance

When a process is working, the usual understanding suggests leaving it alone. If it isn't broken, why fix it?

At our firm, though, we'd rather devote extra energy to earning a good process great. Rather than resting on our laurels, we have spent the last few years focusing on our private equity finance research, not because we are dissatisfied, but because the world thinks even our strengths can be stronger.

Private Equity
As an investor, then, what in case you look for when considering an individual equity investment? Many of the same things we all do when considering it on a client's behalf.

Equity finance 101: Due Diligence Basics

Private equity finance is, at its most basic, investments that are not on a public exchange. However, I use the term here much more specifically. When I speak about private equity, I do not mean lending money with an entrepreneurial friend or providing other styles of venture capital. The investments I discuss are widely-used to conduct leveraged buyouts, where huge amounts of debt are issued to fund takeovers of companies. Importantly, I am discussing private equity funds, not direct investments in privately owned companies.

Before researching any equity finance investment, it is crucial to understand the general risks a part of this asset class. Investments in private equity can be illiquid, with investors generally not allowed to make withdrawals from funds throughout the funds' life spans of A decade or more. These investments also provide higher expenses plus a higher risk of incurring large losses, or perhaps a complete loss of principal, than do typical mutual funds. In addition, these investments in many cases are not available to investors unless their net incomes or net worths exceed certain thresholds. Due to these risks, private equity investments aren't appropriate for many individual investors.

For our clients who possess the liquidity and risk tolerance to consider private equity investments, the fundamentals of due diligence haven't changed, and thus the muse of our process remains the same. Before we propose any private equity manager, we dig deeply in the manager's investment process to make sure we understand and are comfortable with it. We must be sure we are fully conscious of the particular risks involved, therefore we can identify any warning signs that require a closer look.

As we see a deal-breaker at any stage from the process, we close the lid on immediately. There are many quality managers, and then we do not feel compelled to invest with any particular one. Any queries we have must be answered. If a manager gives unacceptable or unclear replies, we go forward. As an investor, decide on should always be to understand a manager's strategy and make sure that nothing regarding it worries you. You've plenty of other choices.

Our firm prefers managers who generate returns by causing significant operational improvements to portfolio companies, as opposed to those who rely on leverage. In addition we research and evaluate a manager's reputation. While the decision about whether to invest should not be according to past investment returns, neither if it is ignored. On the contrary, this can be among the biggest and quite a few important pieces of data with regards to a manager that you can easily access.

We consider each fund's "vintage" when searching for its returns. A fund that began in 2007 or 2008 probably will have lower returns when compared to a fund that began earlier or later. Even though the fact that a manager launched previous funds prior to or during a down period for that economy is not an instant deal-breaker, take time to understand what the manager learned from this point and how he or she can apply that knowledge in the future.

We look into how managers' previous fund portfolios were structured to see how they expect the actual fund to be structured, specifically how diversified the portfolio will probably be. How many portfolio companies will the manager expect to own, by way of example, and what is the maximum amount of the portfolio which can be invested in any one company? A more concentrated portfolio will carry the opportunity for higher returns, and also more risk. Investors' risk tolerances vary, but all should comprehend the amount of risk an investment involves before taking it on. If, as an example, a manager has done an inadequate job of constructing portfolios previously by making large bets on firms that didn't pan out, steer clear about the likelihood of future success.

As with all investments, one of the most critical factors in evaluating equity finance is fees, which can seriously impact your long-term returns. Most equity finance managers still charge the normal 2 percent management fee and Twenty percent carried interest (a share of the profits, often over a specified hurdle rate, which goes to the manager before the remaining profits are divided with investors), however some may charge approximately. Any manager who charges more had better give a clear justification for that higher fee. We've got never invested which has a private equity manager who charges greater than 20 percent carried interest. If managers charge below 20 percent, that can obviously make their funds more attractive than typical funds, though, like with the other considerations on this page, fees should not be the sole basis of investment decisions.

Invest some time. Our process is thorough and deliberate. Be sure that you understand and are at ease with the fund's internal controls. While many fund managers won't get a sniff of great interest from investors without strong internal controls, some funds can slip over the cracks. Watch out for funds that will not provide annual audited financial statements or that cannot clearly answer questions about where they store their balances. Feel free to look at the manager's office and request for a tour.

The more or less open secret inside the private equity industry is that it is all totally negotiable. See if you can negotiate lower fees or, if you want it, a reduced minimum commitment. At private equity's peak in 2006 and 2007, managers had every one of the leverage, so negotiating with these was difficult. Currently the tables have turned, therefore it may be much easier to create an investment on your own terms, especially for investment managers and institutional investors, but with a lesser extent for individuals as well.

Next Steps: Going Above And Beyond

Times change. Even though the fundamentals remain largely exactly the same, private equity is an industry like all other, which means that new schools of thought and different approaches arise. We make a point of staying current with trends and issues in the industry.

The tools and data open to advisers have improved, even though more information can ultimately make our jobs easier, it is still up to us - as it is to investors performing their unique due diligence - to help make the best use of the data. As an example, when our Investment Committee evaluates an individual equity manager, supermarket look for managers who follow similar strategies and we all can compare them. Even when a manager passes all of our tests, we find it is still worth looking at other managers to determine how they compare.

A definite item of data that is easier to find is how a great deal of manager's investment return was as a result of the manager's expertise and operational improvements to portfolio companies and how much to the macroeconomic environment or leverage. Some managers might not be able or willing to provide this information, but for those who are, it can be very helpful in providing a definite measure of how much value a supervisor added.

We also have created formal procedures in order that our client private equity portfolios are diversified by strategy and vintage. We don't have a maximum that people recommend for any one strategy or vintage, because each client has different goals and risk tolerance. But with the help of this step and keeping track of diversification in a disciplined way, we seek to generate higher returns reducing risk over the long term.

We now have also devoted additional time to considering each client's target equity finance allocation. In the past, organic beef have recommended an optimum 10 or 20 percent, but we understand some clients could have the risk tolerance and liquidity for higher allocations. For other clients, even those that have large portfolios, natural meats not recommend any equity finance at all. A one-size-fits-all approach just isn't appropriate for investment decisions generally, but especially when determining the level of private equity investment. Individual decisions are required.

While you need not necessarily follow everything in our process, doing this will ensure that you have thoroughly considered neglect the before you proceed. Ideally, you still will have identified a private equity manager who has a strong track record and contains provided enough transparency so you are confident your questions have been answered and any additional concerns will probably be addressed. You should understand the investment's strategy and charges and feel sure its returns have been generated by expertise and never luck. If you are ready to make a sizable investment, you'll ideally negotiate favorable terms as opposed to paying rack rates.

They are our goals once we propose a private equity investment to one of our clients. Private equity investing can carry significant risk, nonetheless it can still be an appropriate accessory a long-term investment strategy. While our approach doesn't guarantee a fund will offer market-beating returns, it determines the fund is free of warning flags. We take pride in our due diligence, and we will continue to look for opportunities to improve our process.

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