Private Equity: Throwing a Lifeline to Our SMEs

The pandemic has left a number of our SMEs struggling to stay afloat. New Zealanders have responded in droves to #supportlocalbusinesses and whilst these efforts are admirable, there is potentially more that can be done.

If you read our recent article Closing the Gap, you’d know that New Zealand is a nation of small businesses. Many of these businesses are still in their early stages and usually hit a point where in order to grow more, they require more capital. It’s estimated that $3.15 billion needs to be invested over the next 5 years to keep up with the capital demands and growth of early stage businesses in New Zealand. [2] One way of throwing a lifeline to our SMEs and closing this gap is via private equity. 

What is Private Equity?

As the term suggests, private equity is private. It is an alternative form of investment where private equity firms and investors invest capital directly into businesses that are not publicly listed. In return for their invested capital, private equity firms and investors gain private equity, secure ownership interest in the business.

Who Invests?

Private equity firms typically invest $10-200million to take a stake in a business. They normally invest in companies that are more mature and can be used as a base to acquire further similar businesses to build scale.

Usually, high net-worth individuals hold private equity investments which are relatively illiquid and involve substantial amounts of money and long holding periods (since liquidity events like IPOs or the sale of the business can take some time). The amount they typically invest will depend on the business, and this alternative asset class is slowly becoming more accessible to individual investors. This is because there now exists many ways to invest in private businesses, one example being through private offers to eligible investors arranged by investment banks such as Armillary Private Capital.

How Does Private Equity Work?

Investors typically look for businesses with growth potential and aim to rapidly improve their performance. Improving business performance can come from undertaking many strategies like funding new innovations, expanding working capital, making acquisitions, changing or better incentivising leadership, and improving the balance sheet through operational efficiencies. The aim is to substantially increase the business’ valuation. Eventually investors sell their interest in the improved business or take them public to realise their investment. Whilst private equity investments incur greater risk, these investments potentially offer some of the highest returns in the market, often outperforming traditional investment classes.

Why Private Markets are Becoming More Valuable

As pictured below, increasingly, private markets are becoming more valuable.

Private Equity Investment Strategies

The two most common private equity investment strategies are leveraged buyouts (LBOs) and growth capital.

Typically, an LBO involves buying out a business completely to improve its performance and financial position. The business later is often resold for profit or taken public via an IPO (Initial Public Offering).

Growth investing involves a person, fund or company providing finance to businesses in their growth stage. These businesses often have proven track records and usually operate in relatively established markets. Growth capital can help such businesses expand their operations and enter new markets. In return for their investment, investors usually receive a share holding of the business.  

If you’re interested in private equity investments, please get in touch!

[2] https://matu.co.nz/2019/09/how-big-is-new-zealands-early-stage-funding-gap/