“Angel investing” is sometimes referred to as “private equity investing,” just like “angel investors” are sometimes referred to as “private equity investors.” But don’t confuse angel investing with private equity investing done by private equity firms/PE firms. Angels and PE firms invest differently, although both invest in private equities. Confused? Yah, we thought you might be. So we knocked on Alastair Goldfisher’s doors and squeezed an interview out of him on the topic of private equity.
Goldfisher is the managing editor of Thomson Reuter’s PE Group. For those who get their VC/PE fix from Private Equity Week, Venture Capital Journal, and peHUB.com, his name (and his avatar) is no stranger to you. What you may not know is that he’s one heck of a guy who’s always willing to help. In short — he rocks.
* Edited interview
VH: Alastair, what’s private equity investing?
AG: One way to look at private equity is to compare it to public equities. Public equity investing means to put money into publicly traded companies that are listed on a stock exchange. Private equity investing refers to putting money to work in a privately held company in exchange for ownership of the company. [Typical forms include angel investing, venture capital, growth and mezzanine capital, distressed investments, leveraged buyouts, and private equity funds.]
Private equity investors invest in many different kinds of companies:
In an early-stage venture capital investment, the private equity investor typically invests in young or emerging companies, called startups and which are mostly tech or health care-related companies. They have small staffs and sometimes little more than an idea or basic technology. And they may take years to reach profitability.
A late-stage VC investment is one which the PE firm invests in a company whose staff size is beginning to grow and is earning a small amount of revenue.
The idea with venture capital investment is that when the private companies grow and mature, they can be sold or they can launch an initial public offering (IPO) that will return money back to the investors.
Other private equity investments include leveraged buyouts. In a leveraged buyout transaction, the private equity firm buys a majority control of an existing or mature firm, typically one with revenue and which has a sizable operation. This is different from venture capital investment, in which the PE firm invests in young companies and rarely obtains majority control.
VH: How do angel investors and private equity firms invest differently?
AG: Angel investors invest in very early stage companies. An early stage business is a relatively newly formed company, and it usually refers to tech companies, that are just trying to get off the ground. A typical angel investment in an early stage company, also called a seed stage business, is under US $1 million most of the time, but not always.
Angel investors are often times individual investors. A group of angels that invest together is known as an angel group or an angel network. Angels typically invest their own funds. Typically, angel investors put as much money to work as they like, and they’re not affected by fund restrictions. Nor do they have to pay management fees and other costs, etc.
Venture capital or private equity firms manage a fund, a pool of money raised by the firm’s management. [Managers of a PE firm are called general partners or GPs. They manage the funds sourced from limited partners, or LPs. LPs include pension funds, funds of funds, endowments, and family offices.] The fund is normally invested in several companies over a specific time period. PE firms are affected by fund restrictions and there are management fees and other costs involved.
Hereon, we’ll refer PE to institutional private equity/PE investing by private equity firms.
VH: Is the PE industry contracting or expanding?
AG: Yes to both. I can think of examples of how it’s contracting and expanding. Overall, investment firms are raising less money and putting less to work this year in comparison to recent years as a result of the economic slowdown. But if you look at certain sectors or certain types of investments, such as secondaries and distressed investments, then there’s growth. More importantly is the outlook, and I foresee growth by the end of this year. Not a lot of expansion in the industry, but I believe the industry will start churning out more deals soon and will need to raise more funds next year.
VH: Which sectors do PE firms favor in recent years? Any PE darlings?
AG: In the last quarter, what we witnessed, especially with buyout firms, is that the focus was on supporting the current portfolio rather than making new investments. I think we’re going to continue seeing investors focused on add-on acquisitions and follow-rounds for their portfolio companies, regardless of the sectors.
However, having said that, cleantech has been popular lately. Even though cleantech investments declined in Q1, I’d be surprised if that trend held up, what with federal economic stimulus helping to push cleantech innovation.
VH: What about the performance of PE investments in the past five years?
AG: As you might expect, at the end of last year, venture capital performance fell across all time horizons. The economic slowdown and a frozen exit market pushed down the one-year return numbers throughout 2008. Five-year and 10-year performance posted similar declines from the previous quarter, decreasing 2.0 and 1.6 percentage points.
But it’s all relative. What we need to look at is performance following when the dot-com bust happened about nine years ago. After all, VCs did gangbuster business between 1996 and 1999, but it’s in 2000 when things began to go south. The nine-year pooled IRR horizon is just 1.3 percent. For context, the 10-year return stands at 15.5 percent, according to data from Thomson Reuters.
Quite an intro to private equity. Join Venture Hype tomorrow as Goldfisher shares his observations on the characteristics of successful PE firms, emerging trends in PE investing and more.
* For series, references are published in the last installment of the series.