The State of Private Equity

We’re kicking off the new year looking at private equity.

If you’d like to extend your equity investing beyond public stocks, ETFs and mutual funds, PE can be a rewarding alternative.

We’ll dive into the history, how it works why it’s controversial, recent performance, how it’s changing, and how you can invest.

Note: Since you have the All-Access Pass, you can access the full issue. ✅

Let’s go 🥂

​Jeffrey Briskin​ is a veteran Boston-area financial writer and marketing consultant. His past work with Alts include ​deep dives​ on Sensate, Geoship, and most recently the market for ​pinball machines​. Jeffrey is also the author of the best-selling Biblical crime novel, Bethlehem Boys.

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This issue is sponsored by Arta Finance Wealth Management LLC. Alts.co is not a client of Arta and has been provided cash compensation for the endorsement. The opinions expressed are based on the author’s knowledge of Arta’s services and are not indicative of future results. This issue is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any particular security.

What is private equity?

Private equity investing gives you ownership in privately owned companies of all sizes — from startups, to established retail chains, to healthcare networks that employ thousands.

Here’s the thing: Most of these companies will never trade on the stock market. And that’s okay! This can actually be a bonus for investors, because the value of privately held companies isn’t impacted by the whims of Wall Street.

It’s rarely discussed, but the number of public companies in the US has been ​steadily shrinking since 1996​. Today there are just 4,300 American public companies, compared to ​27 million​ private ones.

You’ve got more opportunities to choose from than ever, and there are a variety of ways to invest. This is just one reason savvy investors include PE in their investment portfolios.

Other reasons:

• To take a more direct stake in funding companies in industries that interest them.
• To help revitalize struggling companies that need an influx of capital to turn their fortunes around.
• To get a deeper level of diversification that can potentially protect against losses in bear markets.

A short history of American private equity

If you think about it, private equity investing went a long way toward making the US what it is today.

It can all be traced back to the nation’s origins in 1620. Not long after the Pilgrims settled in Plymouth, Massachusetts, British investors established the ​Massachusetts Bay Company​, whose mission was to fund the development of the colony.

In fact, private investors have been predominantly responsible for funding most of America’s expansion; from providing capital to struggling railroads, to the nation’s first mega takeover effort, when JP Morgan bought Carnegie Steel in 1901, creating what would eventually become the world’s largest company — ​US Steel​.

Five American PE firms have a history of investing in the steel industry:

• ​American Industrial Partners (AIP)​. Founded in 1989, AIP focuses on acquiring and enhancing industrial businesses. Their portfolio includes companies like Canam, a leading manufacturer of customized steel structural components.
• ​KPS Capital Partners​. Specializing in manufacturing and industrial companies, KPS has a track record of acquiring and transforming businesses in the metals sector. They recently sold their Eviosys packaging business for $3.9 billion, highlighting their active role in industrial investments.
• ​WL Ross & Co. ​Founded by Wilbur Ross, this firm has significant experience in the steel industry. In the early 2000s, they consolidated several bankrupt steel companies to form International Steel Group, which was later sold to Mittal Steel.
• ​Apollo Global Management​. A major player in the private equity space, Apollo has invested in various industrial companies. In 2023, they announced plans to acquire ​Arconic​, a manufacturer of aluminum sheet, plate, and extrusions, indicating their interest in the metals sector.
• ​Steel Partners Holdings L.P.​ Founded in 1990, Steel Partners is a diversified holding company that has made investments in various industrial businesses, including those in the steel sector.

Most economic historians agree that the first firms created solely to invest in and take over private companies were in 1946:

• ​American Research and Development Corporation​ (ARDC) which was founded by Georges Doriot and essentially created the venture capital industry. It ceased operations in the 80s.
• ​J.H. Whitney & Co​., which is still around today

The growth of PE firms started off relatively slow. In 1980, there were just ​28​ private equity firms. But by 2020, that number had exploded to​ over 4,500​!

As of 2022, PE firms managed around ​$11.7 trillion ​in assets — about ​4x larger​ than the entire cryptocurrency market.

How does private equity operate?

PE firms operate differently depending on their investment mandate.

Let’s take a look at the most popular strategies.

Leveraged buyouts

Leveraged buyouts (LBOs) are the infamous PE plays that many people have heard about.

In a leveraged buyout, a PE firm uses massive amounts of debt financing to buy a majority stake in a troubled company, with the goal of improving their fortunes.

It seems complex, but it’s essentially using borrowed money to acquire and enhance a company’s value. To understand the different acquisition approaches in these deals, it helps to compare strategic versus financial buyers.

How it works:

• Investors provide the debt financing capital
• If the company is public, it is typically taken private (delisted from stock exchanges).
• The acquired company is typically restructured & optimized for efficiency (i.e. layoffs), and positioned for a sale or IPO.
• Once the loan is paid off, cash flows are used to pay back/distribute profits to investors

Critics often accuse PE firms of saddling takeover targets with the responsibility of paying off the loans the PE firm amassed to buy the company.

Faced with often-insurmountable debt, the companies often have to make massive layoffs or trim costs to the bone to free up capital to make these payments.

This video explains the controversial concept (known as asset stripping):

LBOs can be performed on either private or public companies. But in recent years, private company LBOs have become more common than public company LBOs

From ​Preqin Global Private Equity Report 2024​:

• Private Company LBOs represent approximately 70–80% of global LBO transactions annually ($350 billion)
• Public Company LBOs make up about 20–30% of transactions but often involve larger deal sizes ($150 billion)

A textbook example is PE firm ​KKR​’s leveraged buyout of RJR Nabisco, Inc., one of America’s largest manufacturer of food and tobacco products, a story that was chronicled in the best-selling book ​Barbarians at the Gate​.

In 1989, RJR Nabisco’s CEO, Ross Johnson, wanted to take the company private to overcome its steadily falling stock price. A bidding war ensued, after which KKR emerged victorious with a $25 billion bid financed by the ​largest LBO in history​.

However, KKR saddled RJR Nabisco with so much debt that the company had to use most of its meager cash flows to make interest payments, rather than diversify its product line! The company gradually began selling off its various divisions to pay down debts before going public in 1991.

The company never overcame its problems, and the combined entity was dissolved in 1999.

However, for every LBO debacle, there are numerous positive examples of PE firms using LBOs to rescue struggling firms. Noted examples include:

• In the late 1980s, KKR used an LBO to acquire the Safeway — a struggling supermarket chain, which had been fending off a hostile takeover. After the deal was completed. Safeway restructured its operations and ​became profitable again​.
• In 2007, on the eve of the Great Recession, Blackstone acquired the privately owned Hilton Hotel chain through an LBO. This actually triggered a US Department of Justice investigation, which both companies survived. By 2013, when Hilton went public, its value soared to $12 billion.
• In 2013, Silver Lake Partners used an LBO to help Dell Computer repurchase its publicly traded stock and become a private company with billions of dollars in assets. This move enabled Dell to shed underperforming businesses and ​return to profitability​.

Growth equity investing

PE firms often become silent partners in promising startups or established private companies.

This is basically just standard VC-style growth capital. Investors provide capital for established companies that want to expand their footprint or restructure their business to boost revenue and profitability.

Growth equity investors generally aren’t trying to take control — they’re happy to receive a minority stake that entitles them to a big payoff if the company goes public, or a share of a company’s future profits.

A textbook example is Silver Lake Partners’ investment in ​Alibaba​. Its stake helped the Chinese ecommerce company issue an IPO that netted $4.5 billion in paper gains for Silver Lake.

Another example is Silver Lake and Sixth Street Partners’ ​$1 billion investment in Airbnb​ at the beginning of the COVID-19 pandemic, which paid off handsomely when the company went public in December 2020.

Carve-outs

Carve-out transactions occur when either a public or private company sells a non-core business or asset to a PE firm.

​Carve-outs​ enable PE firms to add greater diversification to their portfolios and gain hands-on management experience in new sectors.

Examples of noteworthy carve-outs funded by PE firms include:

• Kraft Heinz’s spinoff of its ​cheese manufacturing subsidiary​
• Coty’s carveout of its ​retail hair business​
• BP‘s divestiture of its ​petrochemical holdings​

Distressed assets

Some PE firms focus on companies that may be on the verge of bankruptcy or dissolution.

These companies may still have valuable assets, such as real estate or a retail brand that no longer works in a brick-and-mortar setting but might still work online.

​The Sharper Image​ and ​Pier 1 Imports​ are examples of two firms that sold ownership of their physical assets with the help of PE firms.

What’s the state of PE today?

The first half of 2024 was rough

Let’s not sugarcoat it — the last few years have been difficult for PE investors.

High inflation and interest rates have made it difficult for private companies to stay afloat and for PE firms to boost profit margins.

Since most PE funds and firms aren’t SEC unregistered, it’s hard to get accurate information on total returns for the asset class. But ​State Street’s Private Equity Index​ claims to provide some insights into the sectors.

According to their research, overall quarterly returns for the period ending June 30, 2024 were just 1.44%.

It’s also been tough for PE funds to woo their target audience of high net worth and institutional investors, since they’re competing with a surging stock market, other private alternatives, and even cash instruments like CDs and money market accounts offering interest rates of 5%+.

The situation improved in Q3

However, the situation has improved in the second half of 2024. Inflation has dropped to its lowest level since 2021. The Fed has finally started cutting interest rates. The job market is softening.

These combined factors are likely to create a more favorable environment for private companies seeking capital and investors who want to supply it.

Deal activity is picking up

After several years of diminishing activity, the PE market may be turning the corner.

According to Pitchbook, as of the end of the third quarter of 2024, ​deal volume increased by 12.9%​ YoY, and deal value increased by 23.1%.

A trend towards growth equity

What’s really interesting though is the types of deals getting done.

Over the past decade, there seems to be a greater interest in acquiring or taking smaller stakes in private companies (i.e. growth equity), instead of high-risk plays like LBOs.

Even more interesting is what’s happening with add-on deals.

Since 2014, add-ons (which occur when PE firms add smaller companies to their portfolios) accounted for over 50% of all deals.

PE partners are bullish

Partners at PE firms expect that all deal activities will increase.

According to ​Ernst & Young’s Pulse Survey​, nearly half of general partners (GPs) predicted that their activity would rise by at least 10%.

The types of deals GPs expect will increase moving forward have changed as well.

In the beginning of 2024, GPs believed that there would be more ​secondary buyouts​, carve-outs and restructuring and distressed assets opportunities, perhaps because they were anticipating a full-blown recession that would weaken the market.

But by mid-year there seemed to be more optimism that the number of venture capital and growth equity opportunities would increase

IPOs are making a comeback

IPOs, which had also been tailing off since 2022, also seem to be coming back a bit.

• In 2022, 174 companies went public
• In 2023, this sank to ​154​
• But in 2024, it shot back up to ​225​

​Ropes & Gray​ doesn’t believe that the IPO market will really start gaining momentum until mid-year 2025.

And even if the number does increase significantly, IPO jackpots are rare. ​Less than 0.003%​ of startups who receive PE funding are likely to ever go public.

Whether this lower inflation and interest rates and a soft landing will create a better PE environment moving forward remains to be seen.

And there’s always the key wild card factor: What may or may not happen in the wake of Donald Trump’s re-election.

What are the hottest PE sectors?

Professional PE investors gravitate toward industries offering the highest ROI potential.

According to Pitchbook’s Q3 PE ​report​, more than 50% of all deals in 2024 have been for companies that sell products and services to consumers or other businesses, followed by IT and healthcare.

Many firms are looking for opportunities in specialized sub-sectors. These include:,

AI

As PE firms incorporate AI into their ​due diligence​ and deal making processes, they’re also for AI-driven startups to add to their portfolios.

In 2024, they invested ​$17 billion​ in AI and other machine learning (ML)-oriented companies, three times higher than in 2023.

This growth is likely to continue, with expected CAGRs from ​50% to 73%​ by 2028, depending on the application.

Sports verticals

With loyal customer bases and diverse revenue streams, sports teams and the companies that supply them have become an increasingly attractive vertical market.

Since 2019, $50 billion has been invested across more than ​500 deals​.

Sustainable infrastructure

An increasing percentage of PE firms are targeting investments towards companies focusing on ​sustainable infrastructure​.

These firms are at the forefront of the transition from fossil fuels to solar, wind and hydroelectric power. Many are also involved in initiatives to expand broadband access and modernize transportation and utility systems.

Because many of these initiatives are partially ​funded by the Inflation Reduction Act​ and the ​Infrastructure Investment and Jobs Act​, they’re long-term investments that are both inflation and recession resistant.

How to invest in private equity

PE funds

Investors who don’t want to put their capital into a single PE basket or don’t feel like researching candidates on their own may have access to a variety of pooled funds that invest in private companies.

Traditional private equity funds are created by PE firms and large asset management companies. These funds pool capital to execute various private equity strategies. A fund may have one or many different investment mandates.

Unlike mutual funds and ETFs, most PE funds are not registered with the SEC. This means they’re not required to disclose daily values of share prices, issue quarterly or annual shareholder reports or disclose their holdings or activities.

• They’re only available to accredited investors, who either have an annual income of $200,000 or more or at least $1 million in investable assets.
• Investment minimums generally range from $25,000 to several million dollars.
• PE funds usually require invested capital to be locked up for a decade, and it can be very difficult or expensive for investors to redeem their shares before this period ends.
• At the end of this lockout period the fund usually closes. Principal is returned to investors who also receive distributions of profits earned during this period.

Arta Blue Chip private markets

Getting access to alternative investments and private markets isn’t that challenging.

What remains challenging, though, is getting access to the type of blue chip private market offerings that the ultra-wealthy invest in.

As a private wealth provider, this is exactly the type of access that Arta Finance provides, offering the opportunity to invest in funds managed by firms like KKR in private equity and Carlyle in private credit.

The key thing to understand about Arta’s private investment model is that they aren’t trying to be a marketplace. You won’t be able to find every fund under the sun on Arta.

Instead, their aim is to tailor and curate the funds on their platform to focus solely on the highest quality offerings.

Details

• Arta Fees: Starting from 0.5%
• Qualification: Fund dependent, Accredited Investors and/or Qualified Purchasers
• Investment Minimum: Starting from $2,500
• ​Start here​

GP Stakes

Similarly to the idea that Arta offers access to exclusive funds, they also offer access to exclusive strategies – including ​GP stakes investing​, an intriguing way to invest in the private equity market.

To understand GP stakes investing, here’s a basic reminder about how PE funds work:

• Private equity managers (general partners, GPs) raise money from investors (limited partners, LPs).
• LP commitments are pooled into a fund along with capital provided by the GP itself (the sponsor commitment).
• LPs pay fees to the GP for managing the fund, including fixed management fees and variable performance fees.

The traditional way to invest in PE is as an LP in a specific fund.

But GP stakes investing offers the opportunity to hold minority, passive shares in the GP itself.

The main benefit here is that GP stakes have more diversified revenue streams than basic LP investing:

• GP stakes are entitled to a share of the distributions from underlying PE funds (LPs only get this)
• GP stakes also get a share of the fees paid by LPs
• Finally, the value of a GP stakes investment can increase based on growth of the GP itself (just like owning shares in any other company)

The other big benefit is diversification.

As an LP, you might invest in just a single fund. But GPs have exposure to funds across many different sectors and vintages.

Details:

• Arta Fees: 0.9% (Currently discounted to 0.65%)
• Qualification: Qualified Purchasers
• Investment Minimum: $100,000
• ​Start here​

The largest PE fund firms

The five largest US-based PE fund firms, in terms of AUM, are:

1. ​The Blackstone Group​
2. ​KKR​
3. ​Thoma Bravo​
4. ​TPG Capital​
5. ​Advent International​

When conducting due diligence on any PE equity fund, you might want to investigate the firm’s reputation and any media coverage their activities have generated.

Ethical considerations

While there are ​many examples​ of PE firms helping well-known companies like Dunkin’ Brands, Dell, and Marketo restructure, they tend to get overshadowed by horror stories of greedy PE firms ​destroying companies and entire industries​, putting hundreds of thousands of employees ​out of work​, and gutting the quality of care and safety at ​nursing homes​ and ​hospitals​.

Interval funds

Interval funds offer an easier way for Main Street investors to gain exposure to private equity opportunities.

Many of these SEC-registered close-ended funds invest directly in alternative investments, including private companies and PE funds.

Investors can continuously purchase shares at a net asset value (NAV) that is calculated daily, and these funds are required to disclose holdings and issue periodic shareholder reports and performance updates.

You generally don’t need to be an accredited investor to buy shares. And investment minimums are often as low as $2,500.

Moderate liquidity

Because these funds often invest in illiquid securities that can’t be easily sold, managers try to keep as much capital locked up in the fund at all times.

For this reason, you generally can only redeem shares during a brief, predetermined repurchase period. Often this is a single day that occurs once per quarter, although some interval funds only allow redemptions once or twice a year.

Most of these funds also limit the total number of shares that can be redeemed during these periods, so you may not be able to redeem as many shares at a time as you want.

The top-performing PE interval funds

The ​top-performing interval funds​ in 2024 were:

1. ​Bluebay Destra International & Event-Driven Credit Fund​
2. ​The Private Shares Fund​ (Note: We’re doing a Deep Dive on these guys in January)
3. ​Stone Ridge Trust II​
4. ​BlackRock Total Income + Real Estate Fund​

Private market access funds

These closed-end funds assemble a portfolio of third-party managed funds that invest in privately held companies. Some of also invest directly in private companies

As funds of funds, private market access funds may offer exposure to a wider variety of PE investments than a single private equity fund.

Because they’re not SEC-registered, they’re only available to accredited investors.

Investment minimums can range from under $100,000 to several million dollars.

Like interval funds, investors may only be to sell shares during predetermined time periods.

Here’s a small list of private market access funds:

• ​L&G Private Markets Access Fund​
• ​Ares Private Markets Fund​
• ​NB Global Private Equity Access Fund​
• ​Hamilton Lane Evergreen Advantage Global Private Assets Fund​

PE feeder funds

Many brokerage and wealth management firms offer this option to high-net-worth clients who want to get involved in private equity or venture capital investing but don’t want to commit initial investments of $500,000-$1,000,000.

Feeder funds pool capital from many investors and invest it into a master private equity fund, which then invests this capital in individual private companies.

One master fund may receive capital from many different feeder funds at different financial firms. While feeder funds often have lock-up requirements, investors can often get into them for as little as $50,000.

To get access to these funds, you usually need to work with an investment professional who is affiliated with a broker/dealer that offers them.

However, in a few weeks we’ll highlight a new PE feeder fund that a) removes all bureaucracy from the process, and b) seems to have some very good deal flow.

Stay tuned…

Is PE right for you?

PE investing can shield some of your wealth from the irrational exuberance of stock market swings, while giving you the opportunity to profit directly from private companies that are growing revenue and may eventually go public.

But before you get into it, you need to understand that PE investing is a long-term play with extremely high risks.

• It may take a long time for you to find out how much you’ll profit from your investment — if at all.
• Your money may be locked up for years.
• Be prepared to pay higher investment management fees than you would with most traditional mutual funds and ETFs.

Most individual investors don’t have the knowledge or resources to conduct due diligence of private equity investment options by themselves.

This is why we started Altea, and the ​decentralized due diligence​ approach which Stefan wrote about last week.

—

That’s it for today!

Let’s ​chat private equity​ in the Alts community.

See you there,
Jeff

Disclosures

• This issue was written and researched by Jeff Briskin and edited by Stefan von Imhof.
• This issue was sponsored by ​Arta Finance​​
• This issue contains an affiliate link to ​bookshop.org​
• This is a paid issue. To read the full thing you need the ​All-Access Pass​​
• Neither Alts nor Altea has any current holdings in any companies mentioned in this issue