By Marc Powell.
The well known private equity fund 2/20 model has been the mainstay of private investments over the past two decades. However, the less known and structured direct investment method of investing has some unique advantages for both the investor and target portfolio company which warrant serious consideration to become an alternative in private placement investments.
Rather than raising a fund for investment in certain sectors or regions, investments are made on a per deal basis so debt and equity are raised based on the a particular characteristics of the target acquisition. Thus, the focus becomes the target rather than the fund raise. Also, pressure to deploy raised capital in private equity funds to start generating returns can result in additional risk. Instead of a ‘fee” driven approach, the focus is on the target and more “traditional” system of growing a company.
A classic example of this ‘direct” investment approach is the Family Office or Private Investment Group investment model. Those type of Organizations direct investments have grown exponentially over the past decade – both private investment groups and family offices are pooling resources, they have set up their own investment teams to invest in and manage their investments. Now large pension funds have also brought some of their investing “in house” with investment/management teams dedicated to finding and investing in target companies directly rather than outsourcing or using intermediaries. Previously, these entities made their investments via asset managers like private equity funds to invest their funds and manage the investments until exit with very little input or control over their investment. Another example is a Family office or private investment group investing alongside a PE fund but as a coinvestor vs traditional investor so not subject to the traditional management fees. In essence the middle man is being eliminated resulting in cost efficiencies with the right experienced team in place. Having your own dedicated team also ensures further control, flexibility with less structure and thus makes for a better investment.
The hybrid approach of a direct investment coupled with the traditional PE exit term of 5-7 years results in an optimal situation whereby the investment is closely monitored on a cost effective basis to improve the portfolio companies performance and resulting value in preparation for the exit at a suitable return.
This “bespoke” investment approach can be used to invest in particular sectors to create synergies within particular sectors or subsectors. The resulting “economies of scale” arising from these coordinated investments results in cost savings and a greater return for both the investor and portfolio company. This investment model should see growth in the coming years given the competitive nature of the private investment industry and drive for further control, yield and efficiencies.