Discover in this file the Private Equity (PE) or capital investment, its operation, and its characteristics, as well as its advantages and its limits/risks. Also discover in this article the different ways to invest in private equity, along with our advice. Finally, find our study of 3 major French companies specializing in Private Equity and listed on the stock market.
What is Private Equity?
Private equity: investing in the unlisted
Private equity, or capital investment, refers to investing in companies not listed on the stock exchange. It is therefore a matter of buying shares in small and medium-sized companies, underdevelopment, whose shares are not listed on the stock exchange.
Private equity is therefore one of the sources of financing for unlisted SMEs and ETIs, an alternative to bank debt, which does not require going through the IPO (Initial Public Offering) or IPO, a cumbersome, costly, and with many constraints for companies.
Private Equity-type financing is accompanied by a vision of long-term support. The constraints of this method of financing are often more flexible than those resulting from bank, bond, or IPO financing.
Indeed, creditors or shareholders can sometimes put a certain form of “pressure” with regard to profitability and deadlines for achieving objectives, while financial support through a Private Equity company is generally more flexible and focused on the “long term”.
For example, if the SME has to invest massively in year N to develop its growth, it will undoubtedly be easier if it is financed in Private Equity than if it had shareholders looking for dividend yields. The principle is the same for bondholders who also wish to benefit from returns on their bonds (financial debt securities).
The private equity sector in finance
If you were a Private Equity manager, your job would be to analyze, meet, and support SMEs or ETIs looking for sources of financing to help them in their growth process, other than those offered by bank debt or even lending. IPO and Listing on the Stock Exchange.
Who knows, maybe the company of 200 employees located in the industrial zone of your city is in full expansion thanks to its innovative activity? It could be wise to invest in it and thus support its future growth!
At first glance, this is not an easy task… First of all, you need to have the expertise to target the right profiles of companies among those looking for financing. It is then necessary to have analytical skills within the framework of the study of “files” (growth, the dynamism of the sector, company policy, are some examples).
And above all, you must have substantial capital to finance these companies, knowing that it is better to be diversified.
All these elements present a priori many barriers for the individual investor. It remains very difficult to invest directly with listed companies for individuals. Nevertheless, investment in Private Equity is possible thanks to Private Equity companies listed on the Stock Exchange and Private Equity funds such as FIP, FCPI, and FCPR.
Unlisted investment: operation and characteristics of Private Equity companies
In general, Private Equity companies tend to opt for sector specializations such as health, technology, telecommunications, or even consumption.
Their role is to support the growth of SMEs over the long term, by creating a relationship of partnership and trust, as well as the alignment of common interests. Improving the performance of SMEs can also be part of the objectives.
The common objective is the creation of long-term value for the financed company and attractive returns on investments for the Private Equity company.
In general, the majority of a portfolio of a Private Equity company is made up of SMEs and ETIs. These companies can also arbitrate a share of their investments in companies listed on the stock exchange if they find potential there.
The management teams of Private Equity companies have good levels of expertise. Their main role is to target private companies (not listed on the stock market) with high potential and seeking funding. They also have the role of calculating the rates of return.
Thus, these teams carry out real “field investigations” by meeting managers, visiting premises, providing legal support, etc.
The “entry tickets” of Private Equity companies can be low or high. Indeed, they can be from a few million euros for a small SME, to more than 500 million euros for larger company profiles.
In France, the BPI is a major player in Private Equity, with nearly €2 billion allocated to development capital for the year 2020 .
In the world of Private Equity, there are two main categories. The first is growth capital, which consists of supporting the growth of a private company; the second is venture capital, which consists of financing a company when it is launched.
It should also be noted that Private Equity is not only reserved for investment companies. Individual investors can also take part. In Anglo-Saxon terms, large private equity investors are called Business Angels. One of the most active in France is Xavier Niel (CEO and founder of Iliad/Free) through his school 42 and Station F, one of the largest startup incubators in the world.
Investing in Private Equity: the different ways to proceed
Invest directly in Private Equity
Although this is the least common and most difficult solution, it is – in theory at least – possible for a retail investor to raise a stake in a small unlisted company. He will then play the role of business angel. To buy shares in an unlisted company, the individual will most often have been asked. It may be, for example, a request from those around him or a fundraiser from a brand of which he is a client who turns to his early adopters wishing to take a stake in the company to support it in order to finance its development.
Invest in Private Equity by buying shares of private equity companies listed on the stock exchange
A simple solution for subscribing in the world of Private Equity is the acquisition of shares listed on the stock exchange of Private Equity companies.
These shares of Private Equity companies are accessible via a securities account, a PEA, or a PEA PME if these companies are SMEs and originate from the European Union.
The following are examples of large global companies that include private equity investing as part of their business, ranked by their Assets Under Management (AUM) levels relative to private equity segments.
TOP 10 of the world’s largest Private Equity companies
- KKR & Co (United States) with $459 billion AUM, including $217 billion in Private Equity
- The Carlyle Group with $293 billion AUM, including $162 billion in Private Equity
- Blackstone Group (USA) with $881 billion AUM, including $126 billion in Private Equity
- CVC Capital Partners (USA) with $122 billion AUM, including $92 billion in Private Equity
- Thoma Bravo (USA) with $91 billion AUM (100% Private Equity)
- TPG Capital with (United States) $109 billion AUM, including $87 billion in Private Equity
- Vista Capital with $86 billion AUM (100% Private Equity)
- Neuberger Berman Group LLC with $460 billion AUM, including $80 billion in Private Equity)
- Warbug Pincus LLC with $73 billion AUM (100% Private Equity)
- EQT (Switzerland) with $73 billion AUM, including $34 billion in Private Equity
Investing in shares in a listed Private Equity company makes it possible to benefit directly from the unlisted universe (private companies), which is generally difficult to access for the “general public” investor.
Invest in Private Equity via FIP, FCPI and FCPR
There are also other possibilities for private equity investments, in particular via FCPRs.
These funds, mainly invested in unlisted companies, have a subscription period, then an investment period, and a liquidation period. Despite a very rigid operation and a substantial fund blocking period, they represent a fairly advantageous solution for the individual who wishes to invest in the unlisted, particularly with regard to their tax advantages.
FCPR (Risk Investment Mutual Funds) is made up of at least 50% of companies not listed on the stock exchange. This type of fund is high risk and the investor can potentially lose all his capital or realize significant capital gains. This type of fund is an ideal solution for individuals wishing to invest in Private Equity. Some tax FCPRs allow benefiting from an income tax exemption on the proceeds of the units which is paid to the investor both during the 5-year holding period but also a posteriori if the units of the fund are kept. for at least 5 years. Note also that all FCPRs allow you to benefit from an exemption of capital gains realized but social security contributions at 17.2% remain due.
FIPs and FCPIs are two categories of FCPR which have particular characteristics in their composition and offer additional tax advantages when subscribing to the fund.
FIP (Proximity Investment Funds) is made up of SMEs with less than 250 employees and less than €50 million in turnover. These funds must include investments concentrated in a specific region with the possibility of extending its selections to four neighboring regions. At least 70% of them must be invested in SMEs.
FCPI (Fonds Communs de Placement dans l’Innovation) is made up of so-called innovative companies with less than 2,000 employees. These types of companies are characterized by a necessary threshold of investment in Research & Development (R & D) of at least 15% of their overall expenditure.
FIPs and FCPIs allow you to benefit from a tax reduction equivalent to 18% of the amount invested, a reduction boosted to 25% for payments made from May 9, 2021, and until December 31, 2021, and which could well be new for payments made by December 31, 2022, provided that the European Commission gives its agreement.
NB: the tax reduction is increased to 38% of the amounts invested for Corsica and Overseas FIPs to 38% if the fund’s assets are fully invested in eligible securities.
These tax reductions are part of the overall cap on tax loopholes and there is a cap of 12,000 euros for a single person, i.e. a tax reduction of 2,160 euros if the rate of tax reduction is 18% ( and 3,000 euros if the rate is increased to 25%) and 24,000 euros for a couple sharing the same tax household, i.e. a tax reduction of 4,320 euros if the tax reduction rate is 18% (and 6,000 euros if the rate is increased to 25%).
Major banks and wealth management advisers offer this type of fund as well as investment companies specializing in these sectors.
Investing in this type of fund also allows you to benefit from tax advantages.
What are the advantages of investing in Private Equity?
Private equity: a very vast universe that we would be wrong to deprive ourselves of
The vast majority of companies present on French territory are unlisted. That is to say the reservoir of companies that this sector represents. It would therefore be unwise to close the doors to this manna of companies present in almost all sectors of activity.
Private Equity: very high potential returns
The main advantage of private equity is undoubtedly its potential return. It is indeed a question of financing promising not very mature companies, and by raising capital at their beginnings, the capital gain could be very significant. The earning potential is therefore very high.
Investing in Private Equity can allow you to benefit from tax advantages
In addition, investing in the unlisted via funds allows you to benefit from tax advantages. Indeed, investing in Private Equity via an FCPR makes it possible to benefit from an exemption from capital gains tax if the shares have been held for at least 5 years. In addition, certain categories of FCPR such as FIP and FCPI allow you to benefit from tax advantages on subscription.
The advantages of investing in Private Equity via specialized funds and companies
One of the advantages of Private Equity companies or private equity funds is diversification through multiple investments. Thus, it is not uncommon to find more than 50 holdings in the portfolios of Private Equity companies or Private Equity funds. In this regard, the risk is controlled through diversification.
We should also note the intangible contribution of experience from the management teams of private equity companies or private equity funds. Supporting growth is part of their job and they generally have cutting-edge sector expertise.
What are the risks of investing in Private Equity?
Private Equity: an increased risk of capital loss
Investment in Private Equity concerns, as we have seen, immature companies, at a still very early stage of their development, and if the objective is obviously to select the companies which will be able to gain shares market and impose themselves in their sector, some will never meet with the expected success. Stagnation or bankruptcy are two very real possibilities that can lead to significant capital losses.
Private Equity: an opaque and difficult to access sector
The non-listed concerns small and medium-sized businesses, even very small businesses, very numerous, of course cannot be easily identified. It is therefore extremely difficult for individuals to access this sector and direct investment remains very rare. Individuals will be present in this segment mainly through funds and listed private equity companies.
Private Equity: an illiquid segment
Investing in Private Equity also presents a liquidity risk. In other words, the investor takes higher risk of not finding a counterparty to sell his holdings in companies not listed on the stock exchange.
The risks associated with private equity companies
The risk of investing in Private Equity may come from potential errors of assessment in the choice of companies, made by Private Equity managers.
These errors of assessment come, for example, from investments made in young companies or in sectors or companies in turnaround, which fail to achieve their objectives. The reasons are many, such as the arrival of competition, poor management, or other macro or micro-economic risks.
It should also be noted that the companies targeted within Private Equity activities are often SMEs which represent a potentially riskier universe than that of large companies. Indeed, due to their small size, SMEs are also riskier.
Our advice for investing in Private Equity
Ensure the match between the private equity investment and its investor profile
Before investing in Private Equity, the individual must first ensure that his investor profile, and in particular his risk profile and his investment horizon, are in line with the investment capital which, it should be remembered, is very risky and must be considered in the long term.
The objective of Private Equity is the long-term support of private companies.
Short-term trading-type arbitrage or short-selling strategies are excluded from the business model and investment diversification must be one of the risk management criteria.
Understand your investment in private equity and its specificities
Investors have a wide range of choices within a global universe of several hundred listed companies specializing in “Private Equity” investment capital as well as among FCPI / FIP / FCPR type funds. Before subscribing, he must study their strategies in detail.
With regard to funds, the investor must above all pay particular attention to questions of liquidity, and in particular to the blocking period which must correspond to his investment horizon, bearing in mind that the blocking period may be extended. He must also take into account the level of risk (indicated in the KIID), but also the possible tax advantages, as well as the various costs which will reduce the performance of the investment.
With respect to listed private equity firms, the investor, as with any other stock market investment, will need to assess the fundamentals of the stock and pay particular attention to the tangible net asset value per share, but also to the average earnings per share, to the operational profitability per share, to the debt ratio, as well as to the evolution of the share price.
Private Equity firms are transparent about their various management models and strategies. The investor can therefore move towards those he likes. These companies are specialized in certain sectors or are rather large Private Equity companies, with different types of funds, etc. There are many variations within this universe.
For example, the French listed company Altamir has decided to specialize in specific sectors, in this case, TMT (Technology, Media and Telecoms), digital, services, consumption, and health.
Tikehau Capital favors entry tickets of between 10 and 70 million euros as the investment ceiling per private company, with no sectoral limits.
Don’t overlook diversification
Given the real risks of Private Equity, it is recommended to limit the share of one’s assets invested in this asset class. You will therefore only have to invest in private equity a small part of your financial capital.
But that’s not all. Within the pocket allocated to private equity, you must also ensure good diversification of your assets by investing in several funds and/or private equity companies.
Do not hesitate to be accompanied
It can be difficult to choose the right assets to invest in private equity, especially if tax issues arise. To help you select the private equity funds and companies best suited to your investor profile, you can contact a wealth management advisor who will help you identify the most relevant solutions.
3 French Private Equity companies listed on the Stock Exchange.