A Brief Investor’s Guide: 5 Considerations to Make When Evaluating Private Equity


Well-managed private equity funds regularly produce returns that are unachievable via public markets. Not every private equity firm or partnership, of course, is as capable as others of serving its investors so well.

Fortunately, there are some straightforward ways to highlight the private equity options that are worthiest of investment. In most cases, that will mean looking at the credentials of managers, along with details particular to the investment opportunity currently being contemplated.

Successful investors almost always take the following five factors into consideration when evaluating private equity funds.

#1 Past Performance

There is likely no more reliable way to predict the performance of a private equity fund than to look at the track record of its managers. Private equity fund managers like Lincoln Frost who have performed well in the past are normally more likely to produce similar results with future projects.

Because private equity funds are not subject to the same reporting requirements as publicly traded companies, it is important to make sure to obtain and assess accurate, useful figures. Results reported by third-party accounting firms like Brown Smith Wallace should always be preferred to informal claims made by fund managers and other insiders.

Past performance always has to be contextualized to enable useful comparisons among managers and funds. The year that a private equity fund was raised, for instance, can impact its performance as much as the skill and diligence of its managers.

#2 Strategy

Private equity management teams inevitably bring particular strategies to their work. Some managers prefer to use leverage to extract profits quickly, paying large dividends, and then reselling companies they have recently purchased.

Such dividend recapitalization strategies can work well in certain situations, but many investors see them as risky.

More conservative investors often prefer to focus on private equity funds that aim to produce profits by making concrete operational and financial improvements to companies under management.

#3 Fund Structure

The size and focus of a private equity fund always need to be accounted for. A particularly small fund that will only ever hold stakes in a handful of broadly similar companies might pose large risks to investors but also harbor the potential for impressive returns.

A more generously capitalized fund that will diversify its holdings across industries could be less likely to appreciate at a rapid rate but also hold up better in an economic downturn.

The structure of a fund will typically be implied, to some extent, by the overarching strategy but will normally merit consideration in its own right.

#4 Internal Controls

Private equity funds are regulated quite a bit less strictly than publicly traded companies, most bond issuers, and other investments open to most investors.

While the accredited investors whom private equity funds aim at are expected to be somewhat sophisticated, they can only have so much insight into how particular firms and partnerships operate.

It will therefore always be wise to look at the internal controls that will be used to keep a private equity fund on the straight and narrow.

Most funds today strive to maintain rigorous, reliable controls to win and keep the confidence of investors, but that cannot be taken for granted.

#5 Fees

Private equity managers normally receive an annual fee of two percent of capital plus 20 percent of any returns. While deviations from this industry-wide norm are rare, it will always be best to double-check the fees of any fund being considered.

Looking into these five issues should make it fairly easy to compare the number of private equity funds and identify those that are most appropriate.

Private equity can be rewarding, but it does take some research to use this type of investment vehicle effectively.

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