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Private equity 101: What you should know and why it matters

According to the Canadian Venture Capital and Private Equity Association (CVCA), more than $242 billion has been invested into 5,600 Canadian companies by private equity and venture capital firms since 2013. That’s a significant influence on our economy.

What is private equity

For investors, private equity (PE) is an alternative asset class (along with real estate and venture capital) that is gaining increasing popularity in portfolios. For companies seeking investment, it’s a flexible financing option with a PE partner focused on increasing the business’ value over a period of time in order for the PE firm to exit with a profit.

PE firms create funds and raise capital through investments by limited partners (LPs) who are accredited institutional investors—such as pension funds or banks—and high-net-worth individuals. Once the PE investors have raised the pre-determined fund amount, that capital is invested into promising companies using various investment strategies. The most common is a leveraged buyout (LBO), where the PE firm typically takes a controlling stake in the company through an equity investment that allows the company to leverage additional capital through debt financing. Often, these buyouts are part of succession planning where management will become an equity investor alongside the PE firm, effectively transitioning ownership to the next generation through a management buyout (MBO).

Private equity targets

Whereas venture capital firms target promising startups, PE firms aim for already well-established companies with potential for significant growth through expansion or acquisition. While these companies can be found across all industries, in Canada the most considerable PE value resides in information and communications technology: $3.7 billion in 2020.

“The PE market across Western Canada is strong and growing with a key focus on succession planning for long-standing businesses that are the cornerstones to economic stability, many of which are in the manufacturing industry which is also a significant contributor to local employment,” says Rob Connoly, CFO of Westcap Mgt. Ltd., a locally-based PE company that just announced the largest private equity raise by a Saskatchewan-based
fund manager. He is also a member of the CVCA Board of Directors and chair of the CVCA’s PE Committee.

Private equity goals

The goal of PE investment is achieving a positive ROI after several years (between five to ten, typically) and having an exit strategy that creates a profit for investors. PE firms typically charge management fees (approximately two per cent of assets) to cover business costs, and performance fees of around 20 per cent of investment portfolio growth. The balance of return on the portfolio is distributed to the LP investors.

Private equity advantages

A 2021 report by Deloitte estimates that globally, PE assets under management will reach $5.8 trillion by 2025. Because PE firms focus on longer-term investments, the PE market is resilient to many market influences—for example, a global pandemic. PE offers an effective growth vehicle for businesses, particularly small and mid-sized enterprises (SMEs). SMEs are the most significant job creators in the private sector in Canada. More than 60 per cent of Canadian PE is valued at $25 million or less, demonstrating investors’ support of our SMEs.

A 2020 study commissioned by the CVCA examined the effects of PE on a sample of Canadian SMEs, reporting:

  1. PE investment has a positive impact on employment growth. Three years post investment, companies in the study added 24 per cent to their employee rosters.
  2. PE-backed companies increased capital investment by 75 per cent as a share of revenue.
  3. Average revenue growth of 10.9 per cent per year followed the PE backing.

PE is a proven growth vehicle that has advantages for a business owner. In addition to increased working capital and greater freedom for growth, PE investment is an alternative to traditional financing methods such as high-interest bank loans. PE firms provide expertise to companies, creating operational value by bringing outside strategy and vision to the table. Influential PE firms empower management and employees to execute and
deliver on goals with lucrative incentives.

PE infuses deliberate change on how business is conducted, and growth objectives achieved. By igniting competition and improving products and services, PE plays a significant role in our local economy.