Private Equity Funds
As the “typical” asset classes fail to provide safe and consistent returns, investors continue to look for alternatives. Brokerage firms have seized upon this as an opportunity to introduce investors to “private equity.” At times the name is in vogue, touted as an elite club to which only the institutional investors or the wealthy and sophisticated belong. Its lack of transparency has often created a mystique that has become part of the allure. Behind this mystique and allure, however, is an illiquid and complex investment that is unsuitable for most investors.
Private Equity is an asset class that includes various forms of securities that are not traded on a public exchange. There are various strategies of private equity, including venture capital, leveraged buyouts, mezzanine financing, distressed investments, and the like. Often, these investments are used to help finance various stages of a business, from start-up financing, to just prior to IPO financing, to restructuring after a company has imploded or is undervalued. Private equity’s allure is the potential to receive spectacular returns. A high degree of risk accompanies this potential, however, and the degree of returns as an asset class is often skewed – as private equity funds are not tied to the same reporting standards as other investments, often it is only the best performing funds that provide their returns. This creates unrealistic expectations for potential investors. Furthermore, since the funds that underperform or implode may not report their performance, investors may not have a full understanding as to the risks or potential downside of investing in these vehicles.
The investments are customarily made indirectly through a private equity fund, managed by a private equity firm. A private equity fund is a collective investment scheme used for making investments in various securities according to one of the investment strategies (as mentioned above) associated with private equity. This allows the investors diversification across multiple companies, along with the expertise and resources (via the private equity firm) to monitor the investment. These funds generally draw their investment pools from institutional investors, wealthy accredited investors, pension funds, or investment managers that specialize in this asset class.
Private equity funds are typically limited partnerships and are governed by the terms of a “partnership agreement.” Often, such partnerships are comprised of a General Partner, who manages and controls the fund, and Limited Partners, the investors of the fund who have no say/control over management of the fund.
The partnership agreement will usually contain terms such as term of partnership (duration of investment), management fees, carried interest, minimum rate of return, transfer of interest, and restrictions on the general partner.
Investors looking to diversify into this asset class should realize that the time horizon for these investments is generally much longer than that of publicly traded securities. Private Equity securities are also highly illiquid, as they are not traded on the public market. Depending on the restrictions in the partnership agreement, there may be some opportunity for an investor to sell his/her interest in a secondary market; yet the funds often have significant entry requirements, narrowing the pool of possible secondary buyers.
Additionally, private equity funds may have a lack of transparency about them. The reporting standards currently imposed by regulations include exemptions that many private equity funds take advantage of; therefore, investors may not know exactly how their money is being invested. These funds may also employ leverage, some at very large amounts. Investors should be wary of the high returns some private equity funds may promise, and how these funds will accomplish these returns. As an asset class, private equity funds investments are generally long-term, illiquid, and not usually suitable for retail investors.
If you have investment losses or problems involving private equity funds, call the lawyers at Page Perry for experienced representation at (770) 673-0047 or (877) 673-0047 (toll free).