Vital Signs #122: Private Equity Outperforms Stock Market

financial

Investing In Private Equity: What Advisors Need To Know

 

Financial Advisor Magazine

By Kelly Rodriques and Michael Goering

January 21, 2015

http://www.fa-mag.com/news/investing-in-private-equity--what-advisors-need-to-know-20536.html?section=40&page=2

 

In recent years, investors have woken up to the benefits of investing in private equity and taken a growing interest in the space. A report by the Private Equity Growth Capital Council provided one key reason: Private equity has outperformed the stock market by an average of 6.5 percentage points over the past ten years. Private equity is highly dynamic, with a constant stream of possible investment opportunities coming to market in a wide range of industries. And, with start-up and private placement deals becoming more accessible to accredited investors, thanks to the rapidly growing equity crowdfunding industry, investors will likely continue to seek out opportunities in this space.

 

However, according to a recent poll of 682 PENSCO clients, most investors do not understand how to find a private placement opportunity that would meet their risk profile.  In order to help evaluate these kinds of opportunities for clients, advisors need a better understanding of the private equity landscape.

 

Today, there are a number of interesting factors that advisors should be aware of that are affecting deal flow within the private equity space. The growth of crowdfunding, increased opportunities in the technology sector, and the ongoing impact of regulation are all vital areas of consideration.

 

Growth All Over

 

In 2012 the Jumpstart Our Business Start-Ups (JOBS) Act passed, which lifted the general solicitation ban for accredited investors (meaning investors with a net worth greater than $1 million, excluding the value of their primary residence, or an income of $200,000 a year or more), which allowed private companies and startups to advertise deals publicly through avenues like crowdfunding platforms or social media.

 

The passage of this legislation spurred the launch of a steady stream of new equity crowdfunding platforms that together helped raise an estimated $2.7 billion online, a figure that grew to $5.1 billion in 2013. As new sites come to market almost daily, investment opportunities are emerging everywhere for accredited investors, with many coming from less traditional markets. In fact, areas outside of the traditional east and west coast markets for angel investors and venture capital are seeing more investment opportunities and interest, especially in states like Ohio, Colorado, Arizona, and Pennsylvania.

 

Of course, growing popularity is not without complications. As more companies and start-ups enter the space, the industry becomes more diluted, making it more difficult to find quality deals with high returns. The specter of fraud also comes to the fore. Advisors need to be increasingly thorough and careful in vetting deals for their clients, and must conduct razor sharp due diligence to confirm the viability of deals.  Finally, as the law stands now, participation in these deals are limited to accredited investors, and the industry is still waiting to see if crowdfunding will be opened up to the general public with the passage of Title III of the JOBS Act, which would allow companies to raise capital from non-accredited investors through online portals.  While it could take some time for the SEC to come down with a decision on Title III (according to some reports, these rules might not go into effect until January 2016) advisors should watch this space closely in order to understand the possible implications that these regulatory changes could have on their clients going forward.

 

An Emphasis On Technology

 

The technology sector remains one of the most attractive to private equity investors. In 2013, technology-related transactions grew 14 percent and 2014 is on track for its strongest year since 2007. In fact, according to data from PwC, the deal market through the end of Q3 stands as one of the strongest in years.

 

The past few years have seen an increase in global investor confidence among companies operating within the technology space, as private equity investors remain optimistic about the ability of these companies to raise capital and achieve favorable returns. In addition, improving capital market conditions have also helped to increase the pace of activity for initial public offerings in the tech sector. For the second year in a row, venture capitalists expressed the most interest and confidence in investing in cloud computing, with mobile technology coming up a close second.

 

This kind of increase global investor confidence will help innovative companies in the U.S. expand their footprint, which represents a significant investment opportunity as this sector continue to grow down the line.

 

Regulatory Questions

 

In addition to an anticipated decision about Title III of the JOBS Act, there are many other important regulatory matters that advisors should be watching closely and particularly those that focus on how how investment advisors handle non-traditional asset classes. At the beginning of this year, the SEC published detailed guidance on the precautions advisors must consider before recommending alts to clients. On top of that, Mary Jo White noted that the agency may soon conclude its two years of private fund focused risk reviews. The agency is also considering revising the accredited investor standard, a decision that could potentially impact all clients invested in private equity.

 

To stay on the right side of the SEC, advisors must be transparent, consistent, conservative and compliant. Some observers believe that the SEC is trying to send the message to advisors that they should go above and beyond normal due diligence. The bottom line for advisors is, a strong regulatory framework is key.

 

At both PENSCO and Buttonwood we’ve noted an increased interest in private equity from savvy, self-directed investors. For clients looking for added diversification and additional sources of potential returns, the asset class is especially attractive. While not without its challenges, we see continued opportunities in private equity to come.

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