Why is Private Equity appealing?
As an equity investment, an investment in Private Equity gives you the opportunity to share in increasing the value of a company. Many analyses show that continuous Private Equity investment programs are capable of achieving above-average returns. There are many reasons for this:
Functional Incentive System through Personal Investment
The management of the company purchased, as well as the fund managers, invest their own capital, thus giving them personal interest in leading the company successfully and increasing its value.
Increased Value through the Implementation of Long-term Business Plans
The value multipliers identified during the run-up to acquisition are implemented in a consistent manner. The company is managed by the fund over many years, which creates a focus on long-term considerations rather than short-term quarterly goals.
Rapid and Short Decision Paths
Because of the flat hierarchies typical to Private Equity funds, it is possible to make decisions quickly.
Leveraging Returns on Equity through External Financing
By and large, Private Equity funds finance the purchase of a stake with debt. When selling the company, however, the increase in value achieved returns to the equity investors. External creditors receive only the loan amount and the fixed interest.
Low Dependence on Decision Timing
Returns on liquid assets are often determined by the timing and frequency of purchase and sale decisions that are subject to limited information. Longer review processes are normally required for transactions involving the purchase and sale of Private Equity. Trading approaches typical to stocks do not play a role with Private Equity.
The investment and sales process of Private Equity funds is an important reason for their independence from market timing. Investments are made incrementally over a period of 4-5 years, with sales occurring during a second phase of another 4-5 years. This results in an income and payment structure for investors, which is referred to as a "J curve" because of its shape. The graphic demonstrates an idealized J curve.