Guide to Private Equity and Venture Capital for Pension Funds MEMBER SERVICES MEMBER Invest Europe Pension Fund Guide to Private Equity & Venture Capital Invest Europe Pension Fund Guide to Private Equity & Venture Capital 1 Introduction 01 Introduction 02 Chapter 1: What are private equity and venture capital? If you’re considering investing 06 Chapter 2: Why invest in private equity and venture capital? 12 Chapter 3: How to invest in private equity and venture capital in private equity and venture 20 Chapter 4: How to measure performance 24 Chapter 5: What fees are charged? capital, making the first move 26 Chapter 6: What are the risks and how are they managed? 30 Chapter 7: How are private equity and venture capital regulated? 32 Glossary may seem daunting, given that many characteristics are quite unlike those of more traditional types of investing. That’s why we have put together this guide. Containing practical information on why and how to invest in the asset class, plus an overview of the benefits and risks involved and of the different ways of investing in private equity and venture capital, we’ve also gathered the experience of long-standing pension fund investors in private equity and venture capital to show how they manage their portfolios and exposure. Over the last 15 years, the private equity and venture capital industry has grown and matured substantially to become an established part of many institutional investors’ portfolios, with pension funds among some of the most active investors in this type of fund. Invest Europe’s data We invest in private equity because we are shows that almost a third of the capital looking for a premium over listed equities. raised by European private equity and venture capital funds in recent years To date, it has been our best-performing asset came from pension funds, the largest category of investor. As private equity class, having achieved 17% net returns per continues to outperform other asset classes over the long term, existing annum since 2005 – ahead of the 300-500 basis investors are looking to increase their exposure, with a third of pension fund points outperformance over the public market respondents to a Greenwich Associates that we believe is an appropriate premium. report expecting to up their allocations to private equity and venture capital Katja Salovaara, Senior Portfolio Manager, Private Equity, over the next few years. Ilmarinen Mutual Pension Insurance Company We hope you find this guide helpful in understanding some of the unique characteristics of this asset class. Invest Europe T +32 2 715 00 20 www.investeurope.eu Place du Champ de Mars 5 F +32 2 725 07 04 [email protected] B-1050 Brussels, Belgium 2 Invest Europe Pension Fund Guide to Private Equity & Venture Capital Invest Europe Pension Fund Guide to Private Equity & Venture Capital 3 What are private equity and venture capital? Chapter In simple terms, private equity and venture capital are long-term investments Principal types of private equity Private equity funds often organise deals in private, unlisted companies with the potential for growth. In return for and venture capital investment as buyouts – that is, partnering with the management team, taking a majority stake and investment into the company, private equity and venture capital funds receive Private equity and venture capital can be providing capital to buy the business from, for split into a number of different types: example, a corporate, another private equity equity stakes in the business and partner with management teams to house, the public markets or a family owner. support growth plans and make improvements to the business with the aim — Venture capital refers to equity investments At the larger end of the deal spectrum are 1 in earlier-stage, younger companies that need the global buyout firms, many of which now of increasing its value. This value is realised through a sale (or exit) of the funding and support to get an idea off the manage funds in other asset classes, such as business, at which point the fund makes a return on its investment. ground, develop a business model or launch real estate and infrastructure. Mid-market funds into the market. Venture capital funds provide target equity investments up to around €150m capital and hands-on support to companies often (although the transaction size will often be larger in a series of “rounds” or chunks of funding as as a result of leverage and co-investment) and pre-agreed milestones are met. Venture capital their focus is usually country-specific or regional investors usually take minority stakes in the (i.e. pan-European). Further down the deal size businesses they back. range, there are smaller, more location-specific buyout funds that may invest in companies in The high level of involvement venture capital local regions, for example the North of England investors have with portfolio companies means or Northern Italy. In addition, there are specialist that most funds tend to target local markets, buyout funds that invest in particular sectors, including some of the entrepreneurial hubs e.g. financial services or healthcare. across Europe such as Berlin, Stockholm and London, although there are regional Funds of funds are investment vehicles that pool and global players. investor capital to invest across a range of funds according to a pre-agreed strategy. While many are — Private equity incorporates venture capital but generalist in nature, some, for example, specialise the term is usually used to refer to investments in venture capital, others may provide access to in more mature – usually profitable – companies a range of mid-market funds, and others invest in with the potential for growth. That is how we will a particular geographic region, such as Asia. use the term ‘private equity’ in this guide. Secondaries funds invest in private equity and Private equity funds provide funding to fuel that venture capital funds that are part-way through growth, together with expertise and support to their fund lives, most usually buying a position in improve company performance and to identify a fund from an institutional investor that requires and pursue the correct strategy. liquidity or is fine-tuning its private equity and venture capital exposure. 4 Invest Europe Pension Fund Guide to Private Equity & Venture Capital Invest Europe Pension Fund Guide to Private Equity & Venture Capital 5 What are private equity and venture capital? continued Other types of private equity How private equity and While this hands-on involvement has always venture capital funds invest been a feature of the private equity and venture How private equity and venture More recent times have seen the development of capital investment model to some degree, the other sub-types of private equity. These include Private equity and venture capital are important last decade has seen firms hone skills and bring capital manager raise funds special situations, which are triggered by specific resources for companies at different stages of their in extra resources to help them drive growth and circumstances within the company that mean development. Funds provide not only capital, but improvements to the businesses they back. Many Private equity and venture capital firms raise capital from it requires investment and support, and private institutional investors, such as pension funds, insurance also managerial, operational and industrial expertise. private equity firms now routinely use 100-day companies, endowments, sovereign wealth funds and family debt funds, which have grown in response to the This allows financed businesses to strengthen their improvement plans in their investments, for example, offices as well as high net worth individuals. They raise disintermediation of bank financing since the competitive positions, grow at a faster rate than they while others have in-house industry and operating this capital through funds, which are usually closed-ended financial crisis. Some other types of alternative might otherwise have achieved and create value for the partners that can work closely with portfolio (meaning they have a finite life – generally around 10 years) investments, mainly real estate and infrastructure, economy as well as for the funds and their investors. companies. All these measures are intended to and organised as limited partnerships that pool together also invest using private equity-style funds. increase the value of the company so that it is the investors’ capital. Investors in these funds are known Origination. Yet before funds make an investment, worth more at the point of sale than when the as limited partners (LPs) and the fund manager, or general fund managers undertake a detailed analysis of investment was made. partner (GP), is responsible for sourcing, making and exiting the markets they intend to target to identify the investments on behalf of the fund and in accordance with most promising companies. Given that this type Realising returns. Private equity and venture capital a legal document negotiated at the point of fundraising, known as the limited partnership agreement. of investment involves partnering with those funds remain invested in companies over a period of running the company, time is spent getting to know several years (the holding period), with buyout and management teams and entrepreneurs, in some growth investments usually lasting between three cases years in advance of completing a deal. This and five years and venture capital investments identification stage, known as origination,