Developing a Successful Private Equity Program. The Benefits of a Key Capital Private Equity Fund Allocation

Transcription

1 Developing a Successful Private Equity Program The Benefits of a Key Capital Private Equity Fund Allocation

2 Important Notice This marketing document has been issued by Key Capital Private Limited ( Key Capital Private ). Key Capital Private Ltd is regulated by the Central Bank of Ireland. Key Capital Private may be contacted in respect of the content of this document. Key Capital Private is a wholly owned subsidiary of KC II Limited, trading as Key Capital ( Key Capital ). The information in this document is for preliminary information or discussion purposes only and is not intended to provide, and should not be relied upon for, accounting, legal, or tax advice or investment recommendations. Each recipient should consult its own advisers about the issues discussed herein and each recipient shall be solely responsible for evaluating the risks and merits involved in any investments which are the subject of this document. This document does not constitute or form part of an offer to sell or subscribe, or the solicitation of an offer or invitation to purchase or subscribe, any security or instrument or to participate in any trading strategy. This document reflects the opinions of Key Capital Private only. Past performance is not a reliable predictor of future performance. The value of investments may go down as well as up and you may not get back your original investment. The financial illustrations and illustrative returns and cashflows contained in this document do not constitute forecasts and should not be construed as such. The illustrations cover an extended period of time and the assumptions on which they are based are subject to many uncertainties. There can be no assurance, nor is there any guarantee (implied or otherwise), that any opinions contained in this document related to such illustrations are correct, and no reliance should be placed on such opinions or illustrations. Certain information in this document has been obtained from sources that are believed by Key Capital Private to be reliable. All such information including information obtained from sources believed by Key Capital Private to be reliable may be incorrect, incomplete or condensed; Key Capital Private does not accept any responsibility for, or guarantee, its accuracy. Accordingly, no representation or warranty, expressed or implied, as to the fairness, correctness, accuracy or completeness of this document (or any part) is made by Key Capital Private and no reliance may be placed on such information. None of Key Capital Private, their respective members, directors, officers, employees, agents or representatives nor any other person accepts any obligation or responsibility to advise any person of changes in the information set forth herein after the date hereof. To the extent permitted by law, none of Key Capital Private or any of their affiliates, their respective members, directors, officers, employees, agents or representatives nor any other person accepts any liability whatsoever for any losses howsoever arising from any use of or reliance on this document or otherwise arising in connection therewith. All material contained herein is for discussion purposes only. Key Capital Private is not acting as your adviser or fiduciary in relation to the subject matter of this document or any transaction. Key Capital Private may have positions and may effect transactions in any underlying securities or investments described herein. This document is provided to you on the understanding that you are a retail investor who will not rely on this document in making any investment decision with respect to any securities that may be issued, and will use it only for the purpose of discussing with Key Capital Private your preliminary interest in investing in a transaction of the type described herein. This document is confidential, is for information purposes only and is intended solely for the recipient to whom it is delivered. It may not be reproduced, photocopied or disseminated to any other person without the express prior written consent of Key Capital Private. Please notify Key Capital Private if this is not the case and you have received this information in error.

3 Key Capital s Pillar Approach and Private Equity Key Capital Approach to Portfolio Construction Key Capital has sought to simplify asset allocation by categorising investments across three subportfolios. These sub-portfolios Pillar I, Pillar II, and Pillar III are grouped by their return characteristics, expected volatility and liquidity. This approach ensures that asset allocations within portfolios are consistent with a client s investment objectives. It also helps to provide a summary overview of the risk profile of portfolios based on the relative allocations to each Pillar. Low risk/stable return investments are categorised within Pillar I and are generally expected to deliver consistent returns, even over short time periods. Pillar II and Pillar III investments, meanwhile, will display more volatility and may have periods of under-performance, but over the medium to longer term are expected to deliver higher returns than pillar I. Figure 1 below illustrates the Key Capital Pillar model. Each Pillar is classified by a risk / return profile that map to investment goals. Private equity investments are classified as Pillar III investments. Figure 1: Illustrative Model of the Key Capital Pillar Approach to Portfolio Construction Pillar I Pillar II Pillar III Stable Returns Liquid Growth Strategies Illiquid Growth Strategies Building your Financial Legacy Diversified Growth Model Diversified Balanced Model Focus on Capital Preservation Investment Time Horizon & Investment Risk Profile

4 Benefits of Committing to a Private Equity ( PE ) Fund A commitment to a Private Equity Fund run by Key Capital comes with many advantages, chief among them: 1. Access to leading PE Firms 2. Instant Diversification 3. Cash Management Access to Leading PE Firms Investor s face a number of challenges after initially committing to a Private Equity Program. The first significant challenge is access to leading PE Firms. Due to the institutional nature of the asset class PE funds typically have a minimum investment size of 10 million or higher. Second, due to the increasing global demand for the Private Equity asset class, many PE Firms are now heavily oversubscribed. As a result, some PE Firms are restricting access to their new funds to existing investors. Key Capital benefits from its existing relationships and receives preferential access to new funds launched by PE Firms in which it is already an investor. Diversification Benefit Single PE Firms typically hold concentrated portfolios of private company investments, allowing investment teams to maximise the time spent working on each company. Typically private equity buyout funds will hold between companies. Thus, a commitment to a single PE Firm introduces concentration risk with respect to not only individual investments, but also with respect to the success of an individual PE Firms performance and the performance of the PE firms own specific investment style. By committing to a PE Fund Program run by Key Capital, Investors receive the diversification benefit offered through the program s ability to efficiently commit to a range of different PE Firms. Multiple commitments to a range of managers promotes multi-layer diversification; by firm, manager style, expertise, and vintage. This culminates in a well-diversified portfolio of private company investments as shown in Figure 2.

5 Figure 2: Illustrative Diversification Benefit of a Single Commitment to a Key Capital Private Equity Fund Single PE Firm Commitment Companies Single PE Firm Commitment Companies Key Capital Private Equity Fund Single PE Firm Commitment 3 Single PE Firm Commitment Companies Companies Single PE Firm Commitment Companies Single Commitment Access to Multiple PE firms Investment Portfolio of 100+ Companies Source: Key Capital Cash Management Individual PE Firm commitments are typically followed by a high number of much smaller and frequent cash events. PE firms regularly call and distribute capital back to investors for a range of reasons, and when running a single commitment program investors should be prepared to manage 50+ cash transactions each year. Committing to a Key Capital Private Equity Fund significantly reduces this as an operational issue for investors as the Key Capital PE Fund management team executes these cash flow events for investors using the fund s cash balances.

6 The mechanics of a Private Equity Fund commitment Unlike public equity investments, PE Firms drawdown capital as required Distinct from public market assets, where an investor s capital is invested all at once, PE Funds invest their committed capital over an investment period that typically lasts 3 to 5 years, as shown in Figure 3. PE Firms take time to carefully and thoroughly source, review, and structure each individual investment transaction they undertake. Only when investments are completed will PE Firms request your commitment through an event known as a capital call. As a result, investor capital is called periodically, and only when required. Figure 3: Illustrative timeline between a commitment and return of capital Capital Call Period Investment Period Investments sold, capital returned to investors Year 1 Year 3 Year 5 Year 7 Year 10 Capital Committed Fund Closed Source: Key Capital A commitment does not equal capital invested Investor commitments are drawn down over time as investments are made by the PE Firms. While most PE firms plan to hold investments for c. 5 years a wide variety of developments may result in holding periods ranging from 2 to 10 years - as a result the timing of distributions from a fund are uncertain. In some cases the earliest investments may be sold prior to the final investments being made (Figure 4). In this scenario, the realised capital may serve as a partial or full offset to later capital calls. This results in a cumulative capital call value that never reaches the amount of an investors committed capital, as shown in Figure 4 through the net valuation profile over the life of the fund relative to the target commitment.

7 Figure 4: Illustrative Cashflow and Valuation Profile 1 of a single 1 million commitment 1,200,000 1,000, , , , , , , m 0.30m 0.30m 0.20m 0.20m 0.20m 0.10m -0.10m -0.10m -0.20m -0.25m -0.20m Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Source: Key Capital Capital Calls Net Valuation Distributions Target Commitment Selling company s results in a return of investor capital When a company is successfully sold by a PE Firm, the distribution each investor receives will have the effect of decreasing their allocation by the same amount. Therefore investors in PE Funds are faced with a natural wind down mechanism that decreases their ongoing allocation to a PE Fund as distributions are made. This is shown in Figure 4 by the decrease in net valuation of a fund as distributions from the successful sale of investments continue; until all investments are sold and the fund is closed. 1 Illustrative commitment assumes a 2.0x money multiple and 12.6% IRR investment

8 Valuation of Called Capital, in millions Building your private equity program Building & maintaining a PE allocation requires a long-term plan Developing a Pillar III allocation requires a long-term plan recognising the structural realities of investing in private equity which include: 1. Building towards your target PE allocation 2. Ensuring Program Diversification 3. Maintaining a long-term PE exposure Building towards your target PE allocation Unlike liquid investments where investors can quickly achieve their target allocations, private equity investors need to be more patient with their early allocations. Investors face two challenges when seeking to build towards a target PE allocation: (i) uncertainty around the timing / size of the capital calls, and (ii) the natural reduction in the allocation that is associated with successful private company investments being sold. Should an investor only commit to a single PE fund it is certain that over an appropriate investment horizon a portfolio allocation to PE will fall short of any target allocation made to the asset class. To ensure target allocations are achieved, investors should be prepared to develop a commitment program, agreed and planned in advance to establish the discipline required to grow a PE allocation from its infancy. Each new commitment made further increases the PE program allocation within an investment portfolio. As commitments evolve, a combination of new capital calls and changing valuations of older investments will further influence the program s valuation. Using a continuous commitment program (as shown in Figure 5), investors may expect to reach their target allocation within a number of years with the amount of time varying based on the performance of underlying investments and the speed that each PE Fund calls investors capital. Figure 5: Illustrative Evolution of a PE Commitment Program 2, with a 1m target allocation Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Existing FoF Commitments New FoF Commitments PE Program Valuation Target Allocation Source: Key Capital 2. Assumes no investment performance. PE Program Valuation equals the cumulative value of called capital only.

9 Ensuring PE Program Diversification Commitments to an individual Key Capital Private Equity Fund will provide investors with a level of diversification amongst managers and investment styles not typically available to investors. A commitment program (as per Figure 6) designed to build an allocation to the asset class will increase diversification as further PE Firms are added to your portfolio through subsequent commitments. This will further promote vintage diversification, which will limit the impact of specific market dynamics as investor capital is deployed opportunistically at different points within an investment cycle. Figure 6: Illustrative manager diversification in PE Program Commitment 1 Commitment 2 Commitment 3 Commitment 4 Commitment 5 Commitment Number of Key Capital PE Funds in Your Portfolio Number of PE Firms You Have Exposure to Source: Key Capital Maintaining a long-term PE allocation After building to a target PE allocation, investors will be in a position to maintain their allocation against the natural decrease in the valuation of the PE Fund as distributions increase. To maintain a target allocation, investors must continue to commit to new and subsequent PE funds. Should investors consider their allocation to PE as a percentage of their portfolios value, future commitments will be scaled as required to adjust for the increasing value of their total investment portfolio and ensure a constant allocation as a percentage of an investors financial assets.

10 Glossary of Private Equity Terminology Commitment Capital Call Distribution Pledges of capital to a private equity fund. Typically, this money is not invested all at once, but rather called through actions known as Capital Calls Also known as a Drawdown. When a PE Firm has finalised an investment transaction, it will approach its investors in order to "drawdown" capital from their initial commitment. Cash paid out to the investors in the fund after a company has been sold. Realisations DPI RVPI An underlying investment of a fund that has been sold by a PE Firm. Distributions to Paid-In Capital. The ratio of money distributed by the Fund, relative to the capital called by the fund Residual Value to Paid-In Capital. The ratio of the current value of all remaining investments within a fund, relative to the capital called by the fund TVPI GP LP IRR IRR Hurdle Total Value to Paid-In Capital. Calculated as the sum of the DPI plus the RVPI. Represents the total fund performance capturing performance of current and realised investments. General Partner. In the private equity world, the GP is the PE Firm manager with responsibility of managing the investments made in private companies. Limited Partner. In the private equity world, the LP is the investor in the fund. LP s have no input in the management of investments but their capital is invested by GP s and receive distributions when investments are sold. Internal Rate of Return. A typical measure of how PE Funds measure performance, it s technically a discount rate: the rate at which the present value of a series of investments is equal to the present value of the returns on those investments. Used specifically to describe a return which a PE Fund has to at least equal before any carry is calculated or payable. Carry / Carried Interest A performance incentive. Carried interest becomes payable once the investors have achieved a predefined level of investment performance. Key Capital Private Key Capital Private Ltd. is regulated by the Central Bank of Ireland Huguenot House St. Stephen s Green Dublin D02 NY (0)