While many private equity investors tap the sector by pooling money in a fund alongside many others, there are more direct ways to play in this asset class – with hopefully impressive results.

(Note: This article was originally published on 26 October, 2012).

While many private equity investors tap the sector by pooling money in a fund alongside many others, there are more direct ways to play in this asset class – with hopefully impressive results.

With a fund, the investor is typically tied in to a predetermined lifespan of a fund before any exits are possible; money is often scattered among a wide array of businesses and funds can, as now, carry considerable sums of spare, uncommitted cash, or “dry powder”, to use industry jargon. Unless this money is used by a set date, it dilutes returns and angers investors. Funds, meanwhile, can be unlisted and hard for individual investors to enter, or they are quoted on a stock market, which in the latter case means that the share price of a fund can often trade either at a significant discount or premium to the net asset value of the fund.

A firm that argues it takes a more direct, focused approach to private equity is Beaubridge, a limited liability partnership formerly known as Partner Capital One. In this case, the firm partners with management teams and investors alike – to ensure interests of all sides are aligned, it says. Beaubridge invests on a deal-by-deal basis; its investment approach is not akin to a fund, its partners say.

“What we are all about is alignment of interest with our investors. We don’t have a fund and therefore our investments are not subject to the life-cycle of a fund. We exit only when we have optimised the investment for our investors,” Diarmid Ogilvy, partner at the firm, told this publication in a recent interview.

His colleague, Peter Buckley, who is also a partner and a veteran of the City like Ogilvy, agreed. “Private equity investors have not had a great deal of choice outside funds.” He argues that with many funds, performance can be dragged when it holds a level of uncommitted cash. (Other senior figures at Beaubridge are Michael Joseph, non-executive director; Simon Marshall, Jonathan Seal and Richard Simpson).

A run of deals

The firm has been busy in recent weeks, to some extent benefitting, Ogilvy and Buckley argued, from the reluctance of banks to provide financing for some firms, opening a gap that the likes of Beaubridge can fill. In September, the firm completed its second round of financing for Smilepod, a walk-in dental hygiene business that was looking to expand studios in London and the Southeast of the UK. In March, Beaubridge invested in a property development in the Lots Road area of Chelsea, southwest London – that deal is awaiting an exit. The Smilepod deal involved £1.2 million of financing.

As the sum suggests, Beaubridge’s deals are on the smaller end of the spectrum. It aims to find investments of typically £20 million or less that offer, as its marketing literature says, “significant returns” while limiting downside risks through “carefully structured investment vehicles”.

As ever, the proof, as is said, is in the pudding. The firm has invested in 17 businesses since 2005. A January 2005 investment in Endoart, a healthcare business, and which was exited in February 2007, clocked up a net return to investors of six times; a March 2007 investment in Ferrari’s Bakery, exiting in October the same year, achieved a 20 per cent gain, and a August 2009 investment in Whitecastle, a property deal, made 22 per cent when the exit happened in September last year. Compare these results to data from Preqin, the private equity research firm. Internal rates of return, over a one-year period, showed that for buyout funds, there was a return of 22.2 per cent, while venture funds, funds of funds and mezzanine funds showing IRRs on one year of 15.8 per cent, 14.8 per cent and 14.4 per cent respectively. (IRRs take account of the complex timings of private equity investments and exits). On the other hand, over a three-year period, returns range between about 1 per cent and 5 per cent for different types of vehicle.

Although Beaubridge’s returns are impressive, they are not captured without risk. Such a bespoke and focused style of investing, requiring considerable diligence and hands-on attention to detail, demands that investors take a long-term, patient view. It is not an asset class for the ultra-cautious.

These are a varied set of investments: other planned deals span technology; creative and media; finance, communications, healthcare and as mentioned, property. There are some areas where Beaubridge tends to avoid, due to lack of experience and knowledge, such as biotechnology, for instance.

“We look at firms that may have £10 million to £20 million in revenues; it is a riskier end of the private equity investment spectrum, where investors should expect to be rewarded for the risk that they have taken,” Ogilvy said in the interview.

Changing fortunes

The private equity industry has seen its fortunes gyrate in recent years. In the period leading up to the 2008 financial market crash, private equity was seemingly on a roll, with funds able to raise billions of dollars, euros and pounds in debt to finance buyouts of eye-catching corporate names. Then the credit freeze-up of 2008 and into 2009 knocked the sector down before a slow recovery occurred, although the recent euro-inspired fears have kept the sector under a cloud, along with other asset classes. Ironically, however, analysts say that private equity investments made in a recession can turn out to be the best “vintages” when valuations are heavily discounted.

Firms like Beaubridge are operating in what is a difficult period for private equity as a whole. Recent data from Preqin showed that private equity funds which closed their doors to new investor cash three years ago still have a combined $204 billion of “dry powder”, leaving managers under pressure to put this money to work. As the average private equity fund investment period is five years (real estate funds are the exception), general partners at these funds will want to avoid extending this time horizon so that investors can get a return on their capital, said Preqin. A record $679 billion was raised by the 1,308 funds that closed in 2008 but there are examples of funds that closed during the boom years that have avoided investments completely until this year.

The dearth of bank finance for small and medium size businesses has created an incentive for private equity investors and other organisations to try and make up the difference, such as "angel investors", operating both in the debt and equity spaces. Examples include Envestors, the UK-based investment firm.