PE is closer to the asset

As indicated in a previous post, we consider that PE investors have a fundamental difference to investors in public equity : they are much closer to their asset. For us, this is indeed a fundamental advantage in comparison to somebody who buys shares in an S&P 500 company.

As Mr. Gekko would state it, you're real edge is information. Mr. Buffet thinks no different when he says that he needs to understand the businesses he invests in. And how do you get a better understanding of the company you invest in ? Listening to CEOs giving well-rehearsed speeches and answering besides (sometimes) well-informed questions ? Reading corporate documents that fit a wide standard and hence do not necessarily apply to the given situation ? Reading external analysis on the company without knowing the bias the writer is subject to ?

No, before you buy the famous cat, you want to look in the bag, or if it's a car, you look under the hood. This is done during the due diligence, where you are able to ask your own questions on the asset, where you gauge the quality of the answers (and hence to some extent the quality of the management team), and where you are able to get to the ground of it. Most good investors have already refrained from an investment because they did not feel comfortable with a manager who became aggressive because he didn't want to answer pointed questions !

Once your due diligence has reached a satisfactory outcome, you invest. You might still not know everything, but if you have overseen a fundamental issue, you only have yourself to blame. Mind you, there are new problems and risks that will for sure arise, but then, you come to the second advantage of information : you get it in quasi-real time !

Indeed, lots of problems, be they positive or negative, happen in the life of a company. Sometimes, there is just not a lot you can do, such as when weird European MPs decide -without having given the slightest after-thought to potential consequences of their decision- to ban petrol-fuelled cars at an arbitrary deadline such as 2035 (why not 2027 while they're at it?). But if you are a PE investor, you get this information and best guess of potential impacts on YOUR company in real time. And usually, management will turn to its shareholders and seek for advice and help. Because together, we are all stronger. When have you last heard a CEO of a listed company ask his shareholders for advice or help ? They ask for approval, but they are not all-knowing. They buy consultants, for steep money. Consultants that have no vested interest in your company other than the invoice they will send at the end of their assignment. Your shareholder is a free source of advice. And if he is a professional and somewhat experienced investor, he might even give good advice. And he does have a vested interest in the company, since he has money at stake, or "skin in the game" as we say.

In listed companies, the shareholder also has skin in the game, sometimes much more than the managers, which mainly become rich through their financial packages. But managers tend to take their shareholders for granted, because they usually don't see them, don't talk to them (which is a theme for a later post : why do institutional shareholders refuse to play their role and sub-contract management of their investments to proxy-advisors?), and don't feel that the shareholder brings value to them or helps them (except through their package).

In privately-owned companies, the managers do see that their shareholders bring value, and depending on the strategic plan they want to implement, might even choose the investor that is best placed to help. For instance, if you are a European leader, and want to develop in the USA or in Asia, you shouldn't take a French small-cap fund on board, but maybe a fund based in the US, or a European one that has credible relays in North America.

Which is a good transition to the next post to come. Private Equity seeks above all for alignment of interest between the various stakeholders. This works both ways. Yes, the managers need to share the risk with the investor, by committing significant amounts of wealth to this investment (even if in absolute terms it can be small). But investors also need to commit capital, resources and time, to help their companies to develop. And if they fail to add value, their managers stop respecting them, and consider them as passive shareholders, no better than those that invest in listed companies.

More on alignment of interest in the next post. Hope you found this one interesting. Please give feedback to contact@korafin.com !