Buyers' Market: Growth of Private Equity in Australia

Private Equity (PE) has become a pivotal aspect of the Australian financial landscape, growing significantly over the last few years as the country recovers from the pandemic. The market has seen a surge in private equity deals involving Australian companies and managers continue to raise more and more capital from investors. This has led to a significant increase in domestic and international private equity firms operating in the sector, a contrast to the public markets where ASX listings are slowing.

Below we discuss the developments and explain how this rising asset class provides further opportunities for investors, but also the risk associated with the asset class and why having an experienced team behind you is important for doing the correct due diligence.

Why the move away from public markets?

Australian companies have benefited from deep capital markets since the establishment of the Australian Securities Exchange (ASX) in 1987. These public markets have allowed companies to raise capital from investors and facilitated the efficient transfer of ownership (shares) on their behalf. The largest companies on the ASX are some of the most visible businesses in Australia and tend to benefit from liquid and transparent markets for their shares.

However, the same cannot be said for all companies. Some companies, particularly smaller operations, face significant costs to meeting the reporting obligations imposed by the ASX and do not have active, liquid markets for their shares even when listed. In response to that, companies have, at least in recent times,  preferred to raise private equity capital, which generally involves a smaller number of investors, who do not require the same outlay. This has been positively received, and since 2010 these markets have nearly tripled in size to $66 billion.  

So what is private equity?

PE is ownership or interest in a company that is not transacted in a public market. These companies are often new, fast-growing companies that do not have sufficient cash generation to fund their expansion plans. This cash flow predicament means that they typically lack the collateral or a track record of profits to qualify for bank financing, and other forms of debt funding, such as private debt, may be prohibitively expensive. As such, PE financing is an important source, providing funding in exchange for a share in the future earnings of the company.

What role do private equity managers play?

It is important to point out that PE firms also raise capital rather than investing on their own. Typically, external investors (referred to as limited partners) – such as wealth managers (like ourselves) and or high net-worth individuals agree to finance a PE firms fund. The fund then generally invest in a portfolio of companies and distribute the returns on these investments, after costs, to the investors. The main external investors in Australian PE funds are institutional investors, particularly superannuation funds. This is because private equity funds require a relatively high minimum contribution (some times in the millions) from investors; these investments are also relatively illiquid, with investors typically required to lock their money away for a number of years.

This is where Bratton Wealth comes in, where we can use the combined purchasing power of our client base to gain access to the worlds largest deals, then break down the ownership of the fund into smaller parcels for our clients.

Private Equity Fund Structure

PE firms invest capital from investors in what is referred to as a ‘vintage’. This is where a PE firm goes out to the market (like Bratton Wealth) to raise capital, and once they have a required amount, closes the fund and begins investing the capital. Each fund has their own mandate, such as indicators of growth potential. Investment decisions are normally managed and executed by the general partner (GP) of the fund (the private equity firm), with the limited partners (fund investors) paying management and performance fees to the private equity firm for these services.

At the end of the funds life, generally between 5 and 10 years, the PE firm looks to sell their equity ownership. Over that period of time, the PE firm hopes to have improved the growth prospects and profitability of the company. They do this by having a hands on approach with the operations, capital structure, staff and management. If things go well, they sell their investments for multiples higher than they paid and they distribute the net returns of the funds to investors.

Size of and trends in the Australian private equity market

If growth is a good indicator of performance, then it appears Australia is enjoying what PE funds provide. Assets Under Management (AUM) has grown to $66 billion as at June 2023, which is a little over 2.6% of GDP (See graph below). This is made up of $44 billion in existing investments and $22 billion sitting in cash waiting to be deployed into new opportunities.

While some of this growth stemmed from the returns on the investment portfolios, fund raising has also been a driver in recent years. If we combine the capital raised by Australian PE funds we see a record $11.7 billion (0.5 per cent of GDP) in 2022 (Graph above). This is notably higher than the $4 billion annual average over the last 10 years. Importantly it also 4 times the amount of capital raised on the public equity market through initial public offerings, which, at roughly $1 billion in 2022.

Risks and other considerations

Private equity investment involves a range of risks and factors that demand thorough evaluation. Firstly, it presents a liquidity challenge in contrast to public markets, with capital typically locked in for an extended period and limited exit options. The illiquidity of these investments complicates asset valuation, heightening the risk of overpayment or difficulty in realizing returns. Moreover, private equity deals often lack transparency, leaving investors with limited insight into the operational and financial status of portfolio companies, thus exposing them to unforeseen risks. At Bratton Wealth, we prioritize extensive engagement with fund managers, recognizing their pivotal role in identifying and executing profitable deals. Effective manager selection, based on a track record of recognizing lucrative opportunities and navigating market intricacies, is fundamental to optimizing returns and managing risks.

Conclusion

A large, competitive private equity market can contribute to promoting an innovative, efficient and dynamic business sector in Australia. It is also beneficial to investors in Australia that can now participate in the growth engine of our economy today and into the future. However, like anything in life, it comes with its own set of risk and considerations.  

If you’re interested in finding out more about how Private Equity can be incorporated in your own portfolio, please reach out and we’d be happy to discuss further.