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HOW TO INVEST
Until recently, access to the Precision
Engineering investment market
was limited to private equity and
institutional entities which often used
Precision Engineering investments as a
portion of their portfolio to diversify the
asset classes in the correlated section of
their portfolios. Corporate players have
also been heavily involved, with the aim
of acquiring new knowledge and adding
value to their existing manufacturing or
engineering businesses.
PRIVATE EQUITY
Private equity is finance provided in
return for an equity stake in potentially
high growth companies; private equity
firms raise funds from institutional
investors such as pension funds,
insurance companies, endowments,
and high net worth individuals and
use these funds, along with borrowed
money and their own commercial
acumen, to help build and invest in
companies that have the potential for
high growth.
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Private equity funds managed in the UK
currently back around 3,800 companies.
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Private equity funds typically acquire
multiple portfolio companies, buying
and owning all of a company and
consequently generating a strict
alignment of interests with the
managers of the company – to allow the
company to achieve its growth potential
over time and for investor’s returns to
be realised.
Private equity is suited to the
Precision Engineering sector because
it is well placed to take advantage
of opportunities as they present
themselves because of the availability
of funds at times when funds are not
easy to access from other sources,
such as in the recent credit crunch.
In this way, private equity firms have
invested in debt-distressed businesses
particularly affected by the downturn.
By taking advantage of adverse market
conditions, private equity firms inject
more capital to pay off a company’s
debts and finance expansion to take
advantage of suitable investment
opportunities.
Investors in private equity are looking
to create value and consequently, they
look for high quality management
teams with a credible plan to grow their
business including the improvement
of the company’s performance
and strategic direction by aligning
incentives, improving business plans,
making operational improvements and
strengthening corporate governance.
From a regulatory perspective, all
private equity and venture capital
firms in the UK are regulated by the
Financial Conduct Authority (FCA). FCA
authorisation means that the Financial
Services Compensation Scheme
(FSCS) applies to the company as the
FSCS has the power to compensate
consumers in the event of the failure
of any firm authorised by the FCA,
including investment firms.
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In
addition, how they market their funds,
disclose information and structure
deals, is governed by the Alternative
Investment Fund Managers Directive
which came into full force in July 2014.
The legislation includes hefty fines and
potential prison sentences for non-
compliance.
Independent industry-wide figures are
hard to come by, but growing evidence
exists to suggest that private equity
outperforms the public stock market
over time. This is what investment
theory would suggest, since investors
need to be compensated for the risk
of locking up their money in an illiquid
asset class. The British Private Equity &
Venture Capital Association calculates
that, over the decade to 2013, its
member funds generated an annual
return rate of 15.7%, compared to 8.8%
for the FTSE All-Share index. However,
this average hides a wide range of
outcomes, and even well-established
firms can have disastrous funds.
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By its nature, the private equity asset
class is illiquid, intended to be a long-
term investment for buy-and-hold
investors. For the vast majority of
private equity investments, there is no
listed public market; however, there is a
robust and maturing secondary market
available for sellers of private equity
assets.
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In terms of fees, they can be high
and can approach a hedge fund-like
structure of a 2% annual management
charge levied on the assets under
management plus 20% of the fund’s
profits. The US Securities and Exchange
Commission is among the regulators to
have targeted unnecessary expenses
and hidden fees by the industry.
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With regard to entry levels, these have
traditionally been well beyond the reach
of ordinary investors; generally, unless
you are willing to put up £200,000 or
more, your choices in investing in the
high-stakes world of private equity
are very limited.
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Although, a small
number of private equity managers
such as KKR have recently begun
looking at ways to offer opportunities
for individuals to invest at much lower
minimums, perhaps all the way down
to just $10,000
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. Whether they give any
exposure to Precision Engineering is
another matter.
As a sector, private equity has been
very successful at raising money and
the higher amount of funds available
to acquire equity and purchases usually
range from the tens of millions and
upwards.
Venture capital is a specific component
of the private equity industry and
refers to when funds used to invest in
companies in the seed (concept), start-
up (within three years of the company’s
establishment) and early stages of
development. The investment is likely
to be when companies have very little
track record and are in need of capital,
but the benefit is that this is a time of
huge growth potential.
Recent UK private equity investments
include LDC’s 2013 management buy-
out of Rimor Limited, leading providers
of precision manufacturing and
engineering services predominantly to
the subsea oil & gas industry. The deal
was the eleventh transaction completed
by LDC Midlands’ team using capital
from LDC’s £200million manufacturing
and specialist engineering commitment.
The deal marked LDC’s continuing
strategy of buying mid-market
companies across various industries
