Institutions have so far been the main investors in private equity (PE) partly because of their greater ability to accept the long lockups and high minimum investments demanded by a limited partnership (LP). In the UK, wealth manager and retail clients have gained exposure via investment trusts. Today, new ‘semi-liquid' fund structures mean that private investors have wider options for getting exposure to an asset class that has, over the past decade, helped to add outperformance and diversification to portfolios.
Public markets shrinking – are investors missing out?
Another important driver fuelling the PE market is the growing trend for companies to stay private, meaning that, in effect, public markets are shrinking. This year saw a net reduction of $120 billion in public equities, surpassing last year's $40 billion shrinkage and marking the third consecutive year of decline, according to JP Morgan analysts. This is part of a long-term trend. Between 1996 and 2023, the number of companies listed on the main market of the London Stock Exchange dropped by 60%, while in the US it fell 40%. Today, fewer than 15% of US companies with revenue above $100 million are listed on the stock market, meaning that most savers are missing out on a broad spectrum of growth opportunities.
Understanding PE valuations
Spurred by the growing interest in private assets in the UK, the FCA is conducting a review of private market valuations. Part of the focus will be on accountability for valuation practices within firms, and governance of valuation committees. But it also addresses valuation methods. As the law firm Reed Smith said in a briefing note, a key driver of the review is likely to include the fact that ‘valuations of privately held investments are subjective because of their illiquid nature and lack of secondary market, meaning there is no single valuation technique.' In other words: public equities are priced every day by the market, based on supply and demand. Without an open market, how can private companies be valued?
The valuation techniques used by PE providers fall into three broad categories, which are often used in combination:
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Market approach – Utilises market prices of comparable public companies, as well as acquisitions and significant financing events of comparable private companies. Various valuation metrics can be used including valuation relative to Ebitda, Ebit, net income, revenue or book value. [Schroders Capital, Q2 2024]
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Income approach – Utilises expected cash flows discounted to a present value using an expected rate of return that represents the time value of money and the incremental risk of the specific investment. The income approach for valuing an investment is primarily applied when an investment is expected to generate multiple cash flows.
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Milestone approach – Valuations are based on achievement of past milestones, and probabilities of meeting future milestones. Usually used for companies that won't generate income or cash flows any time soon – often seed, start-up or early-stage events.
Please remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.
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