Strategic Equity Investment: A Comprehensive Guide

Strategic equity investment is a type of investment philosophy that applies a private equity approach to investing in both public and private companies. It involves investing in startups and early-stage companies, typically as minority equity investments by large corporations. The goal is to identify and invest in high-quality businesses with strong growth prospects and well-managed operations, diversifying across sectors, industries, and individual securities. This strategy seeks to achieve superior returns for long-term investors by taking into account rigorous due diligence and a fundamentals-based, high-conviction approach.

Private equity approach to investing in public markets

Strategic equity investment refers to investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.

Private equity firms buy companies and restructure them to make a profit when the business is sold again. They may buy private companies or public ones in their entirety, or invest in such buyouts as part of a consortium. They typically do not hold stakes in companies listed on a stock exchange.

Private equity firms raise client capital to launch private equity funds, which they operate as general partners, managing fund investments in exchange for fees and a share of the profits.

Due Diligence

Private equity firms take a rigorous approach to due diligence when investing in public markets. They conduct in-depth research and analysis to identify undervalued or under-managed companies with strong growth potential. This includes assessing the company's management team, industry, historical financials, and forecasts.

Buying to Sell

Private equity firms typically employ a "buying to sell" strategy, focusing on acquisitions that can be improved and sold for a maximum return. They target undervalued or under-managed businesses, aiming for a one-time opportunity to increase their value. Once the desired gain has been achieved, the firm sells the business to realize profits.

Operational Improvements

Private equity firms aim to increase the profitability of their portfolio companies by implementing operational improvements, expanding market reach, or innovating products and services. They may bring in their own management teams or work with existing management to pursue these initiatives.

Leveraged Buyouts (LBOs)

In an LBO, a private equity firm buys a target company using debt collateralized by the target's operations and assets. This allows the firm to assume control while only contributing a fraction of the purchase price, maximizing their potential return on investment.

Long-Term Investment Horizon

Private equity firms typically operate with a longer-term investment horizon, often between four to seven years. This allows them to implement strategic changes, restructure operations, and realize value over a more extended period before exiting the investment.

Active Investment Approach

Private equity firms often consider themselves active investors, providing operational support to portfolio companies to help them build and grow. They leverage their extensive networks and C-level relationships to increase revenue and improve operational efficiencies.

Maximizing Returns

The primary goal of private equity firms is to maximize returns for their investors. They focus on increasing the profitability and value of their portfolio companies through various strategies, including cost reduction, asset liquidation, and debt imposition.

By applying these principles, private equity firms can successfully invest in public markets, targeting undervalued or under-managed companies, implementing operational improvements, and ultimately, realizing significant returns for their investors.

Due diligence for superior returns

Strategic equity investment is a specialist private equity investment strategy, focusing on the GP-led secondaries market. It involves investing in both public and private companies, with a long-term investment horizon. Due diligence is a critical component of strategic equity investment, enabling investors to make informed decisions and achieve superior returns.

When conducting due diligence, investors should thoroughly evaluate the fundamentals of the business, including its business model, management team, earnings trends, and potential risks. This process helps identify high-quality businesses with strong growth prospects and durable business models. By investing in well-managed companies with sustainable practices, investors can achieve superior returns over the long term.

Additionally, due diligence should also involve a rigorous analysis of the industry, market trends, and competitive landscape. This includes assessing the target company's position within its industry and identifying any potential risks or opportunities that could impact its performance. A diversified portfolio across sectors and industries is often recommended to mitigate risks and maximise returns.

For example, ICG Strategic Equity, a leading global investor, focuses on single-asset continuation vehicles, providing them with a competitive edge in the market. They conduct due diligence by evaluating business fundamentals and backing top financial sponsors to extend the value creation journey of their best-performing assets. This approach enables longer investment horizons and the pursuit of strategic initiatives, ultimately driving superior returns.

In summary, due diligence plays a crucial role in strategic equity investment. By conducting thorough research and analysis, investors can identify high-quality businesses, make informed investment decisions, and ultimately achieve superior returns. A careful assessment of the business fundamentals, industry dynamics, and market trends is key to a successful strategic equity investment strategy.

Structuring single-asset continuation vehicles

Single-asset continuation vehicles are a type of continuation fund, a private equity vehicle designed to extend the holding period of assets from an existing fund that has reached or is nearing the end of its lifecycle. These vehicles allow general partners (GPs) to maintain control over promising assets while providing liquidity options for existing investors (limited partners or LPs) who may want to exit.

When structuring a single-asset continuation vehicle, the following steps are typically involved:

• Identification of assets: The GP identifies a high-performing asset from an existing fund that they believe has further value creation potential and is worth retaining beyond the fund's typical lifespan.
• Structuring: A new vehicle, the single-asset continuation fund, is established to purchase the identified asset from the existing fund. This involves setting up a new investment structure with tailored strategies and focused value creation plans.
• Pricing and valuation: An independent valuation is conducted to determine a fair price for the asset being transferred to the continuation fund. This step can be complex and contentious, as determining a fair price for mature assets can be challenging.
• LP options: Existing LPs are given choices regarding their investment. They can choose to sell their pro-rata share of the assets and exit, roll their interest into the new continuation fund, or opt for a combination of both.
• New capital: The continuation fund raises capital from new investors, often dedicated secondary funds, to purchase the assets and provide additional capital for growth initiatives or add-on acquisitions.
• Transaction closure: The assets are officially transferred to the new continuation fund, and proceeds are distributed to selling LPs.
• Ongoing management: The GP continues to manage the assets in the new vehicle, with a reset of the fund's economics to better align the interests of the GP and LPs. Carried interest, for instance, is typically calculated from the current net asset value (NAV) rather than the initial investment cost, incentivising the GP to generate returns above the new NAV.

Single-asset continuation vehicles offer benefits such as extended value creation, liquidity options for existing investors, alignment of interests, flexible capital, and diversification for new investors. However, they also come with potential conflicts of interest, complexity in structuring and executing, pricing challenges, and regulatory scrutiny.

Minority equity investments in startups

Strategic equity investment is a private equity approach to investing in both public and private companies. It involves investing in companies with a long-term vision, conducting rigorous due diligence, and seeking out high-conviction opportunities in public and private equity markets.

Investing in minority-owned startups is not just a matter of social responsibility but also economic prudence. Supporting minority founders can have tangible benefits for the economy. For instance, a report by the National Association of Investment Companies suggests that if minority-owned businesses were to attain the average revenues of majority-white businesses, the U.S. GDP would witness a boost of $1.37 trillion. Additionally, funds focused on minority-owned businesses often yield higher returns than their peers, emphasizing the untapped potential in this domain.

To address the diversity gap in startup investments, investors should actively seek out opportunities to support minority entrepreneurs. Organizations like the Minority Business Development Agency and more niche groups like the Black Business Association, Code2040, and the National Hispanic Business Group can facilitate this process by helping investors identify and connect with diverse investment candidates. By doing so, investors can contribute to narrowing the socio-economic gaps that exist between different ethnic and gender identities, fostering innovation, and promoting long-term economic success.

Diversifying portfolios

A well-diversified portfolio typically includes a mix of stocks, bonds, and alternative investments. Stocks offer higher expected returns but come with higher risk, while bonds provide stability and lower returns. By combining these investment types, investors can achieve long-term growth potential with reduced volatility. It's important to consider different industries, company sizes, and risk profiles when investing in stocks, and to include a mix of government, corporate, and municipal bonds.

Geographic diversification is also important. Investing in both domestic and international markets, including developed and emerging economies, can further reduce risk and provide exposure to different economic cycles. Additionally, diversifying within asset classes can ensure a portfolio isn't overly dependent on any single performance factor. For example, within stocks, investors can diversify across market capitalisation, sectors, and investment styles.

It's worth noting that diversification doesn't guarantee profits or protect against all losses. However, it can smooth out market volatility and provide more consistent returns over time. Regular portfolio rebalancing is crucial to maintaining diversification, as market movements can cause asset allocations to drift from the intended strategy.

When diversifying, investors should be cautious not to over-diversify, as this can increase costs without adding significant benefits. Additionally, it's important to consider correlation—true diversification means including assets that don't move in lockstep with each other. For example, investing in different types of metals may not provide the desired diversity if their performance tends to be similar.

Frequently asked questions