Possible potential for private equity investing

By Steve Byrom

Friday 2nd May 2003

Although the terms "venture capital" and "private equity" are sometimes used interchangeably, they are different. Private equity refers to the long-term equity financing of an unlisted company at various stages of its life cycle while venture capital is a subset of private equity, referring specifically to financing new business start-ups and expansion funding for fledgling businesses.

Outside venture capital lies development capital (expansion funding for more mature businesses) and management/
leveraged buy-outs. The recent focus in New Zealand has been on developing a venture capital market, aimed at new businesses particularly with a technology angle. The rest of the private equity space has been ignored largely.

In Europe, private equity has grown from 14.7% of all M&A (mergers and acquisitions market) transactions in 1995 to 44.5% in 2002. European private equity investments in 2002 amounted to e39 billion (2001: e31 billion), of which approximately e3 billion (2001: e10 billion) was venture capital and e36 billion (2001: e21 billion) was expansion capital and buy-outs. The increasing role of buy-outs has been driven by successful private equity houses raising "mega buy-out funds" to back ever-increasing transaction sizes, the lack of alternative cash buyers and the inaccessibility of public equity markets in recent years.

In addition to the role in M&A markets, private equity also brings economic benefits. In the UK, one of the most sophisticated private equity markets, the British Venture Capital Association surveys private equity-backed companies to determine the impact of private equity on the economy. It found in the five years ended 2002, such companies:

* increased employment 23%, compared with the private sector average of 1.5%. Eighty-seven per cent of this growth was organic;

* increased sales 30% per annum, more than three times that of FTSE 100 and FTSE 250 companies;

* grew exports at 20% a year, compared with a national average of 2.9%; and

* Increased investment 25% a year, compared with a national average of 2.3%.

It is worth noting that 71% of the respondents to the survey were recipients of development capital or were buy-outs. Also, 83% of respondents said that without private equity their business would not have existed or would have developed less rapidly. Half of the respondents said private equity enabled them to invest at rates higher than were otherwise possible.

That research illustrates the significance of the late-stage (expansion capital and buy-out) private equity markets internationally, yet the New Zealand market remains relatively under-developed.

There are nine late-stage private equity houses covering New Zealand, four Australian based. These houses completed 13 late-stage private equity transactions in New Zealand in the year to December 2002, investing about $50 million.

One could question whether the size and nature of the New Zealand market place is conducive to this asset class. While there are positive indicators to show the market could support private equity, there are also limiting factors.

On the positive side, the roots of the global private equity market have been in the mid-market, an area that is prevalent in New Zealand business. Company owners have limited ability to transfer ownership to the next generation of managers (and extract wealth for themselves) as part of their succession plans. Likewise, for businesses looking to raise capital to expand or to sell all or part of their business, there is a limited number of investors or buyers. Private equity adds depth to these private capital markets.

More importantly, private equity can be used to create the right environment to encourage investment and growth in private companies.

Limiting private equity investment in New Zealand are widespread misconceptions of what private equity is and how it works.

Also, some New Zealand banks lend on security rather than cashflow, reducing the ability of companies to properly leverage their cash flows. Cashflow lending is essential to making these types of transactions work.

Finally, there are issues surrounding establishing private equity funds. Complaints by market participants about the local tax and pension fund environments are well documented. However, contributing to this is the need for private equity investors to demonstrate a track record in making successful investments to attract international investors with an understanding of private equity as an asset class. Therein lies the challenge.

Steve Byrom is a director at ANZ Private Equity, Auckland

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