Why 2023 is shaping up to be a vintage year in private equity

A middle ground between early-stage start-ups and large debt-fuelled buyouts can offer excellent opportunities for private market investors
David Thornton

Livewire Markets

A large part of successful investing is about finding opportunities where others don't. And most of those opportunities exist in private markets.

"If you take the whole listed market, the ASX, there might be two and a half thousand companies. If you filter them for size and sector, you're left with maybe a couple of hundred relevant businesses sub $100 million of market cap, compared to the private markets, where there are over 50,000 businesses with between 20 and 200 employees," says Michael Thompson, Edison Growth Fund.

"Many of the very successful investments in private companies have a backstory where the investor has stumbled across a bit of a hidden gem, or an obscure niche that you may not have heard of, a business that has unit economics that just stands apart from its peers."

“The ability to find good investments on good valuations during more uncertain times can lead to exceptional outcomes”.

In this edition of Expert Insights, Thompson explains the quantity and quality differences between the public and private markets, and why 2023 could be a great vintage for private equity.   

Note: This interview was filmed on 6 April 2023. 


Edited transcript 

LW: Why should investors consider private markets over listed markets?

I think it really depends on the types of businesses people would like to invest into. We focus our investments on small to medium companies but, more importantly, companies that are profitable. That are funding growth through their own cash flows. And in only a small set of sectors, that we know well. And for those companies, the differences between the public markets and the private markets are really significant. To begin with, there are just far more opportunities in the private markets. If you take the whole listed market, the ASX, there might be two, two and a half thousand companies. If you filter them for size and for sector, you're left with maybe a couple of hundred relevant businesses, sub a hundred million dollars of market cap. Compared to the private markets where there are over 50,000 businesses with between 20 and 200 employees, so small to medium-sized businesses. They're not all relevant, but it's a much deeper pool.

But more than just having more companies to choose from, in the listed market, it's not only a small list but everyone has the same list. Many of the very successful investments in private companies have a backstory where the investor has stumbled across a bit of a hidden gem, you know, an obscure niche that you may not have heard of; a business that has unit economics that just stand apart from its peers. And the hard work and the luck of finding those hidden gems can be very rewarding for investors. And there are many fantastic small to medium businesses that are well established, that are robust and profitable, with good pro-growth prospects, that never really want to list.

The private markets can be a far healthier environment for a business to perform over the medium term. 

The very best managers can get distracted by all the noise that naturally occurs in the listed market. The ups and downs of share prices, the attention that comes from releasing results and educating the market and promoting your company to investors.

While in the private market, you have one group of investors for that next phase, where there's alignment and clarity on the strategic priorities of the business. And by removing all that noise, they can focus on the humble work of building their business.

And when it comes time to exit the investment, there are also more options available. Yes, you might be able to list the business, but there's a whole other set of opportunities that might include selling to a much larger competitor, selling to another investment firm. And when it comes time to exit, having the flexibility can mean a lot.

And so for us – when we think about the investment opportunities, there is more of them, it's a better environment to invest, and the ability to generate returns can be far superior. 

LW: Where does "growth equity" fit within the broader private equity universe?

The PE universe is quite a broad asset class. There really are asset classes within the asset class, and the characteristics of each are quite different. At one end of the spectrum, there's venture capital - investing in companies that can be quite cutting edge and disruptive, but early-stage. So, the model there is having large portfolios knowing that whilst a large number of companies may not succeed, some will, and therefore those that do succeed, you want them to be, you know, a very big success story. Which lends itself to putting quite good amounts of capital, large amounts of capital into a company, to fuel what can be, you know, very ambitious growth.

At the other end of the spectrum are the larger buyout funds. The KKRs and the Blackstones, investing very large sums of money, maybe $1 billion or $2 billion funds. Because of their size, they're investing in very large, established, sometimes quite mature companies. Rather than looking to five x or 10 x the size of the company, they'll also extract efficiencies, and use the size of the business and the cash flows of the business to borrow debt, and use that debt to leverage their equity returns.

But there's also a gap in the middle, and we call this gap growth equity. Other people will use different names, but it's essentially the types of businesses that often appeal to larger private equity in the fact that they're established, they've been around, they're profitable, they have robust market positions, but they're just too small for the larger funds.

And in fact, many of the larger funds used to invest in smaller businesses but now have larger funds and it's just not practical for them to put small amounts of capital to work. We love these smaller businesses because they're far less risky in proposition than startups and venture capital. But they're also small enough that they've got room to grow. 

LW: Is now the right time to be making investments in private equity?

I think that depends on whether it's a question of investing into existing private equity portfolios - funds that have made investments in recent years. It's quite a different set of considerations to funds that will be making new investments over the next few years. In that latter category, there are lots of studies that show that investing during challenging macroeconomic conditions has actually led to better returns.

And there's some common sense logic in that. Funds invested after the dot com bubble tended to do better than funds that were invested during the dot com bubble. Funds that were making investments after the GFC tended to perform better than investments that were made prior to the GFC.

The ability to find good investments on good valuations during more uncertain times can lead to some exceptional outcomes. And there are some similarities in the current environment to those other examples. You know, the last couple of years have certainly been a period of high valuations in listed markets and private markets. Anecdotally, we're certainly already seeing some of this uncertainty meaning that even the good businesses are available on more attractive returns and the ability to then help those businesses build, perhaps even take market share from some of their less strong competitors, is a really good time to be investing in these companies. But also, the model is to build and then sell in four or five years. And that allows you to potentially be exiting your investments in a period of your choosing, which can hopefully be in better economic environments.

Invest in a portfolio of proven, profitable, high-growth private companies

The Edison Growth Fund invests in a portfolio of proven and profitable private companies. Edison Growth Fund is open to wholesale investors until 30 June 2023.

Edison is hosting an Investor Information webinar for potential investors on Thursday 1st June. Click here to register. You can also learn more by visiting their site.

To learn more about the advantages of private equity compared with the listed market, you can also read Michael’s earlier wire here.

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David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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