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Key takeaways
  • Private equity is an asset class focused on acquiring ownership stakes (equity) in privately held companies (i.e. not listed on a stock exchange).
  • We will focus on three strategies within private equity in this section: venture capital, growth equity, and buyouts
  • Companies raise external equity funding from investors to accelerate the growth of their business (faster than they could fund it themselves) or to buy out shareholders
  • Companies in early stage of their lifecycle raise capital from a subset of private equity funds, called venture capital and growth equity funds
  • Mature companies may attract capital from buyout funds or list on the stock exchange, after which their shares are publicly traded

The company lifecycle

A company that is not yet profitable or a company that wants to grow faster and needs additional capital to do so can opt to raise external funding. A company can then either take a loan or sell part of its shares (equity) to investors to raise capital. Typically very early-stage companies will raise capital from friends, families and angel investors. As companies grow they may raise capital from institutional investors called venture capital funds. Late stage venture capital firms are also referred to as Growth Equity funds. These funds invest in high-growth scale-up companies that have significant revenues, clear product market fit, and little if any technology risk.

Once companies are mature they may go public. (Less mature companies may also go public - e.g. via a SPAC - but this is far less common). During an initial public offering the company sells part or all of its shares to the public - via the stock exchange. These stocks (or shares) can subsequently be freely traded amongst participants on the stock exchange. Note that the company only raises capital from the stock market if it issues new shares. Typically on the stock market you buy secondary shares - meaning these shares were previously owned by someone else.

Finally, mature companies may be (partially) acquired by private equity firms through a leveraged buy-out (LBO). Leveraged here means that the acquisition is partially financed with debt. Typically a private equity firm - through a leveraged buyout seeks to obtain majority ownership - as a result of which is can execute its strategy which could be a turnaround, restructuring or a buy and build strategy.

Source: Thalein
Source: Nicholas Stern
Private Equity as an asset class

Private Equity refers to a set of alternative investment strategies in which investors purchase shares in privately-held companies. The term private equity can be used in two ways:

  • Private equity can be used to refer to the overall asset class. This asset class includes a subset of strategies including venture capital, growth equity and leveraged buyouts.
  • Private equity can be used to refer to a specific private equity strategy. Often the term Private equity is used to refer to the leveraged buy-out strategy only.

To be clear private equity refers to ownership of a company that is not publicly traded. Public equity refers to shares of companies that are publicly traded on the stock exchange.

Private equity strategies

There are several private equity strategies, of which three are relevant for Carbon Equity.

Venture capital

Venture capital funds invest in early stage ventures. Some venture funds invest at seed or even at pre-seed stage - which means that a company may be pre-revenue or at times even pre-product.  Other venture funds invest when companies have some traction - e.g. EUR 1mn+ in revenues. Venture firms are typically rather hands-on and help companies accelerate by making commercial introductions, offering their advice on hiring and scaling and helping to raise follow on funding.

Venture capital investments are considered high-risk, therefore venture capital funds usually invest in at least 20-30 portfolio companies to spread their bets. Typically only 10-20% of these companies drive outsized returns whereas some might outright fail and others may deliver average returns. When a startup turns out to be the next big thing venture capitalists who got in early and therefore invested at a very low valuation, can realize huge returns.

There is an increasingly rich ecosystem of dedicated climate venture capital funds including for example Worldfund, Planet A, Pale Blue Dot, Astanor Ventures, Extantia, Climentum and Ubermorgen ventures in Europe and Energy Impact Partners Frontier Fund, Clean Energy Ventures, Lower Carbon Capital, Buoyant Ventures, Azolla Ventures and many others in the US, who are helping early stage climate ventures lift-off and scale.

Growth Equity

Growth Equity funds invest in high growth scale-up companies prior to a sale or a listing on the stock exchange through an IPO. Typically these companies have sizeable revenues or may even be profitable. In this stage there is typically less technology risk (i.e. does the technology actually work?) and less market risk (i.e. is there demand for this product or service?). Growth Equity investors may help high growth companies scale-up and professionalise, for example by supporting with hiring C-level executives, streamlining processes or supporting M&A strategies.

Growth Equity is considered less risky than venture capital - because growth equity funds have substantially more data on which to base their investment decisions. Given the lower risk profile, expected returns are also lower than for venture capital funds but still very attractive.

Because the climate investing space is still emerging there are fewer growth equity funds than venture capital funds. Some funds that are active in this space include for example the Lightrock fund, Wellington Climate Innovation Fund, Ara partners, the General Atlantic Beyond Net Zero fund and Planet First Partners.

Buyouts

As the name suggests a buyout implies that a fund buys majority or 100% ownership of a company. Buyouts typically only occur in mature and profit generating companies. Buyout funds can create value for example by pursuing a buy and build strategy (realizing synergies between the individual companies), turnaround or restructuring strategies to name a few. An important difference with venture capital and growth equity is the use of capital. Whereas in venture capital and growth equity the capital is used to grow the company, in buyouts the capital is mostly used to buy out the prior shareholders.

There are two main buyout strategies, Leveraged Buyouts and Management Buyouts. Leveraged buyouts are in large part financed with debt. The assets of the acquired company are put up as collateral against the loan. Management buyouts are financed in good part by the management team of the company - potentially with the financial backing of a private equity fund.

Buyouts have a somewhat mixed reputation - as buyouts have often been associated with corporate raiders, ruthless restructuring and piling debt upon struggling companies. Buy-outs can however also create value - think of e.g. transformation strategies - where funds through majority ownership - help companies transition from carbon intensive operations to low carbon pathways.

Considerations and risk when investing in private equity

  • Management fees and carried interest: private equity is an expensive asset class. In order to attract the best talent and built high-quality investment firms, private equity funds charge a management fee to their LPs. Private equity funds typically charge a 1.5-2.5% management fee per annum. In addition to the management fee, the GP is entitled to a part of the profit (assuming the fund performs well). It’s important to take these fees into consideration when reviewing the fund performance
  • High minimums: A typical private equity fund requires its LPs to commit at least 5 million, making this opportunity only accessible to institutional investors and ultra high-net-worth investors. At Carbon Equity we believe in the democratization of access to private equity funds, hence we allow investors to gain exposure starting at low minimums
  • Low liquidity: Private equity is an illiquid asset class, warranting a long investment horizon. While there are in some cases opportunities to create liquidity or exit your private equity position, one shouldn’t count on it and only invest capital you don’t need in the short to medium term
  • Risk of losing capital: Private equity is a more risky asset class, which can result in (partial) loss of capital. An important way to mitigate this risk is by diversifying your capital over multiple funds (see table X).

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