Investing in Unlisted Companies
There are many asset classes that are available to the common man. The average investor can put their money in stocks, bonds, real estate, gold, mutual funds, etc. However, there are certain asset classes which are not available to every individual. One of the asset classes are unlisted companies or private equity. These asset classes tend to provide the best returns but also have the highest risk. This is the reason why in most parts of the world, the access to these investments is limited.
In the United States, for instance, only accredited investors are allowed to invest in this asset class. The Securities and Exchange Commission (SEC) has taken great care to define what they mean when they use the term accredited investors.
In this article, we will have a closer look at the investing strategies which are followed by these accredited investors when they invest in unlisted companies.
Layered investment is one of the most frequently used strategies when it comes to investing in unlisted companies. Under this strategy, investors, i.e. limited partners allocate funds to fund managers, i.e. general partners. These general partners then allocate these funds a wide variety of private equity funds. This means that the general partners do not make direct investments. Instead, they involve another layer of general partners who make investments on their behalf. The main advantage of this strategy is the increased diversification that it has to offer.
Instead, of focusing on a particular segment or company, investors can apportion their funds into multiple investments. Obviously, the chances of failure are drastically reduced.
Layered investments are also known as fund-of-fund investments. These investments are generally used by accredited investors who are new to unlisted investing. This model allows them to quickly scale up their portfolio without being worried about risk.
Layered investments are also common when newer geographical regions are being explored. The general partners want to include another layer of general partners because of the local expertise that they bring along.
Investing In Private Equity Funds
Instead of using a layered investment, accredited investors can also directly invest in the private equity funds. Under this investment structures, the limited partners partner with the general partners. However, the general partners do not create any layer. Instead, they directly invest in certain companies. This is the most preferred mode of investment when it comes to investing in unlisted companies.
The limited partners tend to have very little knowledge about the underlying companies that the funds are being invested in. Instead, they invest based on the past track record of the fund managers. Simply put, the reputation of the fund manager is of paramount importance to the fund. This is the reason why fund managers in private equity tend to be well compensated. Another advantage of investing using the private equity model is that it is cheaper as compared to the layered structure.
Since one layer of intermediaries is reduced, the cost is reduced by an average of two percentage points! The main drawback of this system is that the limited partners are supposed to directly select the fund that they want to invest in.
In order to take this decision correctly, they must know how to select a fund manager. Also, these funds tend to be relatively illiquid. The investments made are for a fixed duration of time and cannot be recouped before the time period is up.
Sometimes, limited partners, i.e. investors just tend to bypass the entire routine of finding general partners. In some cases, they directly make investments into unlisted companies without having any intermediaries. Since there are no general partners, there are no fees associated with them too.
However, still, it would be wrong to say that this cost structure is more cost efficient than alternate arrangements. This is because the limited partners are responsible for the entire deal cycle. This means they are the ones that have to source the right deals, have to do the right due diligence, conduct the valuation and be aware of the possible exit strategies before making the investment. This is one of the riskiest ways of investing in unlisted companies. This is because there are practically no regulations regarding how unlisted companies can and must operate.
Hence, it would be right to say that the investors are pretty much on their own. This is why expert help is needed, and in the absence of this expert help, investors are more likely to make mistakes.
However, many limited partners have been particularly successful while using this model. They have built their own teams of talented individuals who perform the tasks that general partners do for a much smaller remuneration. This method is preferred by many because it provides more control over the investments. Despite its advantages, direct investing is still a pretty recent phenomenon. The advantages and disadvantages of direct investing are yet to be empirically analyzed.
To sum it up, unlisted equities is a very good asset class. It has provided great returns which beat the general market on more occasions. However, the method of investing in private equities must be carefully selected after due diligence.
|❮❮ Previous||Next ❯❯|
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Introduction to Forex Markets
- History of the Forex Market
- Bretton Woods Agreement and Smithsonian Agreement
- Currency Pegs
- Common Terminologies Used in Forex Markets
- Forex Trading vs. Regular Trading
- Understanding the Trading Cycles in Forex Market
- How Are Exchange Rates Determined ?
- Types of Quotations in Forex Market
- Types of Orders in the Forex Market
- Advantages and Disadvantages of Forex Market
- The Importance of Forex Education
- Major Currency Pairs
- Types of Market Participants
- Types of Intervention by Central Banks
- Dollar Yuan Peg
- Forex and Labor Arbitrage
- Carry Trade and Rollovers
- Special Drawing Rights (SDRs)
- Interest Rates and Forex Market
- Exorbitant Privilege: US Dollar
- Freely Floating Exchange Rates
- Argentina Financial Collapse
- Asian Financial Crisis of 1997
- Currency Wars
- Freely Falling Currencies
- Black Wednesday of 1992: The Day the Pound Sterling Came Under Attack
- Russian Ruble Crisis of 1998
- The Mexican Currency Crisis (Tequila Crisis) of 1994
- The South Sea Bubble
- Tulip Mania of the 17th Century
- Spanish Property Bubble of 2008
- Poseidon Bubble in the Australian Stock Market
- Bernie Madoff Scandal
- The Dot Com Bubble of 2001
- The Harshad Mehta Scam in India (1992)
- The Ketan Parekh Scam
- Savings and Loan Crisis in the United States (1980s)
- The Failure of Long Term Capital Management (LTCM)
- The Albanian Revolution and Pyramid Schemes
- Puerto Rico: The Greece within America
- Israel Economic Crisis: 1983
- The Nordic Crisis of 1992
- The Historic Iceland Crisis of 2009
- The Latvian Crisis: A Short History
- John Law and the Mississippi Bubble
- Brexit after Effects: British Economy Beats Slowdown Fears
- The End of the Dollar Hegemony
- Why Devaluing the Currency is a Bad Idea ?
- What is Causing the Bitcoin Boom?
- The Big Fat Bitcoin Bubble
- Gold vs. Bitcoin
- The Problem with Having Bitcoin Futures
- The Problem with Venezuelan Cryptocurrency
- Traditional Bonds vs. Islamic Bonds Called Sukuk
- How Decisions Made By Central Banks Affect the Stock Market?
- How to Leave the Euro?
- Are We In A Stock Market Bubble?
- Why Does the Stock Market Crash?
- Hard Brexit vs. Soft Brexit
- What is Blockchain, Why is it so Popular, and Benefits and Challenges of Using it
- Cryptocurrencies and Taxation
- Is this the Longest Bull Market in History?
- Investing in Unlisted Companies
- Why Is Short Selling A Dangerous Financial Strategy?
- Development Impact Bonds
- How Credit Enhancement Works?
- How Ultra Long Term Bonds Work?
- How to Identify an Overvalued Market?
- How do Companies Choose which Exchange to List on?
- The FAANG Sell-off
- Why are Investors Getting Spooked by an Inverted Yield Curve?
- Catastrophe Bonds
- The NSE Co-Location Fraud
- The Economics of Blue Bonds
- How the GameStop Saga Proves That Shoe is on the Other Foot for the Investors
- 5 Principles of Forex Trading Systems
- 5 Reasons Why Fundamental Analysis Does Not Work In Forex?