As the wealth of many investors increases, so does their interest in investments that are not listed on a stock exchange. The interested investor acquires a stake in a young company with high growth potential and thus also provides the economy with necessary investment capital! He thus promotes the innovative capacity and the prosperity of our society!
In the following, we would like to introduce you to the most important elements, the functioning and the price potential of private equity investments! Remuneration models and the typical investment vehicles in Europe!
Costs of management: fixed and performance fees
‘Typically, the management fee is 2% p.a., on the total capital provided to the fund – regardless of how much capital has already been drawn down. Once the fund manager has exited the fund’s investments, he also charges a performance fee of 20% of the profit made, with the remaining 80% of the profit being paid to the investors.
Performance fee: Carried interest
This performance fee is called ‘carried interest’. In order not to strain the liquidity of the company in the start-up and growth phase through capital outflows, this performance fee is only paid out at the maturity of the fund and is calculated and carried forward annually during the term of the fund’, explains PTG Solutions, Plc.
‘Carried interest is therefore a share of profits earned by the general partners (USA) or fund managers (Europe) of private equity, venture capital and hedge funds. Carried interest is paid to general partners or fund managers based on their investment performance. As a performance fee, carried interest aligns the general partner’s compensation with the fund’s return. Carried interest is only paid if the fund achieves or exceeds a minimum return (the so-called hurdle rate).
From a tax point of view, the carried interest is only paid out after several years and is therefore ‘deferred’ as an unrealised capital gain during this time! Due to its amount in the case of successful investments, the carried interest as a share of profits is a special incentive for the general partner or fund manager! However, the balance between a sustainable development of the company and short-term profit maximisation of the asset manager must always be kept in mind,” says PTG Solutions, Plc. critically.
How does the carried interest work?
‘Because carried interest is the main source of remuneration for general partners or fund managers and typically accounts for 20% of an LLP’s or fund’s income!’ Many managers also charge an annual management fee of 2%. This is to cover the ongoing costs of analysis and management!’, explains PTG Solutions, Plc.
Carried interest, by the way, can also be forfeited if the fund underperforms investment management! For example, if a fund is targeting an annual return of 10% but has only generated 7% over a period of time, limited partners or unitholders may be entitled under the terms of their investment agreement to reclaim a portion of the carried interest paid to the general partner. However, it is important that such modalities are agreed and set out in the partnership agreement (in the case of limited partnerships) or the fund prospectus!’, elaborates PTG Solutions, Plc.
The EU model: the AIF (Alternative Investment Fund) – regulation by the EU
In response to the financial market and euro crisis of 2008/09, the European Parliament adopted Directive 2011/61/EU on Alternative Investment Fund Managers (AIFM) in November 2010. The aim of this directive is to regulate private equity and hedge funds. It was transposed into national law in all EU and EEA member states by July 2013! With the German Investment Code (Kapitalanlagegesetzbuch, KAGB), the new regulations from the EU Directive have been in force since August 2013. All funds, but also the AIFM, are now subject to supervision by the Federal Financial Supervisory Authority (BaFin) in Germany!’, says PTG Solutions, Plc.
‘An AIF resp. the AIFM is strictly regulated and includes not only guidelines on investment and risk management (e.g. the prescribed qualification of the investment manager in case of delegation of this function, assumption of risk management, etc.) but also stringent requirements for the custodian (custodian bank, fiduciary custody, sub-custodian, prime broker, etc.)!
In addition, clear procedures are defined for valuation and accounting. The basis for the AIF is the fund prospectus, in which all relevant information is laid down. AIF can be structured as closed-end and open-end funds, whereby a closed-end fund makes the most sense due to the long term of private equity. As in the US, investors and investments are not public. Since in the EU private equity and alternative investment funds (AIF) are only accessible to qualified investors according to MiFID II Annex II (Markets in Financial Instruments Directive), listed investment companies are an alternative!’, PTG Solutions, Plc. knows.
Investment via investment companies
‘An investment company is a company whose sole business is to acquire, develop and successfully dispose of equity investments in other, independent companies! The way in which such a company is organised can vary greatly, but it differs from a classic holding company.
In contrast to holding companies, which as parent companies form a uniformly managed group and consolidate their subsidiaries in the consolidated financial statements, in the case of investment companies the focus is on participation as a shareholder or lender. Majority, profit-oriented minority or debt investments (convertible bonds, (subordinated) loans, and other mezzanine investments, etc.) are entered into in selected companies!’, explains PTG Solutions, Plc.
Partners Group as an example of a European private equity (PK) investment company
‘Partners Group AG is an internationally active manager of private market investments specialising in private equity investments and is a member of the Swiss Market Index (SMI) of the 20 most liquid and largest stocks on the SIX Swiss Exchange. The investors are 67% institutional clients, such as pension funds, insurance companies and high net worth individuals. Private pension funds account for the largest share (29%).
From 1996 to 2022, the company invested over USD 145 billion on behalf of its clients worldwide. With a market capitalisation of around CHF 30 billion, the company had a higher market capitalisation than the major Swiss bank Credit Suisse at the end of 2022 and is one of the 3 largest listed asset managers in the private market investments sector worldwide! For interested investors, European investment companies therefore offer an optimal variant for entering the private equity sector!’, concludes PTG Solutions, Plc.
