Understanding Private Equity

What is Private Equity?

By definition, Private Equity (PE) is a type of alternative investment in which the investors purchase shares in a privately-held businesses. The investment funds from PE are usually managed by PE firm, also called the adviser, in exchange for fees and a share of profits from the hurdle rate. Similar to a mutual fund of hedge fund, a PE fund is like a pooled investment vehicle where the adviser or PE firm pools together the money invested in the fund by all the investors and uses that money to make investments on behalf of the fund. 

Typically, the PE firm would manage their portfolio companies to increase their worth or to extract value before exiting the investment years later. A distinctive investment strategy commonly assumed by the PE funds is to take a controlling interest in an operating company or business (the portfolio company) and engage actively in the management and direction of the company or business in order to increase and maximize its value. While other PE funds may specialize in making minority investments in fast-growing companies or start-ups, however, based on the common practises, PE firms would generally focus on matured companies to invest rather than start-ups in their investment portfolio.

Investor in Private Equity Funds

As mentioned, PE firms usually focus on long term investment opportunities where the portfolios managed under PE firm would require the investors to commit a significant capital for years, from 5-10 years, and the money invested is not available for subsequent withdrawals. Hence, such investment is often limited to institutions and high net worth individuals, called accredited investors.

Accredited investors and institutional investors such as insurance companies, pension funds and university endowments, are the eligible groups that can provide a large sum of initial investment amount needed to partake in the PE funds. However, many of us might have participated in PE fund investment too, indirectly, when we participate in retirement plan or own an insurance policy as these retirement plan and insurance companies may invest some portion of their large portfolios in the PE funds too.

The Common Terms of Investing in Private Equity Funds

• Illiquidity

An investment in a PE fund is often not liquid and it is expected to hold an investment in PE fund for several years before any return is realised due to the long-term investment horizon. The fund also typically imposes certain limitations on the withdrawal of investment too.

• Fees and Expenses

The PE funds are managed by PE firm in exchange for fees and a share of profits from the hurdle rate. When investing in a PE fund, the investor will receive offering documents and agreements disclosing the terms of investment, fund’s tenure and also the fess and expenses to be incurred by the funds and the investors. 

• Disclosure of all Conflicts of Interest

As the fund trustee, advisers or PE firms must make full disclosure of all conflicts of interest between themselves and the funds they manage in order to get informed consent as they may be managing multiple PE funds as well as a number of portfolio companies. PE funds often have interest that are in conflict with the funds they manage and also the limited partners invested in the funds.

Private Equity in Malaysia

In tandem with the expansion of Securities Commission Malaysia’s registration framework to include PE firms in 2015, the PE industry in Malaysia has been developing and growing ever since. Malaysia is blessed with a vibrant entrepreneurship ecosystem dominated by innovative start-ups that are generally ready for commercialisation and their funding requirements have also led to the growth of PE firms in Malaysia. As at end-2021, the market has recorded a total of 19 registered PE companies.

Source: https://www.capitalmarketsmalaysia.com/

The PE industry in Malaysia has been charting an encouraging growth with RM9.65 billion of committed funds as at end-2021. Efforts to cultivate a healthy entrepreneurship culture with a favorable business and regulatory environment have been extended to ensure early access to financing and review of the existing policies on the commercialisation of innovation. 

Source: https://www.capitalmarketsmalaysia.com/

According to Securities Commission Malaysia’s 2021 Annual Report, the funding sources for PE funds can be categorised into three sectors where 28.6% of the PE financing was derived from large corporations followed by individuals and family offices at 19.1% and financial institutions at 11.9%.

Source: https://www.capitalmarketsmalaysia.com/

The wholesale and retail trade sector received about 35.0% of the PE financing in 2021 whilst the some 32.2% of the financing was directed towards accommodation and food services and 8.2% to financial services.

More Room for Growth

While the global PE industry has enjoyed strong growth over the last decade, the industry in Malaysia has remained quite sluggish. According to ICMR (Institute for Capital Market Research) Malaysia, more needs to be done to grow and boost the market. A healthier and more diverse ecosystem of fund managers and private investors are needed to address the rising liquidity needs in the country. ICMR added, the asset under management (AUM) for Malaysia’s PE industry has been growing at a slower pace of 6.7% annually (from US$3.7 billion in 2010 to US$6.8 billion in 2020) compared to other developed countries which recorded a CAGR of over 10% over the same period.

As part of the Malaysia government’s concerted effort to encourage and supporting the growth of domestic PE industry, Bursa Malaysia has launched the Leading Entrepreneur Accelerator Platform (LEAP) Market in 2017 to address the funding gap faced by local SMEs as well as providing an alternative exit avenue for the PE firms. 

Since the debut of LEAP Market in 2017, a total of 48 companies had been listed on this board as of end-2021. The LEAP Market is accounted for 12 of the 30 listed entities on Bursa Malaysia and recorded a market capitalisation of RM1.21 billion in 2021. Given the growth potential of this market segment, the relevant stakeholders are striving hard to enhance the attractiveness of its ecosystem to both investors and issuers.