In the upcoming SuperReturn CFO/COO North America event, Ashley Roche delves into the dynamic realm of private capital investment with insights into its advantages, including flexibility and long-term focus, as well as challenges such as due diligence and regulatory oversight. Delve into emerging trends like larger fund sizes and heightened competition, and uncover the pressing legal and regulatory issues facing the industry, from SEC scrutiny to AI implementation concerns. Read on to gain valuable perspectives on navigating these complexities to optimize investment strategies in the ever-evolving landscape of private markets.
1. What are some of the advantages and challenges you face in investing private capital compared to other sources of funding?
Investing in private markets offers both advantages and challenges compared to other asset classes. Advantages include flexibility, access to expertise, and a long-term focus. More specifically, investors in private markets often have more flexibility in structuring deals and negotiating terms compared to public markets. In addition, private equity and venture capital firms can provide valuable industry expertise and operational support to their underlying portfolio companies. Finally, private capital investors typically have a longer investment horizon, allowing portfolio companies more time to grow and execute their strategies without the pressure of short-term performance expectations.
Challenges to investing in private markets include a need for extensive due diligence, illiquidity, valuation challenges, and lack of regulatory oversight. Securing private capital often involves extensive due diligence as investors are locking up their capital for several years. Similarly, private investments are typically illiquid, meaning investors cannot easily sell their stakes or exit their positions despite changes in the market or the construction of their portfolio. Investing in private markets always comes with inherent valuation risk, as valuing private companies is a challenge due to the lack of publicly available information and established market prices. Finally, depending on the jurisdiction and type of private capital raised, there may be less regulatory oversight for the investment than investors receive in public markets.
2. What trends or developments do you see in the private capital market that could impact your approach to investment that market?
There has been a growing trend of private equity and venture capital firms raising larger funds, which gives those firms the opportunity to pursue larger deals and compete for high-profile investment opportunities. However, they also face increased pressure to deploy this capital efficiently and generate returns commensurate with the fund size. There has also been an increase in competition. With more capital flowing into private markets, competition for attractive investment opportunities has intensified. This could lead to higher valuations and potentially more aggressive deal terms, making it more challenging to find investments that meet return expectations.
In addition to increased fund size and competition, potential changes in regulations, such as tax policies, antitrust enforcement, or industry-specific regulations, could impact the attractiveness of certain investment opportunities. Finally, the terms of each investment factor into the overall risk and return analysis, and we have seen a growing shift to the American waterfall distribution structure and increased debt maturity limits.
3. In your opinion, what are the most pressing legal and regulatory issues being faced in the industry as a whole? And how do you overcome these challenges?
The SEC and DOJ have had a heightened focus on private markets for the last couple of years. More specifically, the SEC has prioritized the regulation of compliance programs, fees and expenses, custody, fund audits, valuations, conflicts of interest, and disclosures of investments risks for firms and funds in private markets. This focus is meant to protect all investors, but particularly sophisticated, institutional investors, representing a shift from the SEC’s traditional focus on retail investors. Navigating the new rules resulting from the SEC’s focus on private markets is the most pressing regulatory challenge faced by both GPs and LPs in the industry today. There are contradicting opinions on the ultimate impact of these rules, and GPs will need to work closely with their legal counsel and compliance teams to ensure proper adherence.
From a legal perspective, the time and costs associated with side letter negotiations continues to be a challenge in the industry. We appreciate the managers that build most favored nation provisions into their fund documents, streamlining compliance with the provision and the negotiation of subsequent side letters. Other heavily negotiated provisions include the scope of the manager’s fiduciary duties, fees and costs, and transparency. Failure to take a fair and reasonable approach to the terms in the fund documents is resulting in large legal fees for investors, both directly for their own counsel and indirectly as legal fees for the fund are often passed through to the limited partners.
Lastly, the use of artificial intelligence (“AI”) is an issue in our industry, as well as other industries. AI can significantly increase operational efficiencies within organizations. However, there continues to be significant risk around confidentiality, security, and accuracy provided by AI platforms. Understanding how GPs are using AI, and what measures are being taken to protect confidential information of limited partners and portfolio companies is paramount.
