What is private equity?
The Burger King / Tim Horton’s deal is being driven in part by Burger King’s majority shareholder, 3G Capital. 3G is a multi-billion dollar Brazilian private equity firm that focusses on iconic brands. They have significant stakes in Heinz, Anheuser-Busch, and America Latina Logistica, the largest railroad company in Latin America.
Private equity firms have direct stakes in the firms they own. Their shares aren’t traded publically. That means their investments can be locked up for years. It’s like investing in a friend’s business: you’re at the mercy of your friend and any other investors if you want to buy more or reduce your share. Usually private equity firms bring some kind of expertise with them—brand management, or financial savvy, or technological expertise. Firms sometimes accept private equity investment to get those skills onto their Board.
The advantage of private investing comes from its governance structure and accountability. Managers can’t control their Boards, since investors are independent. There are no issues of insider trading, so investors can ask whatever they want whenever they want. If managers behave badly in the morning, they can be gone by the afternoon. As with the Burger King deal, decisions can be made quickly.
But private equity is risky because it’s so concentrated. To have a meaningful impact on their investments, firms need to limit their focus. In equities, diversification reduces the volatility of returns. That’s part of the reason private equity funds are limited to accredited investors—who in theory can afford to lose it all.
Private equity funds provide one more way for institutions and wealthy individuals to put their money to work. But they’re not for everyone.
Douglas R. Tengdin, CFA
Chief Investment Officer
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