Direct equity investment refers to when an investor directly acquires private equity stakes in a company, rather than investing through intermediaries like private equity funds or brokers. It has become an increasingly popular approach for large investors like pension funds, sovereign wealth funds, and family offices. Direct equity investment provides certain advantages like lower fees, more control, and access to deals. However, it also requires building an internal team with specialized expertise. Critical factors to consider include deal sourcing, due diligence, valuation, investment decision-making processes, and portfolio management. Overall, direct equity investment can be highly rewarding but requires thorough planning and preparation.
Direct equity investment avoids intermediary fees like management fees and carried interest
One major advantage of direct equity investment is that it avoids the extra layers of fees charged by private equity funds. Investing directly means not paying annual management fees in the range of 1-2% of assets under management. It also avoids carried interest, which is typically around 20% of realized gains. For large institutional investors making multi-million dollar investments, these savings on fees can really add up over time. According to a HarbourVest whitepaper, an investor committing $100 million over 5 years to a private equity fund versus co-investing directly could save over $21 million in total fees. Fees like legal, accounting, and due diligence will still apply, but avoiding management and carry can meaningfully improve net returns.
Direct equity investment provides more control over deal selection, timing, and governance
Investing through intermediaries means giving up control over deal selection and timing. The fund manager makes investment decisions, and you as the LP have little say. With direct equity investment, you source and select the specific deals based on your own strategic goals and preferences. This also provides more flexibility in managing the pace of investments versus relying on a fund’s predetermined investment period. More control also applies at the portfolio company level. Direct equity investors often negotiate better governance rights like board seats, voting rights, information rights, and liquidity rights. Overall, eliminating the fund intermediary provides more customization of investments and governance.
Direct equity investment enables access to proprietary deal flow and co-investment opportunities
Experienced private equity firms receive proprietary access to acquisition opportunities that most investors don’t see. Building relationships with top-tier GPs can provide co-investment access alongside a fund’s deals. Investing directly in a GP’s deals improves overall economics by avoiding extra layers of fees. According to a 2015 Preqin survey, 80% of LPs that co-invest reported returns higher than their regular fund investments. Direct equity investment can also improve access to deals by allowing flexibility to provide minority growth equity versus taking full control. High-quality companies often prefer minority partnerships with value-added investors.
Direct equity investment requires building an internal team with specialized expertise
The main tradeoff of direct equity investment is the need to build internal expertise across sourcing, due diligence, valuation, portfolio management, and exits. Global deal sourcing networks, screening capabilities, due diligence skills, and experience pricing private company investments are essential. Companies also benefit from follow-on guidance around growth, operations, and strategy. Small investors likely lack the scale for a large specialized team, but large pensions and sovereign wealth funds can justify the costs. Firms also often partner with external consultants or advisors to supplement their capabilities.
Legal, regulatory, and tax considerations must be addressed in direct equity investment
Direct equity investment introduces some legal, regulatory, and tax complexities versus fund investing. The appropriate corporate structure, jurisdiction considerations, and compliance procedures must be determined. Tax treatment also differs across countries for direct versus fund investments. For global investors, specialized advice is often needed to optimize legal entity choices and meet regulatory standards in target countries and industries. Governance rights may also need to be negotiated separately for each direct deal. Hence advisor relationships and internal team expertise are key to navigating these issues.
Direct equity investment provides benefits like lower fees, control over deals, and proprietary access. But it requires strong internal capabilities and navigating legal, tax and regulatory factors. Large institutional investors like pensions and sovereign wealth funds are the most likely to have the scale to justify the required investment. Overall, direct equity investment can improve returns but needs thorough planning.