Finding Your “Edge” in Private Equity

Building a great and successful entrepreneurial business is an extra-ordinary challenge. Many people think that building (and then selling) their business is the “hard part” and that investing the proceeds conservatively for retirement will be easier. It turns out that preserving wealth in today’s environment is even harder than ever before when real interest rates are negative, and one is still trying to fund a lifestyle (however conservative) and offset inflation.

The stark reality is that for any investor trying to preserve wealth in today’s environment, shedding all risk is simply not feasible. Unlike a generation ago, when business sellers could live (and preserve capital) happily ever after on the earnings from passive investments, today, just trying to stand still financially can all too easily result in going backwards.

Consider a successful entrepreneur with a business earning $2 million a year. At a typical 5-10x earnings multiple, that business might sell for $10 to $20 million, or $8 to $16 million after capital gains tax. Since the start of this century, public equities have returned just over 4% a year, so proceeds from such a sale would have earned $320,000-$640,000 per year - a far cry from the $2 million this business was earning before the sale. Mix in some debt and cash for safety and the numbers look even worse. This seller’s dilemma results in incomes plummeting by 70-80% after the sale of the business.

After a sale, entrepreneurs are generally advised to take risk by investing in publicly-traded securities. The irony is that with passive investments, entrepreneurs who built wealth through hands-on involvement are depriving themselves of leveraging the very edges they developed over a lifetime of success.

The limitations of public investments

There is nothing wrong with investing in public companies. They allow for liquidity and a degree of diversification that would be difficult to achieve with private equity investments. Still, for people who have spent their careers using their talents to find a competitive edge, passive investing in public equities (or indexes) is a step back, and the returns are likely to reflect it.

In contrast, private equity allows access to opportunities that have not yet been watered down by mass exposure (there is more potential for alpha). It also does something more. It allows people who have been successful in business to use that expertise to create an investment edge because of all the experience and perspective they can bring to bear.

Making money is different than receiving money

Making money is different from receiving money, say by divorce, winning the lottery or inheriting wealth. People without a track record of business achievement may be best served by focusing on preserving wealth via well-diversified public market investments. Those with a history of successfully creating wealth in private companies should not be limited to trying to preserve wealth in public investments.

The combination of mediocre public market returns and the opportunity to leverage their business skills in private equity is no doubt a major reason why TIGER 21 Members report an average private equity allocation of 23%.  TIGER 21 is exclusively for people who have been actively involved in creating their wealth. By investing in private equity, our Members create opportunities to continue applying the same types of insights and strategies that allowed them to build great businesses in the first place. No wonder Members’ allocations to private equity have almost doubled in the past decade.

With passive investments alone, entrepreneurs who built wealth through hands-on involvement are depriving themselves of the very edges that insured their success – not to mention the joy that comes with finding those edges.

The Fun Factor

I have been an active investor in outdoor solar lighting for almost 30 years.  I am now the Chairman and largest shareholder of Carmanah Technologies, a small public company in Canada, which because of my position is really like a private equity holding. As rewarding as it has been financially, one of the great joys I experience is sailing along the United States coastline and seeing one of the red or green flashing Coast Guard buoys I know was made by Carmanah.  One of my fellow TIGER 21 Members calls it the “fun factor.” 

So what does this joy have to do with making and preserving wealth? They are all tied together.  Taking a personal involvement in a few, select investments can prove to be financially rewarding and it can also be fun.

Michael Sonnenfeldt
Founder and Chairman
TIGER 21 

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