WHAT is private equity? This is ownership of shares in a company that is not public (privately owned), that is, it is not listed on a stock exchange.

In the last few years, Jamaica has seen a significant increase in the number of private equity deals floated.

The right environment is critical for private equity to flourish, namely, it is important that interest rates remain low. As interest rates rise, the number of defaults on debt increase which simultaneously reduces the number of deals because costs become too prohibitive. A flourishing/growing economy is also a positive for the growth of private equity.

Features of private equity include fairly high barriers to entry, which makes it ideal for institutional investors, pension funds and high net-worth individuals. Generally, you would have to be an accredited investor to participate. An accredited investor as defined by the Financial Services Commission would have to either earn J$10m consecutively in the last two years or have a net worth of J$50m or more or invest US$100,000 in the instrument.

So, in a nutshell, private equity is not for everyone!

A typical deal will involve a private equity fund seeking attractive deals, which involves extensive due diligence. The method of investing varies considerably from a passive purchase in stocks by a small investor.

In the case of private equity, an equity/ownership stake is usually taken, and the private equity firm is actively involved and will lend their expertise to the running of the company. However, they earn the bulk of their money upon the exit from the investment.

There are several exit strategies that may be employed but there are two that are most commonly used. The first is, that the company is taken to a point where it is more attractive than at the start, and it is sold to another larger company.

The second exit strategy, which has become very commonplace in Jamaica, is to list the company on the stock exchange. This is a very convenient way for private equity investors to get back their funds.

Generally, a private equity investor has to exercise patience, as their timeline is likely to be anywhere from three to seven years. It could be less, depending on the business, if they are lucky.

The returns are not guaranteed, this means that the private equity investor is taking on considerable risk, hence the need for an equity stake.

In addition, there is the matter of liquidity, private deals are illiquid, and a premium must be paid for that type of deal. This is the reason it is so important for private equity investors to make sure they are appropriately compensated for the level of risk that they are taking.

I overheard someone making a joke that in Jamaica every deal is priced the same regardless of the level of risk! Well, you be the judge.

Jamaica continues to be well poised to experience further growth in this area, since in addition to lower interest rates and an improving economy, Jamaica’s overall debt reduction as a percentage of GDP (from highs of 147 per cent down to below 100 per cent) is a huge positive factor, as this leaves more room for the private sector.

The recent reduction in BOJ’s cash reserve requirement from nine to seven per cent is another critical factor, as the death of credit is the absence of liquidity. Therefore, an increase in liquidity in the industry should lead to increased opportunities in the private sector.

As usual, not everything can be dealt with here, but hopefully it whets your appetite when you are reviewing your next deal.

Yanique Leiba-Ebanks, CFA, FRM is the AVP, Pensions & Portfolio Investments at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: if you wish to have Sterling address your investment questions in upcoming articles, e-mail us at info@sterlingasset.net.jm.