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No Reward Without Risk

Private equity and alternate asset classes more than just a potential pot of gold


Financial experts say increased sophistication and diversification of private equity funds over the past decade are creating an unprecedented suite of new investment opportunities for Canadian investors.

Yet, they also caution against visions of get-rich-quick grandeur, noting the rewards are not without their share of risks.

“The reason private equities are becoming more popular is even the mid-range ones are beating what they’d get through the general stock market,” says Jeff Belford, senior managing director with TriWest Capital Partners, a Calgary-based western Canadian-focused private equity firm that has invested in more than 40 companies across multiple industries over the past two decades.

“Yet there are reasons for that. It’s a higher-risk asset class with a higher-hold period and less liquidity. Your fund life from start to finish can be about 10 years or higher. It’s a long hold for investors. The returns are higher, but it’s not a liquid invest.”

Case in point: TriWest has been around for 20 years and raised just five funds – in the excess of $1.25 billion, mind you.

“It’s patient capital,” adds Belford, noting a typical TriWest investment would be a multigenerational, family-owned private company where the fund would come in to provide a liquidity event for material shareholders, and work to build the business up with the goal to sell it. The fund’s big investors tend to be some large Canadian pension funds.

“It’s not a business you can buy and flip in a year. When we buy businesses, we assume that we’re going to hold them for at least five years.”

He adds every private equity fund uses some leverage to generate some return – meaning they’ll put some debt on businesses.

“Where things can go offside sometimes is companies can put too much leverage on a business that has a significant setback, and then they get into financial difficulty,” says Belford, noting, however, that Canadian banks are disciplined, and generally do not allow leverage levels to spiral out of control.

Green Acre Capital co-founder and managing director Tyler Stuart similarly says venture capital funds – generally earlier stage than private equities – are comparable in their exposure for investors.

“It’s not like investing in bonds. There are no dividends or fixed-rate returns,” says Stuart, whose Calgary-based private investment fund is dedicated exclusively to the Canadian medical and recreational cannabis industry.

“I often say that when investing in private businesses, you should essentially be comfortable in losing 100 per cent of your money. You’re running the risk of investing in something that could go to zero. Eighty-five per cent of new businesses fail in three years. Well, that’s the space we’re participating in – these startup businesses.”

When it works, however, “that” space can also be its own reward because it opens investment opportunities that otherwise wouldn’t exist, adds Stuart.

“One of things we wanted to address was the ability for people to invest in private businesses,” says Stuart, who likens Green Acre to a pick-and-shovel fund that invests in private companies ranging from packaged goods and edibles to science and research.

“It’s not very accessible. You have to either know someone or be a really good client of a really aggressive stockbroker who can put those deals in front of you. And even then, it’s not easy to find those deals, so your choices are limited.

“When we set this up, we wanted to give people a platform to come in and invest with a minimum of $100,000 that gives them exposure to roughly 16 businesses in the cannabis space. Here, you get exposure to companies that are not on the stock exchange. They’re unique business models. And you generally get exposure to better evaluations because they’re early stage.”

Green Acre was founded in 2017, raising $25 million with its first fund, and has since raised nearly $90 million for a second fund that closed at the end of 2018.

In its Top Five Investment Risks for 2019, the Alberta Securities Commission (ASC) singled out the relationship between risk and reward; generally, the higher the potential reward, the higher the risk. It noted the number of complaints relating to private, high-risk investments promising high returns that are marketed as low risk are on the rise in Alberta.

“Investing is important in financial planning for goals such as retirement,” says Alison Trollope, director of communications and investor education for ASC.

“That said, in order to make suitable and informed investment decisions and protect your financial future, it’s critical to protect yourself by gaining a solid understanding of the investment before handing over your money. Some factors to consider include the business underlying it, the risks involved, how the company expects to grow or return value to shareholders, and how easy or difficult will it be to cash out your investment.”

Trollope adds it’s also helpful to understand the red flags of fraud, such as high rates of return with low or no risk, or pressure to “get in now.” She points to a full list of red flags available on Checkfirst.ca.

The ASC is the regulatory agency responsible for administering securities laws and protecting investors in Alberta. Its enforcement division uncovers, investigates and prosecutes breaches of those laws.

“Check the registration of the person or individual offering the investment; generally, anyone offering securities in Alberta must be registered with the ASC,” says Trollope, encouraging investors to also read any offering documents or financial statements relating to the investment. “Lack of registration is a red flag of fraud.”

The Institutional Limited Partners Association (ILPA) also exists as an advocacy and governing body for its 4,500 members across more than 50 countries. Over the past two decades, the global organization has focused on equipping ILPA members with intelligence regarding legislation and regulation in their respective jurisdictions.

Belford says each private equity fund treats governance differently, but most, like TriWest, provide regular quarterly and annual reporting to investors. That way, they know which companies their investing in and those companies’ narratives.

He also points out that TriWest doesn’t call on its capital out of the gate – meaning investors only write their cheques when there’s a specific investment opportunity on the table.

“Our current fund is for $500 million, but we don’t call that capital right away. We just have a commitment from investors that the capital is available,” says Belford. “We only call the capital when we have an investment. So, investors get visibility at that point. It is very transparent.”

Stuart says any personal or institutional investor considering private equity or venture capital should take a portfolio approach, and purchase funds where there’s a professional managing that fund.

“Because that professional is going to take 16 shots, and hopefully there are a couple in there that go from $1 to $10. Because there are a couple of them that, guaranteed, go to zero within the course of seven years,” he says.

“It should be viewed as a diversification tool as part of your portfolio.”

Concludes Belford, “When you have the ability to be patient and really help businesses grow, you can create some tremendous value,” adding, “there’s still a place for bonds and stocks and lower interest rate instruments.”

SOURCEJamie Zachary
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