The Rise of Malaysia’s Private Equity Industry
Varying the components of your portfolio can enable resilience. One way is through the use of alternative investment classes, of which, one is PE (Private Equity). Private equity is made up of a landscape of investors, as well as funds. These companies/funds can take over public companies or invest directly in private companies. After a slump brought about by the COVID-19 pandemic, the private equity market in South-East Asia appears to have recovered with a deal value exceeding RM110 billion (more than double the 2020 projections).
According to the Securities Commission Malaysia's (SC) 2021 annual report, Malaysia's total committed funds for private equity and venture capital increased by 26.75 per cent to RM14.83 billion in 2021 from RM11.7 billion in 2020.
The sectors receiving the most private equity investments in 2021 were wholesale and retail trade (34.97 per cent), followed by lodging and food services (32.24 per cent), and financial services (8.15 per cent). It seems that there’s been growth across the board with regard to private equity investments.
Both the number of licensed private equity management companies and the number of private equity specialists increased gradually across the nation. From 26 agreements the year before, Malaysia saw 36 deals in venture capital and private equity in 2021.
Value Creation Through Private Equity
Successful private equity funds, managers, and organisations are able to select from their ‘deal flows' and then restructure their target businesses into more valuable assets. Because of this, reputable private equity firms, institutional investment managers, and hedge funds have reported exceptional returns that surpass those of publicly traded companies (stocks). In 2021, Malaysia saw the value of private equity and venture capital deals rise to 1,106 (value in million US dollars) from 145 in 2020.
Managers have control over their portfolio companies, enabling them to use a variety of organic or inorganic avenues (i.e., via acquisitions) to work towards adding noteworthy value within the typical 5-year holding periods of their investments.
This gives private equity a notable advantage over rival asset classes. Even when markets are declining, this typically results in a larger exit multiple. Having said that, growth in sales and EBITDA rather than multiple expansion is the main value generator. Multiple expansion involves generating synergies and using buy-and-build arrangements (in which a PE firm purchases a company and then expands on that "platform" through add-on acquisitions). Buy-and-build methods can result in higher exit valuations due to raised market expectations for portfolio businesses' sustained growth and margin expansion.
So, three primary methods are used by private equity firms to build value:
- Multiple expansion
- Leverage
- Operational improvements
Of the three, financial leverage was the main driver of wealth creation in the 1980s. This can increase the internal rate of return (IRR) on portfolio companies.
However, the sector has shifted its focus away from financial engineering and toward enhancing the operational performance of the businesses it invests in. Many fund managers believe that business transformation can result in more enduring and replicable ways to add value to portfolio companies, which can therefore draw a bigger exit premium.
Therefore, as mentioned, the most frequently applied lever now for value creation is operational improvement.
What Rules Apply to PE Financing?
In Malaysia, the Securities Commission of Malaysia is the governing authority for anyone wishing to engage in any venture capital or private equity-related activities.
According to the Capital Markets and Services Act of 2007 (CMSA), the SC must provide the proper licence or registration to anyone conducting business in any regulated industry.
Under schedule 4 of the CMSA, corporations engaged in venture capital or private equity activity are considered registered persons.
"The Guidelines on the Registration of Venture Capital and Private Equity Corporations and Management Corporations" is the guiding document produced by the Securities Commission. This policy should be thoroughly referenced. Otherwise, you run the danger of non-compliance, which could cost you.
Investors in PE funds should complete their tax due diligence and consider strategies to reduce their tax liabilities.
To protect their interests, investors should insist that certain clauses be included in an LPA (Limited Partnership Agreement). After that, investors should continue to check the GP's (General Partner) semi-annual reports to keep track of the performance of the fund.
Types of Private Equity
The three primary categories of private equity strategy are:
- Venture capital
- Growth equity
- Buyouts
Each of these techniques has a role in the life cycle of an organisation and requires different abilities to succeed. Here is a closer look at each private equity strategy.
1. Investment Capital
An early-stage startup may get venture capital (VC), a sort of private equity funding in exchange for a stake in the firm. Venture capitalists typically do not want a majority share (more than 50%) and founders may find this appealing.
2. Growth Equity
Growth equity, which involves making a financial investment in an established, expanding company, is the second kind of private equity strategy. Later on in a company's lifetime, when it is already established but needs additional money to expand, growth equity comes into play. Growth equity investors, in contrast to venture capitalists, can examine the company's financial history, speak with customers, and test the product before determining whether it is a sensible investment. Growth equity offers the option for the company to demonstrate that it can generate a return before the private equity firm invests, reducing the risk.
3. Buyouts
Buyouts are the last major private equity tactic and the one that is most advanced in the firm lifecycle. Buyouts take place when a mature, normally public company is taken private and bought by either the existing management team or a private equity group. The majority of the money used for private equity investments is used for this kind of investment.
When a buyout takes place, all of the former investors in the company sell their shares and leave. The management group or private equity firm becomes the only investor and is required to own a controlling stake in the business (more than 50 per cent).
Issues Facing the Private Equity Sector
Competition among private equity firms is one of the big issues they currently face. There are a large number of PE firms with billions of dollars available. The number of PE firms is increasing, but the number of businesses that might be for sale is still around the same
A former vice-president of VC firm Gobi Partners has stated that some brick-and-mortar businesses were still reluctant to raise funds from PE deals because they didn’t want to let go of decision-making power and control.
According to Nicholas Ashby, advisor at Navis Capital Partners, Malaysia’s private equity sector has issues with the flow of quality deals, as well as too many "me too" business ideas. There may also be issues finding seasoned management groups.
Economic Resilience and Sustainability
Steps should be taken to guarantee that economic opportunities are shared and that people are not left behind. A conscious approach to both sustainability and resilience may be in order.
In a rapidly changing world with shifting consumer behaviour, the market may either support or oppose businesses based on ideals like environmental or social sentiment. However, this can function as a positive stressor that can aid the growth of organisations in Malaysia that are able to grow through stressors.
One of the largest bourses in ASEAN, Bursa Malaysia operates and regulates a fully integrated exchange offering a comprehensive range of exchange-related facilities.
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