At the most basic level, private equity is the ownership of shares in a private company, while public equity is the ownership of shares in a public company. Public companies have shares that are traded freely on a stock exchange, whereas private company shares are traded only via private transactions.
There are many similarities between private equity and public equity, but also some key differentiators to these asset classes. These differences make exposure to both private equity and public equity an important component of any accredited investor’s portfolio.
How are Private Equity and Public Equity Similar?
Both private equity and public equity involve equity positions in the respective entities. In terms of capital priority, equity positions are subordinate to debt positions, meaning that debt has the priority of repayment over equity positions. This structure means that equity positions have inherently higher risks than debt positions, but, because of that, equity positions have significantly greater upside potential to compensate for this higher-risk position.
Private equity and public equity have many of the same market risk exposures related to macroeconomic factors, including GDP, inflation, interest rates, unemployment rates, and geopolitical conflicts. In addition, private and public companies within the same industry will have the same industry-specific risk exposures.
What Are the Differences Between Private Equity and Public Equity?
Private equity and public equity have key differentiators, including liquidity, size, and strategic patience, which is why these are separate asset classes.
Public equity has significantly more liquidity than private equity, as shares can be bought and sold any time the stock market is open. In contrast, private equity typically has a predetermined 5–7 year investment hold period. There’s a liquidity discount applied to private equity valuations (when compared to public equity valuations) that compensates private equity investors for this illiquidity.
On average, public company total enterprise value (TEV) is much larger than private equity TEV. Public companies are typically more established with greater market share and therefore have more revenue and profitability than private company peers. There’s a size discount applied to private equity valuations (when compared to public equity valuations) that compensates private equity investors for investing in companies with less revenue and profitability.
The most important difference, where private equity can drive substantial value compared to public equity, is in the strategic patience that private equity affords. Because public company shares can be bought and sold daily, public company management teams aren’t always incentivized or afforded the patience required to drive long-term value creation through significant capital investments in strategic plans.
Because of this, there are significant incentives for public company management teams to make decisions that drive improved short-term results that can rob long-term value creation. For example, public companies may be hesitant to invest in additional resources that require time to generate a return-on-investment, because it results in increased costs, which in the short-term decreases profitability.
In contrast, private equity has significant runway to patiently implement strategic plans due to the predetermined 5–7 year hold periods. At Roebling, this strategic patience is what allows us to create significant long-term value.
How Does Roebling Capital Partners Strategically Model Private Equity Investments?
We model our investments on a “J Curve,” meaning that we anticipate Year 1 EBITDA (profitability) to be less than EBITDA “at close.” This anticipated profitability decrease may sound counterintuitive, but one aspect of the Roebling Value Added™ playbook involves investing strategically, and many times significantly, in additional resources immediately post-close.
We know these resource investments take time to generate a return, and so our increased expense-load in Year 1 is likely to outweigh the increased revenue or efficiencies gained in Year 1. However, these resource investments multiply in value over time, which drives increased EBITDA, higher exit valuations, and substantial returns for Roebling’s investors. This strategy is much easier to execute in private equity than public equity, which is why private equity is an important component to any investment portfolio.
ABOUT THE AUTHOR
David Graham is an Associate at Roebling Capital Partners, a lower-middle-market private equity investment firm.