View: Why Asset Heavy Private Equity is Superior to Traditional Private Equity

It's all About the Exit.

If you start carefully examining extravagant purchases of people around you, such as; a car, a second home or apartment, or perhaps a boat. You'll quickly start to see a pattern, the funds for these purchases typically come from events of large-sum cash-outs. Importantly, not Neccessarily a Rags-to-Riches event or a Get-Rich-Quick Scheme. The person who bought it may or probably is already wealth and has a steady stream of income from somewhere. But in most cases these purchases aren't a result of savings. But rather gifts to themselves from something like a closure of that big deal, contract, client or a sale of an asset.

In part this phenonom is psychological, it's certainly easier to part ways when a purchase is a fraction of your cash balance and when you recieved a lump-sum immediately vs when you spent years grinding and saving up every dollar.

However, this tendency is visable in the investment business as well, significant returns tend to not come from dividends, but from 3 key events; Compound Growth/Interest (only visible in the retrospective, and mostly a bi-product of inflation), Events of Significant Uncorrelated Returns (rarely predictable), and the Exit (a sale of asset or security at the end of the investment lifecycle).

The most vanilla play there is in Investments, is to purchase an asset, break-even over the next 5-20 years (depending on your risk tolarence) and sell it. In my experience in you might generate a cumalative return of 2-3x net. 1x in small returns over 5-20 years and 1-2x in a lump-sum payment once the sale is completed.

Because of this the exit is one of the most critical aspect in most investments.

Private Equity 101

Before I go any further, I'll adress in this section the fundementals of Private Equity and what it does. If you're familiar or work in finance, I recommend you skip over this section Entirely.

Fundementally if you look at how jurisprudence (Legal) around the world stuctured investments is distinctly places them in 4 categories

• Physical & Digital Assets

• Equities (Shares/Stocks)

• Securities (Bonds & 'Rights')

• Cash (Physical & Digital)

Physical & Digital Assets are basically anything and everything that exists defacto, a car, a house, a vintage collection or records. It can also be something you have direct access to and own the Intellectual Property of; Music, NFTs, etc. (note: if you dig deep enough, you'll find you never actually own anything in life, it's only your turn to use it).

Equities are shares/fracations or stock of a private or a public company, essentially a voucher of ownership from that company that you are entitled to certain rights within that company (the rights assigned depending on the bylaws of a company). The major difference between private and public stocks, is that public once are just onces that have been listed on an exchange.

Securities are typically debt bonds (contracts) issued by governments, companies, individuals or organizations. but also include other certificates/vouchers that entitle the holder to a certain right, these can also be private, by you lending john doe money, or public and listed on an exchange, whereby you start selling pieces of the contract by which you lend john doe money. This also includes things like emissions credits, which is a certificate the government gives you for being super clean and ecologically friendly in one place that allows you to be more dirty than is allowed. alternatively you can sell that to a third-party.

Securities can also include your agreements with third-parties on what will happen to a government, organization, individual or company. They may also be private, i.e. a 'bet' or again listed on an exchange, e.g. trading contracts (futures, options, derivaties etc).

Lastly, you have cash which is a certificate from the government, that claims the certificate is worth something.

Within Investment Spaces

Investment companies essentially use these 4 categories of tools within distinct strategy of focusing on a certain parameters of the various tools. Typically they'll establish a fund (or another company), within which they'll sell shares nominated as Limited Partner (LP) shares or shares that are bought up by investors and General Partner (GP) Shares which is held by management for their work. The bylaws then establish who gets what in what case.

This Fund will then use it's funds, to Invest within their strategy. When it comes to Equities (ownership in a company) there are two key parameters that companies often distinct themselves by; by the stage of maturity of the business in which they buy stock and by whether the stock is listed on an exchange or not.

Private Equity, as the words imply are investors into non-listed stocks (ergo private shares), from that point onwards it's all really a cafe, some may call themselves a coffee shop, some a cafe, some a pitstop and some gas station. As the only thing decides if the firm serves miachto or american black is the firm itself.

Similiarly, althought technically part of private equity firms, venture capitalists tend to refer themselves as VCs due to been only partial investors into small early stage startups. Whilst most who call themsleves private equity, are firms that either do alteranative investments or use LBOs (Levereged (Debt) Buy Outs), to buy mature companies in hopes that change in management will make them more efficient, and within 7-9 years they will be able to sell it off to a larger competitor.

Non-Traditional Asset Heavy Private Equity firms, may focus their Fund(s) on investing into physical assets such as real estate, container ships, airplanes, natural resources, etc, whereby the majority of their model is trying to lease the asset at a good price to an operational business.

They are still referred to as private equity firms because they still fundementall invest into equities of a private company created to hold an asset as the Fund company doesn't hold titles or rights to the asset themselves.

Traditional PE firms vs Asset-Heavy PE Firms.

In my humble and biased view, the critical flaw in traditional private equity firms stems from 2 issue;

1) Their minimum ticket size (total investment size)

2) The market size (deals per year) for their exits (coinciding with point 1)

Whilst these points are debatable, the average size per deal in Private Equity in the US in 2024 is US$134.40m, even if we assume that this is due to PE concentration, the average value of mergers & aquisitions worldwide is around US$60m.

In compairson, the average real estate deal in the US is around US$362,481 +/- closing costs. even if we take out of the equation residential, we are still left US$1,391,00. a significantly smaller deal size.

Imagine for the momment, your in traditional private equity, you buy a mature sportswear brand, within 7 years with experience and good management you turn it into a large sportswear company. It's time to start liqudating, your investors are asking for their big paycheck. Who do you sell it to?

You only realistically have maybe 3-4 large companies, like Addidas, Nike, Puma who have the finacial capacity and interest into purchasing something. Alternatively you can list it on the stock exchange (Risky, as you might find that the valuation you told investors it's worth is nowhere close to what the market might think) also will add additional complexity, and depending on the stock lock-up period, might add another 2-3 years to offload it all. You also have the option, of selling it to other private equity firms (but, if you did your job well, there's unlikely to be a lot of interest, since what is in it for them to do, profit?) Lastly, and what we have come to see as common, is to resell the asset to yourself, or start a new fund, get new investors for another 7-9 years and sell from one fund to the new. Essentially just switching investors and creating history of the assets potential to sale. My view is that it's a charade no better than agreeing with friends to stand at your stall and make a fake line, but at a slightly larger scale.

At the end of the day, you're very limited in options on selling the asset, If there's no interest by Puma, Nike or Addidas, no possibility to IPO, you're doomed to be stuck with an asset or look for a buyer who'll try and sell it for lower.

Real Estate on the other hand has the benefit, that the amount of deals happening constantly is significantly bigger, the pool of potential buyers is significantly larger. The lower barrier to entry in combination with increased liquidity and access of the average person to the mortgage market, backed by simplicity of the product and the ever engaging government ensuring people have a place to live. Allows for your asset to be far more liquid at prices far closer or even higher than you were looking for.

If one person fails to buy, you have significantly more options.

In full transparency, all of this of course depends on the subsegement of the market you are operating and the region, apples shouldn't be compared to oranges. Traditional Private Equity is by default a bigger scope and has far more markets in which conditions can be significantly different. However, on a qualitative level, it doesn't take numbers to see that on the whole bigger picture. Real Estate has far more deals at significantly lower deal size than Companies. It's far easier to exit by selling a residential home, rather than say selling the a sports brand.

You'll find a similar situation, When looking at other Asset-Heavy examples, such as ships, airplanes, etc.