Jennifer Tagney
Partner

Understanding the J-Curve of PE investments

1 May 2021

The J-Curve often refers to the shape commonly associated with astronomical returns (which is what we are all trying to achieve). We are writing about a different type of J-Curve that specifically refers to the negative cash flows that can last for several years after investor commitments are made, poor apparent performance in the early life of the investment and the valuations of assets that are held at, or near to cost even when they are several years old. It is important to remember, this isn’t an indicator of performance, but an indicator of life cycle … by understanding this, investors will be able to better prepare for what lays ahead with their investment into Private Equity, which is a long term, lumpy investment by way of cash flows.

 

Why is this the case?

There are a few reasons that this occurs:

  1. Cash flow pattern of PE investments
  2. The valuation process of the managers
  3. The impact of management fee structures

This blog is focused on cash flow. At RoBne, we anticipate the draw-down and deployment of capital into the appropriate investments will take at least a couple of years. This is due to the complicated nature of completing an investment ‘deal’, which means it is extremely unlikely the fund is invested quickly or concurrently. There are many reasons why is this the case:

  • Identifying the range of companies that fit within our mandate
  • Extensive desk top research into the industry and companies
  • Multiple company meetings, which can last over many months, sometimes years
  • Internal and external due diligence
  • Agreement on price and terms
  • All the while the portfolio company continues to operate
  • Investment completion

Once this has completed, the first ‘capital call’ from investors is realised. Which means committed investors are called to transfer their proportion of the investment, for a simple example:


RoBne Fund
Size
Investor Commitment Initial RoBne Investment Investor Capital Call
$30m $1m $9m $300,000

This is also the trigger for management fees to begin being deducted. This process is repeated until the fund is fully deployed.

What this means for investors is that you see money going out, yet not a lot of money coming back in for some time. This is simply because, of the timing of cash flows. From the time of the initial investment, RoBne will unlikely receive any ‘return’ until the investment is sold, which will likely be 3-5 years from the initial investment. So, ideally, the fund and your investment will come home with a wet sail.

We understand valuation can be a contentious issue in funds like ours, so our next technical blog will be focused on this topic.

The best investment you can make is an investment in yourself … The more you learn, the more you’ll earn.

Warren Buffet

 

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