Decoding Private Equity Returns: A Guide for Portugal Golden Visa Investors

Introduction

This article aims to provide a comprehensive understanding of how to evaluate the performance of private equity (PE) investments, with a specific focus on the nuances that impact investors participating through the Portugal Golden Visa (GV) program. While fund managers (FMs) report on fund performance, the unique characteristics of the GV program can significantly influence an individual investor's returns. It is crucial for GV investors to grasp these details to effectively assess fund track records and make informed investment decisions. These impacts are inherent to the GV program's structure and are not the direct responsibility of the fund manager.

In the realm of private equity, the General Partner (GP) is the fund manager responsible for making investment decisions and managing the fund. The Limited Partner (LP) is the investor who provides capital to the fund. For simplicity, throughout this article, we will refer to the LP as the investor and the GP as the Fund Manager (FM).

Understanding Performance Metrics from the Investor's Perspective

From an investor's standpoint, two primary metrics are key to evaluating a PE fund's success: Total Value to Paid-In Capital (TVPI) and Internal Rate of Return (IRR). It's important to note that FMs also track performance metrics from their perspective, such as the Multiple on Invested Capital (MOIC) and a gross IRR, which may be presented in fund materials. Investors should be aware of these different perspectives and always clarify whether the reported figures are net of fees and expenses – a good practice ensures transparency and reflects the actual returns delivered to the investor. Ultimately, an investor's focus should be on the net cash-on-cash returns. As the adage goes, an investor shouldn't be overly concerned with the Fund Manager's operational expenditures, whether they fly in a private jet or economic class, as long as the net returns generated are strong and meet expectations – meaning the cash ultimately returned to the investor is significantly higher than the cash initially invested (cash-to-cash).

Total Value to Paid-In Capital (TVPI)

TVPI=DPI+RVPI

Illustrative Example:

Consider an investor who contributes €100,000 upfront. After five years, they have received €70,000 in distributions, and the residual value of their investment (based on the Net Asset Value or NAV, which reflects the current market valuation of the remaining fund investments) is €200,000.

Internal Rate of Return (IRR)

The Internal Rate of Return (IRR), on the other hand, measures the annualized rate of return on an investment, taking into account the timing of all cash inflows (distributions) and outflows (capital calls). It is crucial to understand that IRR is highly sensitive to the timings of these cash flows. Even with the same total amount invested and the same total amount returned, shifting the timing of these flows can significantly impact the calculated IRR.

Illustrative Example:

Let's consider the two scenarios from the previous IRR example, now looking at the IRR over the entire investment period, including the estimated residual value for Scenario 1. The initial investment is €100,000 in both cases.

This further emphasizes that while TVPI provides a clear picture of the total return generated, IRR is significantly influenced by the timing of cash flows. For Golden Visa investors, potential delays in distributions can lead to a lower IRR, even if the ultimate TVPI of the investment remains attractive. Therefore, analyzing both metrics is crucial for a comprehensive understanding of performance.

Investor Classes in Funds Eligible for Golden Visa

Funds eligible for the Portugal Golden Visa are typically general private equity funds that attract a diverse range of investors (institutional investors such as pension funds, endowments, family offices, banks, high net worth individuals, etc), including GV participants. It's important to understand that the best-performing PE funds are usually not specifically designed for the Golden Visa program. If a fund's primary focus appears to be solely on GV investors, it could be a red flag. Typical investor categories within such funds include:

• Management Team Investors: Fund employees and executives who often invest with preferential terms.
• Non-GV Investors: Institutional investors (e.g., pension funds, insurance companies) and accredited individual investors who generally follow standard capital call and distribution schedules.
• GV Investors: Individuals investing to qualify for the Portugal Golden Visa, who are subject to specific program requirements that can impact their investment experience and returns.

Key Nuances Impacting Golden Visa Investor Performance

GV investors face two primary nuances that can lead to different performance outcomes compared to non-GV investors in the same fund:

1. Single Capital Call vs. Staggered Calls:

The Portugal Golden Visa program requires investors to deploy their full committed capital upfront. This contrasts with the standard practice in private equity where non-GV investors usually experience staggered capital calls, with the Fund Manager drawing down capital as investment opportunities arise.

Illustrative Example:

2. Dividend-Only Distributions During Residency vs. Capital Reductions:

Golden Visa regulations require maintaining the initial minimum 500.000€ investment for a specific period (at least for five years) to qualify for permanent residency or citizenship. During this time, and sometimes longer if the investor chooses to renew their residency for Schengen access until they get the citizenship (the whold cycle may take up to 7-8 years), GV investors might prefer or need to receive distributions primarily as dividends rather than capital reductions to ensure their invested amount remains above the required threshold. This can delay the receipt of capital gains and the full return of capital compared to non-GV investors.

Illustrative Example:

To illustrate this point, assume a fund invests in a company that is sold after 4 years for a significant profit, resulting in a total return of 3 times the initial investment (before fees). For a €100,000 investment, this translates to a total return of €300,000. The distribution is structured as 2/3 dividends (€200,000) and 1/3 capital gain (€100,000). Note: This example is a simplification and excludes fund management fees, carried interest, and other potential expenses that would affect the net returns for both investor types. It serves only to illustrate the specific impact of delayed capital reduction distributions on the GV investor's IRR.

Both result in an identical TVPI of 3.0x. However, the timing of these cash flows differs significantly. The non-GV investor receives the entire €300,000 after 4 years. The GV investor receives €200,000 after 4 years (as dividends) and the remaining €100,000 (as capital reduction) in year 7, due to the assumed restrictions related to their Golden Visa residency. This delay in receiving the capital reduction portion negatively impacts the GV investor's Internal Rate of Return (IRR), even though the total return (TVPI) is the same. The non-GV investor achieves a higher annualized return because they have access to the full proceeds earlier.

Understanding Return Expectations Amidst the Nuances

Given the complexities and nuances that can affect the performance of private equity investments for Golden Visa investors, how can one form realistic expectations about potential returns? The most reliable source of information for this purpose is the Key Information Document (KID), which is mandatory for funds to provide to potential investors.

As detailed in our dedicated article on the KID, these documents present performance scenarios that evaluate different potential outcomes of the investment under various conditions (e.g., stressed, moderate, and favourable scenarios). Critically, funds are obligated to provide a KID tailored to your specific investor category, which, in the case of Golden Visa investors, should account for the unique aspects such as the upfront capital call and potential delays in receiving capital reductions.

These performance scenarios illustrate potential returns at the end of the recommended holding period and often at interim points, such as after one year and at the halfway mark of the investment period. The moderate scenario within the KID is generally considered the Fund Manager's central expectation under normal market conditions and should offer a reasonable benchmark for your return expectations.

To gain a deeper understanding of how the GV-specific conditions might impact your returns compared to other investors, it is advisable to request the KIDs for all relevant investor categories within the fund (if available). Comparing the performance scenarios presented for GV investors versus non-GV investors can provide valuable insights into the potential differences in outcomes.

However, it is crucial to remember that the precise impact of capital reduction delays on your individual returns can be challenging to forecast accurately. This impact is highly dependent on your specific Golden Visa timeline, including when you obtain your resident card and your decisions regarding its renewal.

Given the potential for IRR to be significantly influenced by the timing of capital reductions, which can be uncertain for GV investors, we recommend placing a greater emphasis on analyzing TVPI (Total Value to Paid-In Capital). TVPI provides a more stable measure of the overall return multiple achieved by the fund, irrespective of the specific timing of cash flows. For Golden Visa investors, TVPI offers a less misleading indicator of the total value generated by the investment over its life. While IRR is a standard performance metric, its sensitivity to the timing of distributions, particularly the delayed capital reductions often experienced by GV investors, can make it a less reliable metric for assessing the ultimate success of the investment for this specific investor group.

Therefore, while the KID's performance scenarios offer valuable insights, GV investors should prioritize understanding the fund's projected TVPI and carefully consider the potential impact of delayed capital reductions based on their individual Golden Visa circumstances.

Conclusion

Understanding how standard private equity performance metrics are calculated and, more importantly, how the specific requirements and preferences of the Portugal Golden Visa program can influence individual investor outcomes is essential for GV participants. The differences in capital deployment timing and distribution preferences are inherent to the GV structure and are factors that investors must consider when evaluating fund opportunities. While Fund Managers will report on the overall fund performance based on standard LP terms, GV investors need to analyze these metrics in the context of their unique circumstances to make informed decisions and accurately assess the potential returns of their private equity investments.