An activist investor is an individual or institutional investor that seeks to acquire a controlling interest in a target company by gaining seats on the company’s board of directors. Activist investors are looking to make significant changes to the target company and unlock perceived hidden value within the target company.
Activist investors usually seek companies that they believe demonstrate a structural flaw within their management and look to add value either by influencing the current management’s decisions or by replacing them with new management.
Types of Activist Investors
Activist investors come in many different forms, including:
1. Individual Activist Investors
Activist investors who are individuals are usually very wealthy and influential. They can leverage their capital to purchase a large number of a company’s shares to gain enough voting rights on the board of directors. They aim to influence the strategic direction of the target company.
The individuals are usually well known within the finance industry and use their influence to make structural changes to a company’s strategy. For example, if an individual activist does not believe management is allocating capital properly, they can use their influence over the board of directors to push for different capital allocation.
Some examples of well-known activist shareholders are:
Bill Ackman – Founder and chief executive officer (CEO) of Pershing Capital
David Einhorn – Founder and president of Greenlight Capital
Dan Loeb – Founder of Third Point Partners
Advantages of Individual Activist Investors
Individual activist investors may be able to add value for current shareholders by guiding management actions to the shareholders’ best interests. The activist investors can provide a voice for fragmented shareholders who do not own enough shares to gain influence on management decisions.
Disadvantages of Individual Activist Investors
Individual activist shareholders may not share the same interests or goals as other shareholders and, therefore, may destroy shareholder value. For example, an activist shareholder may only prefer a short-term holding time horizon;. They will influence management to make decisions that benefit the company in the short term to the detriment of shareholders with a long-term holding time horizon.
2. Private Equity Firms
Activist investors in the form of private equity firms employ many different strategies but usually will take control of a public company with the intention of taking it private. The structure of a private equity firm includes limited partners who own a significant amount of the fund and enjoy limited liability and a general partner who assumes unlimited liability. Private equity firms use capital from various investors who are willing to invest large amounts of capital for an extended period of time.
The investments of private equity firms come in many different situations, including:
Leveraged buyouts: Buying a company as a whole with the intention of restructuring its capital structure to increase its value and exiting the investment by reselling the company or conducting an IPO (initial public offering)
Distressed investment: Seeking companies or business lines that are distressed (on the verge of bankruptcy)
Venture capital: Providing capital to startups or entrepreneurs, possibly helping the entrepreneur grow their venture and, in return, receiving an equity stake of the seed investment
Advantages of Private Equity Firms
Private equity firms give many companies and startups access to liquidity and capital in situations where they might be able to access to conventional financing. Additionally, private equity firms may provide value for current investors of a company that is underperforming in the public markets, allowing the company to steer away from the scrutiny of the public market.
Disadvantages of Private Equity Firms
Private equity firms face a more difficult time liquidating holdings since there is no official market to find buyers and sellers. It can take a significant amount of time to find a buyer to sell a private company. Furthermore, pricing is done through negotiations and, therefore, the realized return is subject to variations based on conditions not determined by the market.
3. Hedge Funds
Activist investors in the form of hedge funds can take control of a public company in a variety of ways. Hedge funds can take the approach of an individual activist investor or can act like private equity firms. The underlying goal of a hedge fund is to generate a return for investors no matter what, and the funds are not subject to constraints on the strategies that they can employ to do so.
Many individual activist investors act through opening hedge funds, and similarly to private equity firms, they are established with investments from several limited partners and a general partner. The investments are illiquid since they are usually locked up for at least one year to provide hedge fund managers with flexibility.
Advantages of Hedge Funds
Hedge funds do not have a mandate on how they generate alpha and, therefore, can employ many different strategies without having to worry about conforming to investors or an investment policy statement (IPS). It allows hedge funds to be aggressive in how they target companies and make changes. It provides them with opportunities to make activist investments and increase target shareholder value.
Disadvantages of Hedge Funds
Hedge funds are largely unregulated and, therefore, are prone to numerous controversies. Furthermore, hedge funds are more expensive to invest in; they are typically used by wealthy investors. Also, the funds typically underperform the broad market and provide very volatile returns.