What Is Private Equity?
Private equity (PE) refers to the interest in a non-publicly listed or traded entity. It is a type of investment capital that comes from individuals and firms that have a high net worth. They purchase stakes in private companies or acquire control over public companies in order to privatise them and delist them from the stock exchanges later on.
The PE industry consists of institutional investors like pension funds and large PE firms that are funded by notably recognised investors. Private equity firms hold about $3.9 trillion assets as of 2019, which is an excellent share.
Why Do Investors Invest In PE?
Investors are interested in investing in private equity since they seem to earn better returns than what is achieved from the public equity markets. As it entails direct investment, it also enables them to gain influence and control over how a company operates. The minimum capital required for investors to invest in PE varies from firm to firm and fund to fund.
However, the funding is always in millions, requiring deep-pocket investors. The pursuit of receiving a high return on investment is what drives the investors to invest in PE. The investment time horizon is generally 4-7 years.
How Does Private Equity Work?
Before understanding how private equity works, we need to understand what a private equity firm does. A private equity firm is a company that invests in businesses by raising money from institutional investors like insurance companies, sovereign wealth funds, family offices and pension funds. They invest intending to increase the business’ value over time and often take a majority stake of 50% or more in the company. They generally take this majority ownership in more than one company at once.
Private equity firms generally invest in companies with high growth potential but are either stagnant or distressed at that particular point in time.
Since private equity firms raise funds to invest in private businesses and profit from the same, they strive to grow them further in the future and sell them at a considerably higher amount years later. This leads to generating better returns for the investors than they would usually get from the public market.
The private equity firms appoint an experienced management team to carry out an exponential growth plan for about 3-5 years to help the business reach the desired level. The management team’s only focus is to execute the growth plan and succeed.
After the investment takes place and the process is completed, the private equity then takes a non-executive role but are considerably active in the business. They contribute in areas where their skills, as mostly financers, can help the business boom. The skills generally involving finding and funding acquisitions, assisting with the senior hiring recruitments, strengthening the company’s finances and building its governance.
Private Equity Strategies To Follow
Leveraged buyouts
In a leveraged buyout investment strategy, the private equity firm borrows large capital to buy out other companies. They do this because they believe that they will get a significant return from the company when it is sold in the future. About 90% of the entire investment is financed through debt. Once the company gets acquired, the PE firm either sells some parts of the company or improves the investment value to exit at a profit. They then repay the lender and take away the profit.
Growth capital
A growth capital investment strategy is used for well-established companies looking for capital to expand the current office operations or their target markets. These investments by the private equity firm are usually made as a minority. Since these companies are already established, all they look for is to expand operations without affecting business ownership.
Fund of funds
The FoF strategy is the type of strategy where the private equity firm invests in various funds and not just stock and securities. This gives them a diversified portfolio that lets them hedge the risk during different funding stages. However, this is an expensive strategy as it involves additional fees, like the management and performance fee.
Conclusion
A private equity investment is an excellent opportunity for businesses willing to grow and expand to the best of their potential. The PE investors bring in multitudes of knowledge and experience that improves the company value, raises revenue and helps leverage its local and international position in the market. In addition, it allows them to derive a growth plan and actually execute it to reach a level that may not be possible without private equity investment.
Over the years, private equity has become an attractive investment area for wealthy institutions and individuals. Since it attracts the best and brightest minds in the corporate, the professionals at PE firms are generally always successful in their investment capital strategies and increasing the company’s portfolio as a whole.
