Private Equity Firm at a glance
A private equity firm is a type of investment company that either utilises capital from other big investors or its own fund for expansion and operations. They are not listed publicly, so their shares are not traded on the stock market. They are also called financial sponsors, as they raise capital to invest in other companies with a growth potential according to their specific investment strategies. The private equity firm investors raise capital from high net worth individuals, venture capital companies, or institutional investors.
A Private Equity Firm’s Purpose
The main purpose of the private equity firm is to provide the investors with profit within 4 to 7 years and help build the company they have invested in. Once the company grows, the private equity firm sells it off to secure its profit for themselves and their investors.
How does a Private Equity Firm purchase a company?
The purchasing of any company happens via an auction, most commonly. After the private equity firm buys it, it appoints a management team that works solidly to increase its value through specific growth strategies. Then, a growth plan is developed and executed to process the improvement. New processes and systems are introduced to improve operational efficiency and enhance the company’s productivity.
The equity firms also make hard decisions like closing down non-profitable units or laying off existing workers to increase productivity. As soon as the company starts showing positive results with higher profit margins, the private equity firm decides to exit the investment. This happens by offering the company for sale to another strategic buyer or a similar firm willing to take the company further from there. An initial public offering is also an exit mechanism that can be used.
Functions performed by a Private Equity Firm.
The following are the main functions that a private equity firm performs as company investors –
Raise capital
The first and most important function performed by any private equity firm is to raise capital for the company they have purchased. It acquires capital commitments from financial institutions like pension funds, insurance companies, or wealthy investors. Some private equity firms also put in personal funds to contribute. The limited investors are given some control for a huge capital commitment with a promised high return in the future.
Company management
A private equity firm does not just raise capital for the companies they have bought but also appoints a solid management team to manage this. The private equity firm is themselves involved in the company’s growth by improving its operations and cutting costs wherever necessary. They do not get involved in the company’s day-to-day functioning but provide strong support in terms of strategy and advisory.
Exit the companies at a profit
As soon as the companies they have invested in starts growing and earns a profit, it is time for the private equity firm to exit from the company. Existing at a sizable profit is their end goal and generally takes place at least 3 to 7 years after the investment. While exiting the company, the private equity firm cuts through all costs, pays the debts, and optimizes the working capital to realize the real profit.
Sourcing, closing deals, and due diligence
This is one of the most important functions performed by the private equity firm. During the acquisition of any company, private equity firms do thorough analysis concerning the industry, products, company’s financials and management, and profit and loss scenarios. After sourcing a deal that seems profitable, due diligence is conducted by the private equity firm’s team to evaluate the company’s business model, strategy, risk factors, exit potential, and more. Final deal terms are negotiated with the lawyers before closing. Once closed, funds are released, and equity trade takes place.
Advantages of investing in private equity firms
- Private equity firms tap in on the potential of companies that have either just begun or started years ago but could not perform the way they had anticipated. Companies that have not been doing very well in the stock market are privatized through such private equity firms, which then grow them to an unparalleled level.
- Private equity firms follow a stringent selection policy and are highly selective about which company to invest in. They spend a great deal of time analysing and assessing potential companies. This involves understanding the company’s business model and risks. They only choose a company that possesses all the idealistic traits they feel can unleash its potential.
- Private equity firms appoint management teams to the companies they purchase and privatize. These management teams are completely accountable to a professional shareholder for everything that happens with the firm thereon. The shareholder can then protect the shareholding of the company accordingly.
Conclusion
From what we have understood above, private equity firms are investment firms that raise capital to be invested in companies that have potential but are either stagnant or declining. Upon investing in such companies, they work on the company’s growth and, once it starts earning considerable profits, sell them off. The profit is then distributed amongst the investors and the private equity firm to strengthen the company’s value.
