Private equity is a dynamic and rapidly-evolving field that has been gaining increasing attention in recent years. Essentially, private equity refers to the practice of investing in private companies or purchasing a stake in these firms, with the aim of generating significant returns for investors over the long term. This investment approach has unique characteristics that differentiate it from other types of investments, including the use of leveraged buyouts, the active management of portfolio companies, and a focus on value creation.
For a quick insight into the global activity in the private equity field, let’s review the statistics for this market growth for the past and the future period. As the graphic below shows, the market reached 4.5 trillion assets under management in 2019, with the potential of reaching up to 5.8 trillion by 2025. Quick explanation: unrealized value, also known as “dry powder” is the proportion of investments that are not yet put to use.
In this article, we’ll cover the basics of private equity, including:
- Distinction between private and public markets.
- The mechanics of a private equity fund.
- The distinctive attributes of private equity as viewed through the lens of the fund, company, and investor
Contents:
The World of Private Equity: An Introduction
What is Private Equity?
Private vs Public Equity
A Brief Overview of a Private Equity Fund Structure
Characteristics of private equity from the perspectives of Fund, Company, and Investor
Private equity characteristics: Fund perspective
Private equity characteristics: Company perspective
Private equity characteristics: Investor perspective
What is Private Equity?
Private equity refers to an investment approach where investors invest in private companies or purchase a stake in them. Private equity firms raise funds from various sources, such as institutional investors and high-net-worth individuals, and use these funds to acquire private companies or provide growth capital to existing ones.
The aim of the activity is to generate significant returns for investors over the long term, typically through a combination of capital appreciation and cash flow generation. Private equity firms often take an active management approach to their investments, working closely with portfolio companies to improve operational efficiency, reduce costs, and grow revenue.
The private equity investment approach has unique characteristics that differentiate it from other types of investments, such as a focus on value creation and the use of leveraged buyouts to finance acquisitions. Private equity has become an increasingly popular asset class among investors seeking high returns and diversification from traditional investments such as stocks and bonds.
Private vs Public Equity
Public equity refers to stocks or shares of companies that are publicly traded on a stock exchange. Anyone can buy or sell these shares on the open market, and the value of the shares is determined by the supply and demand of investors.
Private equity, on the other hand, refers to investments in companies that are not publicly traded. Private equity firms typically invest in private companies or take public companies private by acquiring all outstanding shares. Private equity investments are typically made by institutional investors and high-net-worth individuals who have a longer-term investment horizon and are looking for higher returns than can be achieved in the public markets.
In essence, the main differences between private and public equity investments are the level of liquidity, the size and stage of the companies being invested in, and the level of regulatory oversight.
A Brief Overview of a Private Equity Fund Structure
A private equity firm establishes a “Limited Partnership” when it creates a private equity fund. It can then invite investors to contribute to a pool of capital that will be used to invest in private companies that align with a predetermined investment strategy. By contributing, investors become “Limited Partners” of the fund, while the private equity firm assumes the role of “General Partner” and is responsible for managing investments.
You may take a look at what the typical private equity fund structure looks like in the image below.
- Fundraising. The private equity firm raises capital from institutional investors, such as pension funds, endowments, and wealthy individuals, who commit to investing a certain amount of money in the fund.
- Investment period. Once the fund has raised sufficient capital, it enters into an investment period during which the private equity firm makes investments in private companies. This period typically lasts 3–5 years
- Management fees. During the investment period, the private equity firm charges an annual management fee, which is typically 1-2% of the committed capital. This fee covers the costs of managing the fund, such as salaries, office rent, and travel expenses.
- Carried interest. The private equity firm also receives a share of the profits generated by the fund, known as carried interest or “carry.” Typically, the carried interest is 20% of the profits generated by the fund, above a certain threshold return.
- Investment process. The private equity firm identifies potential investment opportunities, performs due diligence on the target companies, negotiates the terms of the investment, and closes the transaction.
- Portfolio management. Once an investment is made, the private equity firm works closely with the management team of the portfolio company to improve its operations, increase its value, and prepare it for a potential sale or IPO.
- Realization. The private equity firm exits its investments by selling the portfolio companies to strategic buyers, financial buyers, or through an IPO. The proceeds from the sale are distributed to the fund’s investors according to their capital contributions and the terms of the fund agreement.
For many investors, the right call is to join the community of like-minded experts with extensive knowledge of the private equity market. Schedule a consultation with a White Sails representative
Characteristics of private equity from the perspectives of Fund, Company, and Investor
Let’s get to know some principles that lie at the core of the behavior patterns of another participant in the private equity investment process.
Fund
The following characteristics are crucial when reviewing private equity from a company perspective.
Access to alternative funding. When companies seek capital, they may turn to loans, which often come with high-interest rates and fixed repayment schedules. Alternatively, if they are ready to go public, they face increased scrutiny and pressure to report regular earnings. Private equity funding offers an alternative option that can be tailored to their unique needs.
Reduced scrutiny. Innovative companies often have growth strategies that may not pass the approval of cautious public investors. For instance, tech startups have pioneered growth hacking techniques that are only adopted by more conservative companies once they are tried and tested. Private equity firms are more willing to take on such risks, especially in venture capital, where investment decisions are often based on the vision and capabilities of the founding team.
Long-term strategic focus. The objective is to enhance its value over a period of several years rather than achieving quick gains, which is often the case for public investors. Private equity investments typically have a holding period of three to five years, but this can be extended to ten years or more if the firm chooses to reinvest, holding onto their stake by selling it to a later fund. This allows companies to pursue long-term opportunities and execute a value-creation plan without being overly concerned with short-term results.
Company
The following characteristics are crucial when reviewing private equity from a company perspective.
Access to alternative funding. When companies seek capital, they may turn to loans, which often come with high-interest rates and fixed repayment schedules. Alternatively, if they are ready to go public, they face increased scrutiny and pressure to report regular earnings. Private equity funding offers an alternative option that can be tailored to their unique needs.
Reduced scrutiny. Innovative companies often have growth strategies that may not pass the approval of cautious public investors. For instance, tech startups have pioneered growth hacking techniques that are only adopted by more conservative companies once they are tried and tested. Private equity firms are more willing to take on such risks, especially in venture capital, where investment decisions are often based on the vision and capabilities of the founding team.
Long-term strategic focus. The objective is to enhance its value over a period of several years rather than achieving quick gains, which is often the case for public investors. Private equity investments typically have a holding period of three to five years, but this can be extended to ten years or more if the firm chooses to reinvest, holding onto their stake by selling it to a later fund. This allows companies to pursue long-term opportunities and execute a value-creation plan without being overly concerned with short-term results.
Investor
The following characteristics are crucial when reviewing private equity from a company perspective.
Access to alternative funding. When companies seek capital, they may turn to loans, which often come with high-interest rates and fixed repayment schedules. Alternatively, if they are ready to go public, they face increased scrutiny and pressure to report regular earnings. Private equity funding offers an alternative option that can be tailored to their unique needs.
Reduced scrutiny. Innovative companies often have growth strategies that may not pass the approval of cautious public investors. For instance, tech startups have pioneered growth hacking techniques that are only adopted by more conservative companies once they are tried and tested. Private equity firms are more willing to take on such risks, especially in venture capital, where investment decisions are often based on the vision and capabilities of the founding team.
Long-term strategic focus. The objective is to enhance its value over a period of several years rather than achieving quick gains, which is often the case for public investors. Private equity investments typically have a holding period of three to five years, but this can be extended to ten years or more if the firm chooses to reinvest, holding onto their stake by selling it to a later fund. This allows companies to pursue long-term opportunities and execute a value-creation plan without being overly concerned with short-term results.
Contact White Sails to get assistance with private equity and real estate investment from our team of well-seasoned niche experts.
