What is Private Equity?
When it comes to investing, most of the investors opt for the traditional route. They invest in bonds or stocks or purchase mutual funds. While for some others, private equity is an appealing investment option. But what is private equity fund and what is the private equity fund structure? How can one invest in it?
In this article, we explain private equity fund meaning in depth to give you a better understanding of the concept.
What is Private Equity Fund?
Private equity is a general term which describes different kinds of funds pooling money from several investors to acquire stakes in companies. Such a private equity fund may amass millions or even billions of dollars to directly invest in companies. These companies are not publically listed on the exchange or traded. So, a private equity fund either directly invests in private companies or engages in buyouts of public companies, resulting in the delisting of public equity.
Private Equity Fund Structure
A private equity fund comprises of Limited Partners (LP) who own 99 per cent of the shares in a fund. They have limited liability. The remaining 1 per cent is owned by General Partners (GP) who have full liability. They are responsible for executing and operating investment.
Understanding What is Private Equity
Private equity involves investing in unlisted companies at different stages of their development. This is done with the objective of creating an added value to these companies. After some years, such companies can be sold with a significant capital gain. Simply put, private equity funds are created with the intention of raising money from several investors to deploy it progressively by acquiring companies and helping them grow more profitable.
Since private equity investment directly invests into a company, it requires a large capital outlay to gain a significant level of influence over the company’s operations. This is why not every investor can afford to invest in private equity. The minimum amount of capital required varies depending on the fund and the firm. Some funds have a $2,50,000 minimum investment requirement, while others can run into millions of dollars. Therefore, most of the private equity firm industry comprises of large institutional investors such as pension funds. Or, they may be funded by a group of accredited investors.
How Does Private Equity Work?
Private equity firms raise money from accredited investors and institutional investors to invest in companies through the following investment strategies:
• Distressed Funding
This is also known as vulture financing. In this type of private equity funding, the money is invested in troubled companies with underperforming business assets or units. The funding is aimed at making necessary changes to the operations or management for a turnaround of the company. This could mean selling their assets for a profit ranging from patents to real estate and physical machinery. Mostly, companies that have filed for bankruptcy fall in this category and require this type of funding.
• Leveraged Buyouts
This type of private equity funding is the most popular investment strategy. Here, the private equity firm buys out a company completely with the objective of improving its financial and business health. Later, the company can be sold at a profit to an interested buyer or made public by conducting an Initial Public Offer. The firm uses debt as leverage to buy out the company so it does not have to spend the purchase price at once. The money from various investors can be used to improve the company’s earnings and create a higher return.
• Funds of Funds
As the name suggests, this type of funding invests in other funds, typically hedge funds and mutual funds. The aim of the FOF strategy is to achieve broad diversification and minimal risk. For an investor who cannot afford the minimum capital requirements in such funds, FOF serves as a backdoor entry.
• Venture Capital
Venture capital investments focus more on investing in newer companies or startups that are on the verge of developing a new technology or industry. This type of funding can be done at different stages of a company. For example, seed financing funds a company to scale an idea from its prototype stage to the development of a product or a service. Similarly, an early stage financing can assist the entrepreneur in helping his company grow. Or, Series A financing which can enable an entrepreneur to actively compete in a market or create one.
Advantages of Private Equity
Private equity offers multiple benefits to startups, businesses and companies. It provides them access to liquidity instead of having to rely on traditional forms of financial mechanisms such as listing on public markets for funding. Another huge advantage of private equity funding is that companies can operate away from the glares of public markets. They are not required to submit quarterly reports to the outside world and can undertake a long-term approach in bettering their fortunes. Certain forms of private equity financing such as venture capital funding can be ideal for early stage companies who do not wish to take high business loans.
What are Some Myths Regarding Private Equity Firms?
Here are some myths surrounding private equity firms which are not true.
• Private Equity Firms Strip A Company’s Assets
Many analysts believe that private equity firms are able to turnaround a company by stripping it of its best assets. In reality, private equity firms have been known to create added value to a company by expanding their geographical footprint. Or, acquiring and integrating smaller competitors, and repositioning an out-of-date concept into a trendy product.
• Private Equity Firms Cut Costs
Private equity firms do cut costs, but only the unnecessary ones with a view to reinstating the money into other functions. For example, research, marketing, sales, and more. This can help support the company expansion with a lesser capital outlay.
• Investor’s Money Is Blocked For 10 Years
Growing companies can take time. Thus, investments made into private equity funds are generally seen as long-term or illiquid. However, it is not rare that a company can be sold off after a 4 or 6 year holding period. Private funds usually have a 10-year maturity, but it is possible that all the money gets invested in the first 5 to 7 years of the fund's life.
Private Equity Fund v/s Other Kinds of Equity
Private equity is not traded on public exchanges whereas equity through stocks is publically traded. In addition, private equity firms only invest in failing companies that need a turnaround or strong performing companies that can further improve margins and efficiency. For other kinds of equity, investors can invest in all types of companies.
Private equity firms are attractive investment vehicles for institutions and wealthy individuals. Private equity operations at IndiaNivesh Ltd. are aimed at creating value for our investor clients seeking growth opportunities in unlisted businesses at an early stage. You may get in touch with our team of highly-knowledgeable fund managers to know more about investing.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.