Private Equity (PE) is an investment scheme used by investors to acquire a company that is not publicly traded. This investment is generally done by private equity firm, venture capital firm or an angel investor.

Private Equity returns are generally used in mergers & acquisition, expansion of business or to strengthen the balance sheet. This funds are usually managed by a firm or a limited liability partnership. The tenure (investment horizon) for such funds can be anywhere between 5 to 10 years.

Since private equity funds are not open for public, the funds is usually raised by institutional investors (HNIs and Investment Banks) who can afford to invest large amount of money for longer time period.

What do Private Equity Firms do?

Private Equity firms are group of investors that collects capital from wealthy individuals, pension funds, insurance companies, endowments, etc. to invest in private businesses.

PE firms invest in such companies with a goal of increasing the value over time before selling the company at a profit. Just like Venture capital (VC) firms, PE firms also use capital that is raised from limited partners (LPs) to invest in private companies.

Generally, PE firms invest in multiple companies at once with a majority stake of ownership (i.e. 50% or more). For PE, the list of companies in which they have invested in, is known as its portfolio companies.

Investors who are working at Private Equity firms are called Private Equity Investors.

Types of Investment for Private Equity Funds

1) Venture Capital (VC)

This funds are pools of money that is invested in small businesses or a new emerging start-ups that are expected to have potential growth in near future.

For startups, VC funds are an essential source of raising funds as they contains small amounts of debts.

For investors, venture capital funding carry high risks and requires a good knowledge about the company’s business, but when invested in right company, they can generate extraordinary returns.

Venture capital investment are mostly for short period of time.

2) Buyout or Leveraged Buyout (LBO)

Unlike VC funds, LBO funds are invested in more mature businesses (more than 5 year old businesses), usually taking a controlling interest. Also the money invested is LBO is very high compared to venture capital.

The purpose of holding majority stake in large company for a longer time is to manage the funds within the company in order to generate a sizable value. Once a good value has been generated, the PE firm release their stake and exit the company.

3) Real Estate Funds

Private equity firms also invest their capital in ownership of various real estate properties. This type of investment have strategies such as –

  • Core Strategy – Investments are made where there is less risk which results in less-return on investment. Example – Investment on shops in building.
  • Core Plus Strategy – Moderate risk with moderate return in properties that requires some form of value added element. Example – Investment on 1 or 2 BHK flats.
  • Value Added Strategy – Medium to high risk involved which in turn gives medium or little high profit on investment. This strategy involves purchasing of property and improve and then sell it in higher value. Example – investment on big bungalows or old corporative society.
  • Opportunistic Strategy – High risk is involved with very high return on investment. In this type of investment, properties require very huge amount of enhancement. Example – Investment in development, purchase of raw land, and mortgage notes.

4) Growth Capital

Private Equity firms also invest in mature corporates who’s running successful businesses for decades to enable companies to expand or restructure their operations, enter in foreign markets or to finance for major acquisition project.

5) Fund of Funds

Fund of funds (or FOF) strategy focuses on investing in other funds, such as Mutual Funds or Hedge Funds. This strategy offer a backdoor entry to investors who cannot pay heavy amount of capital required in such funds.

Common Modes of Exit for PE Investors

1) IPO

One of the common way to exit is to come out with a public offer of the company, and sell their shares as a part of IPO allotment. In such cases, PE investors can share their share immediately, or those share are allotted to them after the company gets listed.

2) Strategic Acquisition

Another great alternative is strategic acquisition or trade sale, where the invested company is sold to another suitable company, and later PE investors take their share from the sale value.

3) Secondary Sale

In this exit type, the private investors will sell their stake in the business to another private equity firm. This is good for those businesses who requires more money as their current equity fund is not enough for business operations.

4) Repurchase by the promoter

In this type, the promoters or the management of the company buy back the equity stake form the private investors.

Private Equity VS Venture Capital

 Private EquityVenture Capital
MeaningPrivate Equity means investing on those companies which are not listed on stock exchange.Venture Capital means investing in small business seeking high potential growth.
Investment profileInvestment done in mature firms.Investment done in early-stage companies (start-ups).
Stage of InvestmentLater stageInitial stage
No. of InvestmentIn few companiesIn large no. of companies
Target company typesPE firms invest in companies across all industries.Venture capital firms mainly invest in technology, biotech and clean-tech companies.
Risk TypeLow riskHigh risk
Payment StructurePayment done in combination of equity and debt.Payment done in equity (cash) only.
Fund RequiredFor expanding a businessFor improving/scaling up operations
Investors’ OwnershipMostly 100 %Always below 50%.

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