If a company needs to raise capital, it can approach a financial institution or go public & get listed at a stock exchange. Where do the Private Equity firms fit in?
References would be appreciated. Private equity is a broad term which commonly refers to any type of equity investment in an asset in which the equity is not freely tradeable on a public stock market. More accurately, private equity refers to the manner in which the funds have been raised, namely on the private markets, as opposed to the public markets. Private equity firms were commonly misunderstood to invest in assets which were not in the public market. However this is not necessarily the case鈥攍arger private equity firms such as KKR and Blackstone invest in companies listed on public exchanges and take them private. Passive institutional investors may invest in private equity funds, which are in turn used by private equity firms for investment in target companies. Categories of private equity investment include leveraged buyout, venture capital, growth capital, angel investing, mezzanine capital and others. Private equity funds typically control management of the companies in which they invest, and often bring in new management teams that focus on making the company more valuable.
As they are not listed on an exchange, a private equity firm owning such securities must find a buyer in the absence of a traditional marketplace such as a stock exchange. The "exit" or "selling out" is often achieved by way of an initial public offering (IPO), i.e. floating the company on a stock exchange, trade sale or secondary/tertiary buy-outs (i.e. sale to another private equity house).
Private equity funds are the pools of capital invested by private equity firms. Although other structures exist, private equity funds are generally organized as either a limited partnership or limited liability company which is controlled by the private equity firm that acts as the general partner. The limited partnership is often called the "Fund," and the general partners are sometimes designated as the "Management Company" (although at times, that is a separate company affiliated with the general partner). The fund obtains capital commitments from certain qualified investors such as pension funds, financial institutions and wealthy individuals to invest a specified amount. These investors become passive limited partners in the fund partnership and at such time as the general partner identifies an appropriate investment opportunity, it is entitled to "call" the required equity capital at which time each limited partner funds a pro rata portion of its commitment. All investment decisions are made by the General Partner which also manages the fund's investments (commonly referred to as the "portfolio"). Over the life of a fund which often extends up to ten years, the fund will typically make between 15 and 25 separate investments with usually no single investment exceeding 10% of the total commitments.
General partners are typically compensated with a combination of a management fee (defined as a percentage of the fund's total equity capital), monitoring fees (fees paid to the general partner by portfolio companies for services), as well as transaction fees (fees paid to the general partner in their M&A advisory capacity). In addition, the general partner usually is entitled to "carried interest", effectively a performance fee, based on the profits generated by the fund. Typically, the general partner will receive an annual management fee of 1% to 2% of committed capital and carried interest of 20% of profits above some target rate of return, which is typically 8% to 10% (called "hurdle rate"). Gross private equity returns may be in excess of 20% per year, which in the case of leveraged buyout firms is primarily due to increasing levels of leverage in the portfolio companies, and otherwise due to the high level of risk associated with early stage investments. Although there is a limited market for limited partnership interests, such interests are not as freely tradeable like mutual fund interests.
Private equity firms generally receive a return on their investment through one of three ways: an IPO, a sale or merger of the company they control, or a recapitalization. Unlisted securities may be sold directly to investors by the company (called a private offering) or to a private equity fund, which pools contributions from smaller investors to create a capital pool.
Considerations for investing in private equity funds relative to other forms of investment include:
Substantial entry costs, with most private equity funds requiring significant initial investment (usually upwards of $100,000) plus further investment for the first few years of the fund called a 'drawdown'.
Investments in limited partnership interests (which is the dominant legal form of private equity investments) are referred to as "illiquid" investments which should earn a premium over traditional securities, such as stocks and bonds. Once invested, it is very difficult to gain access to your money as it is locked-up in long-term investments which can last for as long as twelve years. Distributions are made only as investments are converted to cash; limited partners typically have no right to demand that sales be made.
If the private equity firm can't find good investment opportunities, they will not draw on our commitment. Given the risks associated with private equity investments, you can lose all your money if the private-equity fund invests in failing companies. The risk of loss of capital is typically higher in venture capital funds, which back young companies in the earliest phases of their development, and lower in mezzanine capital funds, which provide interim investments to companies which have already proven their viability but have yet to raise money from public markets.
Consistent with the risks outlined above, private equity can provide high returns, with the best private equity managers significantly outperforming the public markets. Private equity firms buy equity in a business. If the company is public, they will buy it out and take it private. Or, they invest in private businesses. Private Equity firms are Investors who pick up stake in promising business and dispose them off with the sole motive of making gains.
PE firms are not risk averse, ther rely on the ideology risk reward are positively correlated.So, after due diligence,if they are satisfied that business do have prospects and is liekly to have a steep growth curve, they will invest in it. They are less formal and can arrange Quick finance provided they like the idea and consider if profitable. |
