What is Private Equity?
Private Equity is an alternative collective investment class where capital from an investment pool is invested directly in a business that has not yet been publicly listed or traded. Usually, several founding stakeholders create a fund that operates for an average of 10 years. In the first 5 years, the fund managers invest, and in subsequent years they realize the accumulated investment potential. Fund managers invest by buying into companies or take full control of them by buying out most of their shares. Statistics show that at the moment, more than 80 thousand companies are owned by PE firms, which is twice the number of public companies on the US stock exchange. It is rather difficult for ordinary investors to be allowed into the PE, so the main investors are usually insurance companies, pension funds, and large private capital. This asset is also relatively illiquid and one would need substantial capital to gain access to the PE market.
What is the required share in a company in order to participate in its management?
It depends primarily on the strategy of a particular PE fund. For big players, the acquired share often ranges from 25 to 50%. A share of that size also allows the investor to make strategic decisions and participate in managing the company; however, the company’s owner retains the main control over the business. Small funds usually acquire a share of less than 25% and restrictions regarding the company’s management are stipulated in the contract. Also at this level, a common approach is not acquiring shares but loaning out the PE’s capital.
What is the income potential?
The average yield is about 15% per annum. The investment horizon is usually about 5-7 years. Statistically, over this period, the fund has time to reach its peak and profitability goals. We can see this with larger firms, such as Blackrock, KKR, TPG Partners, Apollo Investment, etc.
What is the main difference between PE and venture investments?
PE investors are quite conservative. They invest in full-fledged businesses that have a stable income. Also, PE firms help develop strategies for companies thereby increasing their efficiency and growth rate. VC investors, on the other hand, tend to finance new companies that are just intending to enter the market—therefore those investments are more risky.
PE funds offer a number of advantages to companies in which they participate with their capital. For example, they provide them with access to liquidity as a better alternative to traditional financing mechanisms such as bank loans or listing. In addition to monetary benefits, companies receive strategic ideas and sometimes administrative resources.
Significant disadvantages of PE should also be noted.
First, in some cases, it can be difficult to liquidate investments in private business as compared to assets on the stock market, as they are less liquid.
Second, the share price in a private equity firm is determined through negotiations between the buyer and the seller, not the market, as is the case with companies listed on an exchange.
Third, all shareholder rights are discussed and stipulated in the agreement, and there are no separate charters or rules.
Private investment (PE) is considered a relatively new area of long-term investment. The minimum investment is much higher compared to other types of capital placement. However, if we take into account the synergistic effect of cooperation between the PE fund and a private company, the business growth rate can accelerate significantly due to the new resources received. It’s a win-win situation for all parties to the transaction. It should be noted that there is an opportunity to purchase the company’s shares at the final stage of its development before the IPO. After the placement, investors will be able to get a potentially high yield from the sale of their shares on the stock market.