Pools of capital invested in private companies
What are Private Equity Funds?
Private equity funds are pools of capital to be invested in companies that represent an opportunity for a high rate of return. They come with afixedinvestment horizon, typically ranging from four to seven years, at which point the PE firm hopes to profitably exit the investment. Exit strategies include IPOs and sale of the business to another private equity firm or strategic buyer.
Institutional funds and accredited investors usually make up the primary sources of private equity funds, as they can provide substantial capital for extended periods of time. A team of investment professionals from a particular PE firm raises and manages the funds.
Equity
Equity can be further subdivided into four components: shareholder loans, preferred shares, CCPPO shares, and ordinary shares.
Typically, the equity proportion accounts for 30% to 40% of funding in a buyout. Private equity firms tend to invest in the equity stake with an exit plan of 4 to 7 years. Sources of equity funding include management, private equity funds, subordinated debt holders, and investment banks. In most cases, the equity fraction is comprised of a combination of all these sources.
Types ofPrivate Equity Funds
Private equity funds generally fall into two categories: Venture Capital and Buyout or Leveraged Buyout.
1. Venture Capital (VC)
Venture capital funds are pools of capital that typically invest in small, early stage and emerging businesses that are expected to have high growth potential but have limited access to other forms of capital. From the point of view of small start-ups with ambitious value propositions and innovations, VC funds are an essential source to raise capital as they lack access to large amounts of debt. From the point of view of an investor, although venture capital funds carry risks from investing in unconfirmed emerging businesses, they can generate extraordinary returns.
2. Buyout or Leveraged Buyout (LBO)
Contrary to VC funds, leveraged buyout funds invest in more mature businesses, usually taking a controlling interest. LBO funds use extensive amounts of leverage to enhance the rate of return. Buyout finds tend to be significantly larger in size than VC funds.
Exit Considerations
There are multiple factors in play that affect the exit strategy of a private equity fund. Here are some necessary questions to ask:
- When does the exit need to take place? What is the investment horizon?
- Is the management team amenable and ready for an exit?
- What exit routes are available?
- Is the existing capital structure of the business appropriate?
- Is the business strategy appropriate?
- Who are the potential acquirers and buyers? Is it another private equity firm or a strategic buyer?
- What Internal Rate of Return (IRR) will be achieved?
Typical Exit Routes for PE Funds
When deciding to exit, PE firms take either one of two paths: total exit or partial exit. In terms of a wholesale exit from the business, there can be a trade sale to another buyer, LBO by another private equity firm, or a share repurchase.
In terms of a partial exit, there could be a private placement, where another investor purchases a piece of the business. Another possibility is corporate restructuring, where external investors get involved and increase their position in the business by partially acquiring the private equity firm’s stake. Finally, corporate venturing could happen, in which the management increases its ownership in the business.
Lastly, a flotation or an IPO is a hybrid strategy of both total and partial exit, which involves the company being listed on a public stock exchange. Typically, only a fraction of a company is sold in an IPO, ranging from 25% to 50% of the business. When the company is listed and traded publicly, private equity firms exit the company by slowly unwinding their remaining ownership stake in the business.
Additional Resources
Thank you for reading CFI’s guide on Private Equity Funds. To keep learning and advancing your career, the following resources will be helpful:
FAQs
Private equity funds are pools of capital to be invested in companies that represent an opportunity for a high rate of return. They come with a fixed investment horizon, typically ranging from four to seven years, at which point the PE firm hopes to profitably exit the investment.
What is an example of a private equity fund? ›
There are several well-known private equity firms, including: Apollo Global Management (APO), which owns brands such as Cox Media Group and CareerBuilder. Blackstone Group (BX) invests in real estate private equity and healthcare, including Service King and Crown Resorts.
What are the three types of private equity funds? ›
3 Types of Private Equity Strategies
- Venture Capital. Venture capital (VC) is a type of private equity investment made in an early-stage startup. ...
- Growth Equity. The second type of private equity strategy is growth equity, which is capital investment in an established, growing company. ...
- Buyouts.
Likely the biggest appeal of private equity investing is its potential for high returns. Data from investment firm Cambridge Associates shows private market returns have consistently exceeded those of the public market.
How do private equity funds get paid? ›
Private equity firms make money through carried interest, management fees, and dividend recaps. Carried interest: This is the profit paid to a fund's general partners (GP).
How does private equity work for dummies? ›
What Is Private Equity (PE) And How Does It Work? Definition of Private Equity: Private equity firms raise capital from outside investors, called Limited Partners (LP), and then use this capital to buy companies, operate and improve them, and then sell them to realize a return on their investment.
Why do people invest in private equity? ›
The underlying reason for private equity investing is to achieve returns on investment that may not be achievable in the public market. Partners at PE firms raise and manage funds to yield favorable returns for shareholders, typically with an investment horizon of four to seven years.
Who owns a private equity fund? ›
Private equity funds are generally backed by investments from large institutional investors: pension funds, sovereign wealth funds, endowments and very wealthy individuals. Private equity firms manage these funds, using both investors' contributions and borrowed money.
Is Vanguard a private equity firm? ›
Vanguard's entrance into the private equity market follows that playbook. Private equity at Vanguard seeks to solve the challenges asset owners face, by using our scale and more than 40 years of experience sourcing investment talent as a leader in manager search and oversight capabilities.
What is private equity explained simply? ›
A private equity fund is a pool of capital used to invest in private companies that fit within a predetermined investment strategy. The fund is managed by a private equity firm that serves as the 'General Partner' of the fund. By contributing capital, investors become 'Limited Partners' of the fund.
The overall goal of a private equity fund is almost always to realise appreciation in the pool of private assets acquired within a time frame of generally 10-12 years. Fund strategies and the type of assets held will vary in accordance with the fund's stated objectives.
Is a private equity fund the same as a hedge fund? ›
Hedge funds are alternative investments that use pooled money and a variety of tactics to earn returns for their investors. Private equity funds invest directly in companies, by either purchasing private firms or buying a controlling interest in publicly traded companies.
What are the negatives of private equity? ›
What are the cons of private equity investing? Private equity investments are illiquid: Investor's funds are locked for a certain period. As such, investors in private equity must have a long-term investment horizon and be willing to hold their investments for a few years, if not more.
Can the average person invest in private equity? ›
Traditional private equity funds have very high minimum investment requirements, potentially ranging from a few hundred thousand to several million dollars. As such, most private equity investing is reserved for institutional investors (such as pension funds or private equity firms) or high-net-worth individuals.
How rich do you have to be to invest in private equity? ›
1 Funds that rely on an Accredited Investor standard generally require a minimum net worth of $1 million for an individual (excluding primary residence), and $5 million for an entity. for an individual, and $25 million for an entity. be appropriate for you.
What is private equity in layman's terms? ›
Private equity describes investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.
How much money do you need for a private equity fund? ›
The minimum investment in private equity funds is typically $25 million, although it sometimes can be as low as $250,000. Investors should plan to hold their private equity investment for at least 10 years.
What is the difference between funds of funds and private equity? ›
The key difference is that funds of funds invest in firms rather than specific companies or deals. Or, more accurately, they mostly invest in firms rather than specific companies or deals. The fund of funds is an “extra layer” between a private equity firm and its normal set of Limited Partners.
