Private equity from an investor perspective
The risk-return link
The return on investment in private equity is autonomous to the public markets,
which provides more flexibility. The risk in private equity investment is higher
on the grounds that the companies sold privately don’t undergo the same
scrutiny as those sold publicly. Another variable is that private equity funds are
governed by the general manager, which means the investors have no control
over the deal’s outcome. The fund assets are held until the company value has
increased sufficiently and the correct opportunity for sale arises. Yet all those
risk aspects of private equity bring the opportunity for significant return on
investment.
Simplified – the riskier the investment in a company is, the higher the chance to
add more value to it.
Fees
Considering the private equity firms actively manage the acquired companies
and are involved both in strategizing and operations, the fees for them tend to
be higher than for companies owned publicly. A customary structure in private
equity is “2 and 20” – This illustrates that the general manager receives a 2%
annual fee and another 20% “carry” of profits above an agreed-upon
performance threshold. Still, other structures are employed to incentivize the
company seeks other investments or the manager brings higher results.
Low liquidity in private equity
As things go private equity is a long-haul game, the investments are locked up
for longer than other investment options. Private equity companies need time
to implement their strategies and increase the company’s value. Usually, the
time is set to 10 years with options for extension. During this period, investors
cannot withdraw their investments, but after the company is re-sold, the
investor’s patience is rewarded by a substantial return on investment.
High investment minimums in private equity
Traditional investment markets may allow all players to participate with smaller
or larger amounts, but private equity is for the prominent players. Usually,
private equity funds require large quantities from the investors, coupled with
the fact that the payment will be locked up for a decade at least, which means
that private equity investors must be pretty liquid. Lately, there have been some
options for smaller investors in private equity, but still, restrictions apply.
How big is the private equity market?
Investments in public stock dominated the past century, but the new century
turned the table around for private equity. On a global scale, its growth is much
greater. Yet developed countries still lead the way
Why would one invest in private equity?
It only makes sense for private equity to acquire a company if they have a clear
plan on how to process to increase the value of the company. Sometimes
expanding the value means seriously cutting the expenses or restructuring,
which would have been difficult for the original management. Time is of great
importance, and if the private equity firm is short on time (has to re-sell the
company fast), then more drastic changes are employed.
In private equity experience, connections and partnerships are significant.
Private equity firms take advantage when the original management of a
company lacks the specific expertise needed for growth that they or their
partners possess. This is an easy ticket for a good investment opportunity.
Private equity firms place themselves in a position of power, making important
decisions and driving change without having to answer to shareholders or
board members. This means new management approaches can be
implemented with the original management team or the original management
team to be replaced. The bottom line is the return on investment.
Private equity in the eyes of the low
Since private equity firms are not playing on the stock market, they are usually
excluded from the regulation of institutions such as the Securities and
Exchange Commission still their managers are strictly scrutinized, especially by
anti-fraud acts and provisions.
Tax differences depend on the location and operational area of the private
equity firm. Another reason to considerIn equity deals is that in some countries,
they are eased from part of the taxes.
Each private equity firm must follow best practices. All client’s obligations must
be disclosed. This includes domestic or international obligations, valuations,
and disclosure of conflicts. Each country and the economic area has its
regulations. Those regulations usually include the following:
- Alternative Investment Fund Managers Directives
- Cybersecurity
- European Securities and Markets Authority
- Fees and expenses
- Fiduciary and reporting requirements
- Investment Advisers Act of 1940
- Investment adviser registration
- Performance advertising
- SEC audits, inspections, and enforcement proceedings
Types of private equity firms
While all private equity firms deal in the same investment sector – raising
private equity funds and acquiring companies to re-sell, some private equity
firms prefer to specialize. Let’s say the firm has some marketing background or
strong marketing skills. Then it makes sense for the firm to specialize in
acquiring companies, offering great value products but lacking good marketing.
Then the private equity firm would quickly increase the company’s value
through good marketing and re-sell the company for profit.
Main types of private equity firms
- Acquiring companies that exhibit solid financial needs and are struggling. Called distressed investing.
- Acquiring companies that have surpassed their startup phase. This is called growth equity.
- Acquiring companies in the technology or energy sector. This is called sector equity.
- Acquiring companies owned by another equity firm. This is called a secondary buyout.
- Acquiring corporate subsidiaries or units. This is called carve-outs.
Learn more about ACIP
We are an independent private equity association dedicated to generating value for our members. Our mission is to cultivate enduring relationships built on integrity and trust, while delivering superior outcomes through rigorous research and innovative thinking.
