- Private equity takes an ownership interest in a company with the goal of enhancing the company’s value by bringing about change.
- Compared to public equity, long-term results of private equity investments are less dependent on overall market performance.
- Private equity enjoys a broad opportunity set, encompassing companies of all sizes and in all stages of their life cycles.
In its broadest sense, private equity is an ownership interest in a company or portion of a company that is not publicly owned, quoted or traded on a stock exchange. However, from an investment perspective, private equity generally refers to equity-related finance that is designed to bring about some sort of change in a private business, such as:
- Helping to grow a new business.
- Bringing about operational change.
- Taking a public company private.
- Financing an acquisition.
The Compelling Investment Case for Private Equity
- The factors that drive returns in public equity markets have little or no impact on private equity returns, giving private equity high potential for enhancing the diversification of a portfolio.
- Private equity has exhibited attractive performance on both a risk-adjusted and an absolute basis.
- Private ownership enables long-term strategic focus as opposed to the public market focus on quarterly earnings.
- Returns are achieved through operational improvements and financial restructuring, making the experience and leadership ability of the private equity manager crucial.
Financing Change at All Phases of Development
Investments in private equity can cover companies of all sizes and in all stages of their life cycles. Typically, investments fall into five broad categories:
- Venture Capital – Seed money and funding for start-up and early-stage companies.
- Development, Expansion or Growth Capital – Help mature companies grow through bringing a new product to market, investing in a new plant or acquiring a company.
- Buyout Capital – Used to purchase an existing company or division of a company.
- Mezzanine (Subordinated) Debt – The debt financing used in a buyout.
- Restructuring Capital – Infusing capital into distressed companies undergoing financial or operational reorganization.
Generally, Investing in Private Equity Involves Three Phases:
- Capital Commitment – An investor signs a legally binding agreement to pay a set amount of capital to a fund over a period of time, usually 3 to 5 years.
- Drawdown – The fund manager draws down (i.e., “calls”) the investor’s committed capital in increments as the manager finds attractive investments, typically with notice between 5 and 15 days beforehand.
- Distributions – The investor receives distributions as the manager “exits” investments (i.e., sells or takes them through an initial public offering). These distributions are usually paid to the investor as cash, but sometimes they can be used to offset future drawdowns.