Private Equity Funds are made up of funds collected from institutional and/or accredited investors by Private Equity firms. The firm then invests into several different private companies, typically mature companies within traditional industries. Private Equity firms also buy out public companies, start the process of delisting to then privatise the company. When firms invest in companies, they tend to do so for an extended period, usually 5-10 years, then they will sell the company on to make a profit.
There are several different types of Private Equity funding, however, two of the most popular today tend to be Venture Capital and Leveraged Buyout (LBO). Venture Capital focuses on funding start-ups and entrepreneurs in which investors (also referred to as angels) provide capital to start-ups. Venture Capital is seen most frequently within the tech industry.
Leveraged Buyout (LBO) is when investors buy a controlling stake within a company with a combination of equity as well as debt, which will eventually be paid back by the company. The investor then works to increase the profitability of the company so that the debt is lesser and is not such a burden. Although the firm will usually own 50% of a company, they do not run it, they will have a specialised team that will manage the company to increase its profitability.
Private Equity became more popular in the 1970s and helped to fund many of the large tech companies we still see thriving today, such as Apple and Intel. Private Equity bloomed considerably between 2006 and 2008, and according to a study conducted by Harvard, global Private Equity groups raised around $2 trillion USD. They also found that companies backed by Private Equity funding performed better than those that were not.
Private Equity firms make their money through two main methods:
The first method is through fees, management fees as well as performance fees. Firms charge investors a 2 per cent management fee to invest with the firm in the first place. Firms also charge companies they work with for various reasons such as transaction fees, or monitoring fees. They will charge the companies these small fees throughout the time they work together.
The second method Private Equity firms make their money is through carried interest, which is the firms cut of capital gains created by investments. Firms typically will reap the rewards of their investments by selling a company or by making a company public. A standard percentage of carried interest for firms to receive is around 20%. To achieve a carried interest rate of over 20% is typically achieved by the highest performing firms.
Private Equity is seen as a favoured alternative type of investment, as it offers alternative forms of capital as well as easy access to liquidity, something that is especially useful for start-ups. There is also less pressure put onto companies to perform well for quarterly performance, as there is a separate evaluation for private companies. This means that the companies growth strategies are kept private out of the public market.
Private Equity includes high risks however the profits can be well worth the risk. It can be hard to work within a top Private Equity firm, and it is not unusual for them to have smaller teams of up to 15 people. Many of those who are at the top of the firm can see themselves taking home six-figure salaries, those below them taking home not much less. Private Equity is still a market that is yet to reach its full potential and is still yet to be tapped into fully.
In 2020, the global Private Equity market showcased higher resiliency and low volatility according to eFront, a financial software and solutions provider. They outperformed the Public Equity markets, as many companies struggled to get back onto their feet after the outbreak of COVID-19. This could potentially lead to more interest in the Private Equity market for many as they attempt to recover from the current pandemic.
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