When we hear private equity, we associate this with big names like Warren buffet, Stephen Schwarzman, etc and to define what a private equity (PE) is, we have to look at what they do technically. A PE is an investment in privately held companies through buyouts, takeover or fund raising by rich high net worth investors, institutional investors, and private equity firms.
Why Raise Equity?
3 key reasons why businesses or individuals turn to equity for investment?
#1. Acquisition of the business
#2. To become more competitive, businesses tend to Restructure
#3. Increase expansion and diversification
Who Invests in PE?
As mentioned in the introduction, PE investments are made mainly by private equity firms (Blackrock, Platinum equity, KKR and Co, Apollo Global Management), institutional investors running pension funds and, hight networth (HNIs) investors. The money pumped into private equity is normally from pension funds & plans, university endowments, insurance companies like Zurich & Aviva; foundations & labour unions, wealthy families etc.
Ways to Invest in PE
A lot of private equity follows a route called a ‘fund of funds’ which basically means, you get money from various private partners who have shares in the pot. For those using this vehicle to invest, its advantage is it’s reasonably cost effective and allows them to dip into various portfolios in scale and reducing their risk of loss.
Another common route is using an ETF (exchange-traded funds) which follow publicly traded investment products with no minimum investment required so yet another low-risk option. The downside of this is, you have to compensate the EFT for their time and skills through paying a management fee but it’s still lower than the returns you make therefore making it worth the hustle.
The final way is through buying public shares of PE managers and their firms but this isn’t as profitable as the two options above.
Why Businesses accept offers; what’s the Value Add?
A lot of startups especially in the technology sector find this to be the best route to gain traction in a market where things can progress really faster ad if you don’t have the financial muscle you will struggle to keep up with competition or market needs. Here are a few of the value adds PE bring to organisations:
- Cash infusion – because of the resources they have and mainly deep pockets, businesses are able to scale and grow faster without getting any distractions that come with limited resources.
- Skills & Expertise – Private equity firms don’t invest blindly, they normally have a plan and this comes in the form of networks and experts they can access in that vertical which make it easy for the business to chart a successful path and meet their goals.
As much as we have painted a rosy image of having private equity poured in, nothing comes without risk and below are a few risks associated with PEs.
- Operational risk – As mentioned the investor will come in what they think needs to be done and if you do not have adequate systems in place the business might spiral out of control from this external influences.
- Funding risk – Sometimes because the investment is not always cash at hand the investor might default and this will affect the cause of the business as promised when they were raising capital from the PE.
- Liquidity risk – Once you accept the offer, your business is locked in for a certain term and if the investor wants the money back, they cannot redeem it even if the business seemed like it was failing. They must honour their term.
- Capital risk – Your business may not be able to receive this capital amount as capital is summed up as the net asset value of the dormant portfolio and any future undrawn capital commitments.