Private Equity Investing: A Driver for Change
June 30, 2013 | Topics: Alternatives
- Private equity takes an ownership interest in a company, with the goal of enhancing the company's value by bringing about change
- Long-term results of private equity investments are less dependent on overall market performance
- A broad opportunity set encompasses 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
- Diversification potential is high since many of the factors that drive returns in public equity markets have lesser or no impact on private equity returns
- 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, invest 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
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Incorporating alternative investments into a portfolio presents the opportunity for significant losses including in some cases, losses which exceed the principal amount invested. Also, some alternative investments have experienced periods of extreme volatility and in general, are not suitable for all investors.
Utilizing private equity involves significant risks along with the opportunity for substantial losses.
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