What is Private Equity? Everything you need to know about this popular career field.

What is Private Equity?

Many students and professionals may wonder while planning their career path  ‘What is Private Equity?’.

In short, private equity is the investment of money in private firms.

Private Equity firms invest in the equity of private companies intending to exit at a higher valuation in the future.

Investors of this asset class are usually required to invest their funds for years in private companies. This is why access to such investments is limited to institutions and individuals with high net worth.

Private Equity vs Venture Capital

Now you may wonder “If private equity firms also invest in private companies, just like venture capital firms, then how are they different from each other?

In comparison to venture capital, most private equity firms invest in mature companies rather than early-stage startups. In venture capital, funding is usually provided in exchange for company equity at a minority stake of 50% or less.

But in private equity, funding is provided in exchange for a majority stake of 50% or more or a complete takeover.

Private equity firms raise client capital to launch private equity funds and operate them as general partners. PE firms manage fund investments in exchange for fees and a share of profits greater than the hurdle rate.

The hurdle rate is nothing but the minimum rate of return on a project or investment required by a manager or investor. It allows companies to make important decisions on whether or not to pursue a specific project.

Private equity funds have a finite term of 7 to 10 years and the money invested in them isn’t available for subsequent withdrawals.

Types of Private Equity Funds

Based on the Investment Strategy, broadly there are 4 types of Private Equity Funds.

1. Venture Capital
2. Growth Capital
3. Buyouts or Leveraged Buyouts
4. Distressed Buyout

These are the characteristics of these Private Equity funds.

Venture Capital – Venture Capital funds are the funds that typically invest in small, early-stage companies which have high growth potential. They invest in emerging companies that generally have negative cashflows.

Growth Capital – Growth Capital, also known as growth equity is used to fund established, growing companies. Growth equity comes into play when companies are established but need additional funding to grow.

Leveraged Buyouts – These are buyouts funded with borrowed money. The assets of both the acquiring and acquired companies are used as collateral for the loans to finance the buyout. An example of a leveraged buyout is the purchase of Hospital Corporation of America in 2006 by private equity firms KKR, Bain & Company, and Merrill Lynch.

Distressed Buyout – These buyouts involve investing in loss-making companies that have turnaround potential. These funds specialize in lending to companies in financial crises.

Exit Strategies Employed By Private Equity Firms 

Exiting a venture by making good profits is an important step in the private equity investment process. Let’s understand what are some typical exit routes for a PE firm.

Repurchase by the promoter: If private equity firms can turn a company around and make the business sustainable, then it is possible that promoters will try to buy back their holdings, and PE firms will sell the holdings to the promoters at a higher valuation.

IPO: Initial Public Offering (IPO) means that a private company will offer its shares to the public and register itself as a public company on the stock exchange.

Secondary Sale: When one PE firm sells its holdings in a company to another PE firm, it’s known as a secondary sale. This happens when a firm is interested in buying the holdings from another PE firm even at a higher valuation.

Some popular firms in India engaged in Private Equity

Here is a list of some private equity firms operating in India:

• Bain Capital
• Everstone Capital
• Motilal Oswal Private Equity
• The Blackstone Group
• KKR & Company
• Warburg Pincus
• Baring Private Equity
• Premji Invest