“Private equity is equity capital that is not quoted on a public exchange. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity” (Investopedia)
Most of the private equity consists of institutional and accredited investors who are capable of investing large sums of money over long periods of time. Whereas venture capital is focused on early-stage companies with high growth potential, private equity firms invest in a much wider range of companies. Often they’re mature firms that have been trading for a long time, but need access to funds either to fuel growth or to recover from financial difficulties.
Private equity fund administration models allows a group of fund managers to take a large stake in private companies to make sure that they are run in a way as to be profitable to underlying investors. The private equity ownership model can be applied to a wide range of company types, sizes, sectors and geographies. The common factor is that all investee companies have unrealised potential. Private equity investment will aim to unlock this potential.
Let’s talk about the pros and cons of private equity funds which can help determine if it is the right kind of investment for you.
1.) Huge Amounts of Funding
Of all available options, private equity by far provides the most amount of funding with deals measuring in hundreds and millions of dollars. The playground for these companies when it comes to investing in private equity is huge. It is a vast land of opportunity for companies which are willing to invest huge. They can invest in unlisted companies that are at the beginning of their growth journey and in private hands; or they can take-private those listed companies that are unloved and under appreciated by the stock markets.The impact of such amount of money on a company like this can be massive.
2.) Selective & Significant Spend
Private equity firms are extremely selective and spend significant resource assessing the potential of companies, to understand the risks and how to mitigate them. Managers will often drill down from thousands of potentials to the one company that has all the right characteristics to achieve growth. Private equity firms are much more hands on, and will help you re-evaluate every aspect of your business to see how you can maximize its value. This can lead to problems, of course, if their idea of maximizing value doesn’t match yours, as we’ll see in the next section. But having experienced professionals intimately involved in your business can also result in major improvements.
3.) Patient Investors
Private equity firms invest in a company to make it more valuable, over a number of years, before selling it to a buyer who appreciates that lasting value has been created. Private equity firms are therefore patient investors, unconcerned with short term performance targets. But assets are held for sale, so they always have their eyes on the prize. Sometimes such firms are also known to offer private equity back office services to other firms or companies that need such services for their investments.
4.) Clear Accountability
The management team of companies owned by private equity are answerable to an engaged professional shareholder that has the power to act decisively to protect its shareholding. The combination of this clear accountability between company managers and shareholders combined with the need for a realisation means that incentive structures can directly link tangible value with reward. There are no rewards for failure. Such clear accountability has many benefits. For instance, it gives comfort to potential lenders, allowing investments to be leveraged.
5.) High Returns
This combination of major funding, expertise and incentives can be very powerful. If utilised in the right manner and direction, they can reap huge amount of returns for all involved.
Cons of Private Equity Fund
1.) Loss of Ownership Stake
With other type of funding options, sure the funding comes at a cost but you are still in control of your company. But with private equity funding, such is not the case. You receive much more in returns but at the same time you have to let go of a major share of your ownership in business. Private equity firms often demand a majority stake, and sometimes you’ll be left with little or nothing of your ownership. It’s a much bigger trade, and it’s one that many business owners will flinch at.
2.) Restricted Access
The traditional way of investing in private equity is through Limited Partnerships. These are institution-only vehicles are mainly open to institutions and other larger sophisticated investors. They cannot be access by many types of investor.
3.) High Costs
Encompassing such a vast and unregulated opportunity set as the private company universe requires resource, infrastructure and expertise. The due diligence required can translate into higher costs.
4.) Different meanings of Value
A private equity firm invests in companies to make them more valuable, and sell their stakes for large profits. Mostly this is good for the companies involved.But a private equity firm’s definition of value is very specific and limited. It’s focused on the financial value of the business on a particular date about five years after the initial investment, when the firm sells its stake at a profit. Business owners often have a much broader definition of value, with a longer-term outlook and more concern for things like relationships with employees and customers, and reputation, which can lead to clashes.
5.) Lock Up Time
With private equity funds you are required to invest large sums of money for a long period of time. There is usually 5 or 10 years lock in period. Which means you cannot have any access to your invested funds during that period of time. So your money is lying there and will hopefully give you huge profitable returns but for that time being you have to forget your funds and wait till it’s time to reap the benefits.
6.) Type Of Company
Private equity firms are looking for particular types of companies to invest in. They have to be large enough to support those major investments, and also they have to offer the potential for large profits in a relatively short time frame. Generally that either means that your company has very strong growth potential, or that it’s in financial difficulties and is currently undervalued.
So private equity is another distinctive type of funding option, with its own unique pros and cons. It can give a company access to large amounts of funding, and the expertise of the private equity firm can help it to grow or return to profitability. But remember that a very large portion of your business in the hands of outsiders whose interests are partially but not perfectly aligned with yours.