How do you understand the concept of private equity? If you think that it stands somewhere next to private property, this article is for you. Let’s make it clear and simple. Private equity is a particular type of investment capital that is not noted on a stock exchange. It is composed of investors and funds that invest in private companies or participate in public companies’ buyouts, delisting the public equity.
By acquiring equity ownership in different companies, private equity partners raise funds and manage them to get good returns with an investment horizon from 4 to 7 years.
The minimum capital, required for investors, can differ according to the particular company and the funds raised.
Private equity is attractive, isn’t it?
The private-equity industry attracts top professionals from various consulting firms and even Fortune 500 companies. And it is no wonder why. The fee structure of these firms may vary, but usually it includes a management and a performance fee. For example, it may consist of a 2% fee from the managed asset and a 20% fee from the company’s gross profit.
Let’s say that a private-equity firm operates assets of $1 billion. Having no more than two dozen investors, their 20% fee from the gross profit could bring them millions of dollars. If the associates of such firms usually earn a salary of six figures, the executives may earn more than a million. Sounds tempting, doesn’t it?
How does it work?
Private-equity firms have two major functions: deal origination and portfolio oversight.
Deal origination includes launching and developing relations with M&A (mergers and acquisitions) intermediaries and investment banks to ensure a stable, high-quality deal flow. Deal originators, usually associates or directors, try to build good relationships with transaction professionals in order to be introduced early to deals.
Executing transactions includes careful assessing of the industry, historical data, financial forecasts and performing valuation analyses. After the decision to proceed with the chosen acquisition candidate is taken, deal specialists transfer their offers to sellers. In the case that all the parties agree to go further, deal professionals continue negotiations with investment bankers and consultants to perform the due diligence stage. This stage is highly important and presupposes the investigation of the financial records and other significant aspects that may even kill the deal.
The second but not less important function of private-equity specialists is to oversee portfolio companies. They support the management teams, showing them the best practices of strategic planning.