Defnition
Private equity is an asset class within Private markets. It involves investing long-term capital in exchange for ownership stakes in companies that are not traded on public exchanges. Transactions in Private markets occur privately between parties.
The core model for generating returns in private equity involves several steps:
- Investing money from third-party investors into a private company.
- Improving the business (which is referred to as Value creation).
- Selling the company after a limited holding period.
While any investment in a private company can be considered private equity, whether done privately or professionally, most professional investments are managed by specialised intermediaries that advise Private equity funds. Private equity funds are stand-alone vehicles managed by advisors who have a mandate and fiduciary duty to invest pooled funds from multiple third-party Investors into stakes of private companies over a long-term horizon.
Private equity aims to outperform public markets. However, this comes at the cost of liquidity, as capital is not accessible to Investors for a long period of time, and typically requires higher entry tickets.
Private equity fund managers can focus on different strategies:
- Leveraged Buyout (LBO): These are acquisitions of mature companies where a large portion of the purchase price is financed with debt. An LBO involves the purchase of a company by a small group of private investors with a limited investment horizon. LBOs are typically pursued to enhance investment returns through financial leverage, often targeting undervalued or underperforming businesses with potential for operational improvement. Suitable targets typically have stable and predictable cash flows, strong asset bases, and a capacity for value creation.
- Venture capital: This typically involves acquisitions of usually minority positions in younger companies with high growth potential.
- Growth capital: This strategy focuses on acquiring minority or non-controlling stakes in more mature companies, usually positioned between the Venture capital and Leveraged Buyout stages.
- Distressed turnarounds: This involves acquiring companies that are undervalued due to temporary cash flow problems.
Typical investors in Private equity funds include Family offices, Sovereign wealth funds, Financial institutions, Corporations, and even individuals, often High net worth individuals.