Harvest partners private equity
Private equity
What is meant by private equity?
What are private equity securities?
How do private equity firms generate returns?
What are private equity funds?
How does the fund work?
What benefits is a general partner entitled to?
What are the considerations for investing in private equity funds?
What kind of investors usually invest in private equity funds
What is the size of the private equity industry?
Who are the prominent players in this segment?
How do I allocate my money across these assets?
What is meant by private equity?
Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market.
The who, what why questions about private equity funds are answered below:
Usually, it is the passive institutional investors who invest in private equity funds, which are in turn used by private equity firms for investment in target companies.
Private equity investment can be done in any of the categories such as leveraged buyout, venture capital, growth capital, angel investing, mezzanine capital and others.
Private equity funds typically control management of the companies in which they invest, and often bring in new management teams that focus on making the company more valuable.
What are private equity securities?
Private equity refers to shares in companies that are not listed on a public stock exchange; while technically the opposite of public equity they are broadly equivalent to stocks, though return on investment often takes much longer.
Since private equity securities are not listed on an exchange, a private equity firm owning such securities must find a buyer in the absence of a traditional marketplace such as a stock exchange. The ‘exit’ or ‘selling out’ is often done by the way of an initial public offering (IPO), capitalizing the value of the security on a stock exchange.
Though not listed on a stock exchange, there are many transfer restrictions on private securities. It may be surprising to learn that this long-term investment area currently has over $ 710bn in assets.
Several attempts have been made to form trading markets, bringing liquidity to private equity. One example is Genesis Exchange who ran a monthly private equity auction in Vancouver, Canada during the summer of 2006 but generated little interest.
How do private equity firms generate returns?
Private equity firms generally receive a return on their investment through one of three ways: an IPO, a sale or merger of the company they control, or a recapitalization.
Unlisted securities may be sold directly to investors by the company (called a private offering) or to a private equity fund, which pools contributions from smaller investors to create a capital pool.
What are private equity funds?
Private equity funds are the pools of capital invested by private equity firms. Although other structures exist, private equity funds are generally organized as limited partnerships, which are controlled by the private equity firm that acts as the general partner. The limited partnership is often called ‘management company’, and the general partners are designed under the ‘fund’.
How does the fund work?
The fund obtains capital commitments from certain qualified investors such as pension funds, financial institutions and wealthy individuals to invest a specified amount. These investors become passive limited partners in the fund partnership and at such time as the general partner identifies an appropriate investment opportunity, it is entitled to ‘call’ the required equity capital at which time each limited partner funds a pro rata portion of his commitment. All investment decisions are made by the general partner, which also manages the fund’s investments (commonly referred to as the ‘portfolio’). Over the life of a fund, which often extends up to ten years, the fund will typically make between 15 and 25 separate investments with usually no single investment exceeding 10% of the total commitments.
What benefits is a general partner entitled to?
General partners are typically compensated with a management fee, defined as a percentage of the fund’s total equity capital. In addition, the general partner usually is entitled to ‘carried interest’, effectively a performance fee, based on the profits generated by the fund. Typically, the general partner will receive an annual management fee of 2% to 4% of committed capital and carried interest of 20% of profits above some target rate of return (called ‘hurdle rate’).
Talking of returns, it is important to note that gross private equity returns may be in excess of 20% per year, which in the case of leveraged buyout firms is primarily due to leverage, and otherwise due to the high level of risk associated with early stage investments. Although there is a limited market for limited partnership interests, such interests are not freely tradable like mutual fund interests.
What are the considerations for investing in private equity funds?
Considerations for investing in private equity funds relative to other forms of investment include:
Substantial entry costs, with most private equity funds requiring significant initial investment (usually upwards of $ 100,000) plus further investment for the first few years of the fund called a ‘drawdown’.
Investments in limited partnership interests (which is the dominant legal form of private equity investments) are referred to as “illiquid” investments which should earn a premium over traditional securities, such as stocks and bonds. Once invested, it is very difficult to gain access to your money as it is locked-up in long-term investments which can last for as long as twelve years.
Distributions are made only as investments are converted to cash; limited partners typically have no right to demand that sales be made.
If the private equity firm can’t find good investment opportunities, they may end up returning some of your capital back to you. Given the risks associated with private equity investments, you can lose all your money if the private equity fund invests in failing companies. The risk of loss of capital is typically higher in venture capital funds, which back young companies in the earliest phases of their development, and lower in mezzanine capital funds, which provide interim investments to companies which have already proven their viability but have yet to raise money from public markets.
Consistent with the risks outlined above, private equity can provide high returns, with the best private equity managers significantly outperforming the public markets.
For the abovementioned reasons, private equity fund investment is for those who can afford to have their capital locked-in for long periods of time and who are able to risk losing significant amounts of money. This is balanced by the potential benefits of annual returns, which range up to 30% for successful funds.
What kind of investors usually invest in private equity funds?
Most private equity funds are offered only to institutional investors and individuals of substantial net worth. The law often requires this as well, since private equity funds are generally less regulated than ordinary mutual funds. For example in the US, most funds require potential investors to qualify as accredited investors, which requires $ 2.5mn of net worth (exclusive of primary residence), $ 200,000 of individual income, or $ 300,000 of joint income (with spouse) for two documented years and an expectation that such income level will continue.
What is the size of the private equity industry?
Nearly $ 135bn of private equity was invested globally in 2005, up a fifth on the previous year due to a rise in buyouts as market confidence and trading conditions improved. Buyouts have generated a growing portion of private equity investments by value, and increased their share of investments from a fifth to more than two-thirds between 2000 and 2005. By contrast, the share of early stage or venture capital investment has declined during this period. Private equity fund raising also surpassed prior years in 2005 and totalled $ 232bn, up three-quarters on 2004.
Prior to this, after reaching a peak in 2000, private equity investments and funds raised fell in the next couple of years due to the slowdown in the global economy and declines in equity markets, particularly in the technology sector. The fall in funds raised between 2001 and 2003 was also due to a large excess created by the end of 2000 of funds raised over funds invested.
The regional breakdown of private equity activity shows that in 2005, North America accounted for 40% of global private equity investments (down from 68% in 2000) and 52% of funds raised (down from 69%). Between 2000 and 2005, Europe increased its share of investments (from 17% to 43%) and funds raised (from 17% to 38%). This was largely a result of strong buyout market activity in Europe. Asia-Pacific region’s share of investments increased from 6% to 11% during this period while its share of funds raised remained unchanged at around 8%.
Who are the prominent players in this segment?
Prominent private equity firms include: Kohlberg Kravis Roberts & Co., Blackstone Group, Texas Pacific Group, Bain Capital, Carlyle Group, Lone Star Funds, Madison Dearborn, Clayton, Dubilier & Rice, TA Associates, Bear Stearns Merchant Banking, Harvest Partners, Francisco Partners, Warburg Pincus, and in financial services, Belvedere Capital and Castle Creek Capital.
Europe-based firms include: Apax Partners, BC Partners, Bridgepoint Capital, Candover, Cinven, CVC Capital Partners, Permira, Terra Firma Capital Partners and 3i.
How do I allocate my money across these assets?
Most of us tend to approach investment decisions based on the returns that we want to achieve. Although returns are an end objective, they should not be the starting point in the portfolio construction process. If returns are the primary driver for your investment decisions, you run the risk of a negative impact on your financial health - you could be taking more risk than you are financially or even psychologically capable of or be losing out on potentially higher returns by assuming lower risk than you can bear.
Different asset classes carry different levels of risk. It is important for you to structure your portfolio in a manner in which the resultant risk profile not only matches your individual risk profile but also your liquidity needs. Moneycontrol Asset Allocator can help you structure your financial portfolio keeping in mind your risk profile.
