What Is Private Equity
What Is Private Equity
What Is Private Equity
KEY TAKEAWAYS
Private equity is an alternative form of private financing, away from public markets,
in which funds and investors directly invest in companies or engage in buyouts of
such companies.
Private equity firms make money by charging management and performance fees
from investors in a fund.
Among the advantages of private equity are easy access to alternate forms of capital
for entrepreneurs and company founders and less stress of quarterly performance.
Those advantages are offset by the fact that private equity valuations are not set by
market forces.
Private equity can take on various forms, from complex leveraged buyouts to venture
capital.
Private equity firms mostly remained on the sidelines of the financial ecosystem after World
War II until the 1970s when venture capital began bankrolling America’s technological
revolution. Today’s technology behemoths, including Apple and Intel, got the necessary
funds to scale their business from Silicon Valley’s emerging venture capital ecosystem at the
time of their founding. During the 1970s and 1980s, private equity firms became a popular
avenue for struggling companies to raise funds away from public markets. Their deals
generated headlines and scandals. With greater awareness of the industry, the amount of
capital available for funds also multiplied and the size of an average transaction in private
equity increased.
When it took place in 1988, conglomerate RJR Nabisco’s purchase by Kohlberg, Kravis &
Roberts (KKR) for $25.1 billion was the biggest transaction in private equity history. It was
eclipsed 19 years later by the $45 billion buyout of coal plant operator TXU Energy.
Goldman Sachs and TPG Capital joined KKR in raising the required debt to purchase the
company during private equity’s boom years between 2005 and 2007.1 Even Warren Buffett
bought $2 billion worth of bonds from the new company. The purchase turned into a
bankruptcy seven years later and Buffett called his investment “a big mistake.”
The boom years for private equity occurred just before the financial crisis and coincided with
an increase in their debt levels. According to a Harvard study, global private equity groups
raised $2 trillion in the years between 2006 and 2008 and each dollar was leveraged by more
than two dollars in debt. But the study found that companies backed by private equity
performed better than their counterparts in the public markets. This was primarily evident in
companies with limited capital at their disposal and companies whose investors had access to
networks and capital that helped grow their market share.2
In the years since the financial crisis, private credit funds have accounted for an increasing
share of business at private equity firms. Such funds raise money from institutional investors,
like pension funds, to provide a line of credit for companies that are unable to tap the
corporate bond markets. The funds have shorter time periods and terms as compared to
typical PE funds and are among the less regulated parts of the financial services industry. The
funds, which charge high interest rates, are also less affected by geopolitical concerns, unlike
the bond market.
Distressed funding: Also known as vulture financing, money in this type of funding is
invested in troubled companies with underperforming business units or assets. The
intention is to turn them around by making necessary changes to their management or
operations or make a sale of their assets for a profit. Assets in the latter case can range
from physical machinery and real estate to intellectual property, such as patents.
Companies that have filed under Chapter 11 bankruptcy in the United States are often
candidates for this type of financing. There was an increase in distressed funding by
private equity firms after the 2008 financial crisis.
Leveraged Buyouts: This is the most popular form of private equity funding and
involves buying out a company completely with the intention of improving its
business and financial health and reselling it for a profit to an interested party or
conducting an IPO. Up until 2004, sale of non-core business units of publicly listed
companies comprised the largest category of leveraged buyouts for private
equity. The leveraged buyout process works as follows. A private equity firm
identifies a potential target and creates a special purpose vehicle (SPV) for funding the
takeover. Typically, firms use a combination of debt and equity to finance the
transaction. Debt financing may account for as much as 90 percent of the overall funds
and is transferred to the acquired company’s balance sheet for tax benefits. Private
equity firms employ a variety of strategies, from slashing employee count to replacing
entire management teams, to turn around a company.
Real Estate Private Equity: There was a surge in this type of funding after the 2008
financial crisis crashed real estate prices. Typical areas where funds are deployed are
commercial real estate and real estate investment trusts ( REIT). Real estate funds
require higher minimum capital for investment as compared to other funding
categories in private equity. Investor funds are also locked away for several years at a
time in this type of funding. According to research firm Preqin, real estate funds in
private equity are expected to clock in a 50 percent growth by 2023 to reach a market
size of $1.2 trillion.3
Fund of funds: As the name denotes, this type of funding primarily focuses on
investing in other funds, primarily mutual funds and hedge funds. They offer a
backdoor entry to an investor who cannot afford minimum capital requirements in
such funds. But critics of such funds point to their higher management fees (because
they are rolled up from multiple funds) and the fact that unfettered diversification may
not always result in an optimal strategy to multiply returns.
Venture Capital: Venture capital funding is a form of private equity, in which investors
(also known as angels) provide capital to entrepreneurs. Depending on the stage at
which it is provided, venture capital can take several forms . Seed financing refers to the
capital provided by an investor to scale an idea from a prototype to a product or
service. On the other hand, early stage financing can help an entrepreneur grow a
company further while a Series A financing enables them to actively compete in a
market or create one.
Positions in a private equity firm are highly sought after and for good reason. For example,
consider a firm has $1 billion in assets under management (AUM). This firm, like the
majority of private equity firms, is likely to have no more than two dozen investment
professionals. The 20 percent of gross profits generates millions in firm fees; as a result,
some of the leading players in the investment industry are attracted to positions in such firms.
At a mid-market level of $50 to $500 million in deal values, associate positions are likely to
bring salaries in the low six figures. A vice president at such a firm could potentially earn
close to $500,000, whereas a principal could earn more than $1 million.
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History of Private Company
The history of private equity can be traced back to 1901, when J.P. Morgan--the man, not the
institution--purchased Carnegie Steel Co. from Andrew Carnegie and Henry Phipps for $480 million.
Phipps took his share and created, in essence, a private equity fund called the Bessemer Trust. Today
the Bessemer Trust is more private bank than private equity firm, but Phipps and his children started a
trend of buying exclusive rights to up-and-coming companies--or buying them outright.
Yet, although there were pools of private money in existence between the turn of the century
and through the 1950s, these were primarily invested in start-ups, much like today's venture capital
firms. The notion of a private buyout of an established public company remained foreign to most
investors until 1958, when President Dwight D. Eisenhower signed the Small Business Act of 1958.
That provided government loans to private venture capital firms, allowing them to leverage their own
holdings to make bigger loans to startups--the first real leveraged purchases.
Soon, other companies started playing with the idea of leverage. Kohlberg Kravis Roberts &
Co. made the first modern leveraged buyout in 1964 through the purchase of the Orkin Exterminating
Co. Others followed, but the trend quickly died by the early 1970s. For one, the government raised
capital gains taxes, making it more difficult for KKR and other nascent firms to attract capital.
Pension funds were restricted by Congress in 1974 from making "risky" investments--and that
included private equity funds.
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▸ Venture Capital
Venture capital funds invest in start-up, emerging, or small businesses. This is done
with the hope of a return on investment should the company become successful. There is a
clear risk in doing this as these companies don’t have a solid track record of turning a profit.
Early-stage funds focus on looking for budding enterprises with extremely capable leaders
looking for capital to develop technologies etc. Later stage funds for emerging businesses that
may have already exhibited a profitable business plan and may be looking to expand or step
into new markets..
Top 10 Active venture Capital firms in India for early stage startups
1. Sequoia Capital
2. Accel
3. Blume Ventures
4. SAIF Partners
5. Tiger Global Management
6. Kalaari Capital
7. Matrix Partners
8. Nexus Venture Partners
9. India Angel Network
10. Omidyar Network India
india/#ActiveVentureCapitalFirms1.SequoiaCapital
https://news.crunchbase.com/news/global-2020-funding-and-exit/
Total India’s venture capital Statistics
In 2020, Indian companies attracted around ten billion U.S. dollars in venture capital
investments. This was a slight decrease compared to the record-breaking year 2019. As the
number of deals increased, it is still the second highest value of VC-investments in the
country.
As the value of VC investments is still on a high level despite the implications of the
coronavirus (COVID-19) pandemic, the investment trend seemed to continue. It was driven
by large deals as well as by emerging sectors like Fintech and software as a service (SaaS).
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▸ Leveraged Buy-Out
A leveraged buyout is one company's acquisition of another company using a
significant amount of borrowed money to meet the cost of acquisition. The assets of the
company being acquired are often used as collateral for the loans, along with the assets of the
acquiring company. In LBO deals the assets and the cash flows of the target company are
used for the purpose of debt repayment. After the buyout; the company’s control is in the
hands of LBO firm. The term LBO is usually employed when a financial sponsor acquires a
company. However, many corporate transactions are partially funded by bank debt, thus
effectively also representing an LBO.
In 2020, there were 43 buyout deals secured in India's private equity and venture
capital sector, aggregating to nearly 12 billion U.S. dollars. This was a decrease compared to
the 16.45 billion U.S. dollars in 2019.
https://www.statista.com/statistics/882347/india-buyout-deals-value/
▸ Growth Capital
Growth capital is a type of private equity investment, usually a minority investment,
in relatively mature companies that are looking for capital to expand or restructure operations,
enter new markets or finance a significant acquisition without a change of control of the
business. Unlike working capital, which is used for bills and basic, cyclical expenses, growth
capital isn’t tied to any particular business cycle. Instead, growth capital is designed to
provide long-term health for the business.
The Top 7 Growth Equity Firms of 2020
1) TPG Growth
2) Blackstone Growth
3) Summit Partners
4) General Atlantic
5) Insight Partners
6) TA Associates
7) TCV
https://www.statista.com/statistics/882365/india-growth-deals-value/
▸ Mezzanine capital
Mezzanine capital refers to subordinated debt or preferred equity securities that often represent the most
junior portion of a company's capital structure that is senior to the company's common equity. This form of
financing is often used by private-equity investors to reduce the amount of equity capital required to
finance a leveraged buyout or major expansion. Mezzanine capital, which is often used by smaller
companies that are unable to access the high yield market, allows such companies to borrow additional
capital beyond the levels that traditional lenders are willing to provide through bank loans. In
compensation for the increased risk, mezzanine debt holders require a higher return for their investment
than secured or other more senior lenders. Mezzanine securities are often structured with a current income
coupon