How does a Private Equity Firm Work?

July 16, 2018

What is a Private Equity Firm?

Private Equity has risen to the fore in the current marketplace, and so has the number of Private Equity Firms. However, many people are still ignorant about how private equity firms work, and what they do. For this, a better understanding of the crux of private equity is required.

What is Private Equity?

Private equity, like equity, refers to the shares representing the ownership of a company or an entity. The only difference between private equity and standard equity is that the companies which have private equity owners are not publicly traded. Private equity firms, therefore, provide investment capital to companies which are not traded publicly or buy public companies before making them private by delisting them off the public stock exchanges in the country.

How do Private Equity Firms Work?

Private equity firms are usually made up of large institutional investors, like pension funds, who are willing to take higher risks than a company who trades in public stock exchanges. However, there is a significant difference- private equity firms invest directly in a company, which gives them a considerable amount of influence in the day-to-day operations and working of companies. This also requires a more significant investment in the company, and that is the reason why most private equity firms have deep pockets.

As in every business transaction, the primary interest of private equity firms is to maximise their returns, to make a profit on their investment. The money is disbursed to shareholder clients, typically within a period of seven to ten years.

A private equity firm is therefore called a General Partner (GP), and the investors who commit capital for investment are called Limited Partners (LP) in this transaction. In most cases, LPs are made up of wealthy individuals, pension funds and large institutional accounts. The Limited Partners only invest cash into the company via the General Partners and get a return on their investments within an investment horizon of around 4 to 7 years.

The General Partner, however, is in charge of managing the whole of the cash transactions and investments which take place. The fund is invested between private and public funds, and the GP also manages the investment portfolio. The GP is also in charge of exiting the investments when there is a sizeable return from them. Owing to the vast network of the GP, they may invest in various companies without many investment restrictions like geography, investment or regardless of the size of the investment.

The Private Equity Firm usually makes around 10 to 12 investments over the course of its life. The companies may return the money with profit is approximately 4 to 7 years, in most cases- they are thoroughly screened for their capabilities and potential returns before investment. At almost all times, the entire fund of the GP may be invested into various avenues- they may, therefore, need to conduct fundraising events to raise new funds, and use their proven track record to significant effect.

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