Jul 04,2019 | 20 min read

Private Equity Explained

Author - Advocate Neeraj Dubey and Associate Sanjani Shah

There are a lot of different options available in the market to invest. However, it can get overwhelming to decide which scheme is the best. One of the places where you can invest your money is the Private Equity sector.

What is Private Equity?

It is an alternative investment class which consists of capital that is not listed anywhere on a public exchange. The private equity sector comprises of investors that directly invest in private companies at their own risk. Also, investors that engage in buyouts of various public companies lead to the delisting of those public companies from the public sectors. Thus, those also can be included in the Private Equity sector.

Usually, institutional and retail investors provide funds for Private Equity. The capital provided is used for making acquisitions, funding new technology, solidifying a balance sheet and expanding working capital.

With Private equity funds, one can just have limited partners. Those partners basically own 99 percent of the shares in the funds and have limited liability in the company. The remaining 1 percent comprises of the General Partners and thus, they have full liabilities in the company. They are also responsible for executing and operating investment.

How does Private Equity Work?

Firms which fall under the private equity sector usually raise money from institutional investors and accredited investors. These investors normally invest their money under different kinds of assets. The different kinds of Private Equity funding are mentioned below. Read on to find out.

-Leveraged Buyouts

This is a very popular type of Private Equity funding. It involves buying out a small or financially weak company completely. The mere intention of doing this is to improve the business and financial profit of a particular company. After doing so, the investor normally resells the company to an interested party for profit. The investor might conduct an IPO as well.

Demographics show that until 2004, non-core business units which were listed in the public sector had a huge number of leveraged buyouts to the Private Equity sectors.

The leverage buyouts work in a particular fashion where the private equity firm will identify a potential company. They will further create a special purpose vehicle for them to take over. The firms usually use a combination of equity and debt to take over the potential target. Private Equity firms use a lot of different types of strategies for financing transactions. They also consider replacing the management teams after taking over.

- Distressed Funding

This type of funding is popularly known as vulture financing. The money is funded to troubled companies which have underperforming business assets and units. The whole intention of the private equity firm is to turnaround their sales and help them make a profit by imposing different strategies.

Even the assets are taken into consideration and are used to make sales and profits. The assets can be physical machinery, products, real estate and intellectual properties like patents.    

-Real Estate Private Equity

This type of funding faces a problem whenever there is a surge in the real estate market. Even when a recession hits, this sector is affected first. The real estate funds always require a higher minimum capital of investment as compared to all the other ones in the private equity sector. However, research suggests that people might start investing in the real estate private equity sector in the coming years.

-Venture Capital

This form of funding is usually for entrepreneurs. The investors provide capital to different start-ups and entrepreneurs to work efficiently. Venture Capital can take several forms depending on the stage it is provided at.

Seed financing in this sector is usually referred to as the capital provided by the investor for a particular idea or prototype. At the same time, early-stage financing is always done for a company with the intention of helping it grow. Series A financing is a type of venture capital which helps a company to actively compete in the market or create a branding market for themselves.

- Funds of Funds

This type of funding basically invests in other funds like mutual funds and hedge funds. They offer entry to a particular investor form the backdoor as he might not be able to generate the minimum required capital. However, such funds require higher management fees and have no guarantee of returns.     

Conclusion

Private Equity financiers actually earn on management fees only. The fee structure varies on the type of funding, but, it mainly has management and performance fees. Thus, private equity financing takes various forms from leveraged buyouts to venture capital.

 

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ABOUT THE AUTHOR


Neeraj Dubey

Neeraj advises start-ups in structuring, funding & compliance requirements, choosing appropriate legal structures, their registration and licensing, conducting legal audits before funding/acquisition, drafting & reviewing contracts/agreements, advisory on employment laws, IP & data protection, dispute resolution & taxation.

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