Private Equity Fund
A private equity fund is a collective investment scheme used for making investments in various equities and debt instruments. They are usually managed by a firm or a limited liability partnership. The tenure (Investment horizon) of such funds can be anywhere between 5-10 years with an option of annual extension. One key feature of private equity funds is that the money which is pooled in for the purpose of fund investment is not traded in the stock market and is not open to every individual for subscription.
Since private equity funds are not available to everyone, the money is usually raised from institutional investors (HNIs & Investment Banks) who can afford to invest large sums of money for longer time periods. A team of investment professionals from a particular private equity firm raise and manage the funds, where they utilise this money for raising new capital, future acquisitions, funding startups or new technology, investing in other private companies or making the existing fund stronger. Private equity funds represent an excellent opportunity for a high rate of return.
Types of Equity Funds
Venture Capital or VCs
Venture capital refers to the fund which further invests in small young companies and startups who have limited or no access to the outside financial markets. These young companies are usually in their initial stage of formation but have a high growth potential in the near future. Venture capital funds are an excellent source of capital for emerging companies with ambitious value propositions and innovations. Venture funds do not carry any debt and when invested in a right young startup, they can generate extraordinary returns. VCs have played a significant role in boosting the startups in India.
Buyout or Leveraged Buyout (LBO)
They are different form VC funds as a leveraged buyout invests money in a larger business along with additional leverage (usually in a form of stake holding), which is placed on the organization to generate favourable and sizeable returns. The money invested is also larger as compared to VCs.
A leveraged buyout takes place when a company borrows a large amount of money in the form of loans and bonds to facilitate its acquisition of another company. The purpose of having a major stake holding in a company for a long period of time is to manage the funds within the company in order to generate a sizeable value. Once a significant value has been created, the PE firms dilute their stake and exit the company.
A leveraged buyout comprises of debt to finance the buyout. The firm undertaking the LBO has to provide a small amount of the financing (typically around 90% of the cost is financed through debt).
The investment objective of a leveraged buyout is to generate returns on the acquisition that will outweigh the interest paid on the debt. For the firm that’s performing the LBO, this is a good option to generate high returns while only risking a small amount of capital.
Real Estate
Private equity real estate funds invest capital in ownership of various real estate properties. Such funds have strategies based on:
- Core: Investments are made in low-risk / low-return strategies with predictable cash flows.
- Core Plus: Moderate-risk / moderate-return investments in core properties that require some form of value added element.
- Value Added: A medium-to-high-risk / medium-to-high-return strategy which involves the purchasing of property to improve and sell at a gain. Value added strategies typically apply to properties that have operational or management issues, require physical improvements, or suffer from capital constraints.
- Opportunistic: A high-risk / high-return strategy, opportunistic investments in properties require massive amounts of enhancements. Examples include investments in development, purchase of raw land, and mortgage notes.
Growth Capital
Private equity growth capital funds invest in mature corporates with a successful business model to enable them to expand or restructure their operations, enter new markets, or finance a major acquisition. It is usually a small investment as the company which requires growth capital is generally a large profit generating enterprise. Such corporates avail growth capital to fund big expansions, acquisitions or other investments as they are not in a position to use its existing assets to avail conventional means of financing required for growth.
Fund of Funds
A ‘fund of funds’ (FoF) is an investment strategy whereby investments are made in other funds rather than directly in securities, stocks, or bonds. A fund of funds is advantageous for investors as their money is invested in various fund strategies which diversify risk.
Advantages of Investing in Private Equity Funds
- Large amounts of funding: Private Equity Funds are an excellent source of capital as they are free of debts. An emerging business can tap large amounts for seed funding via Private Equity.
- Untapped Potential: Private equity is a vastly untapped market with great potential. From unicorn startups to unlisted private companies and much more, there are a wide range of options available in the market.
- Active Involvement: As a shareholder, you can hold the professional management PE team completely accountable for protecting your shareholding interests.
- Incentives and Returns: PE Firms which hold and manage private equity funds are highly selective and spend a considerable amount of resources to assess the potential companies which they could invest in. This also involves an understanding of the risks involved and how to ease the same.
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