Private equity is an alternative form of financing for investing directly in private companies. Occasionally, private equity funds participate in buy-outs of public companies leading to delisting.
In simplified terms, the private equity fund earns a return on its investments by improving the sale price of each investment relative to the initial purchase price after a period of time of participation in the company.
The structure of a private equity fund consists of the limited partners, who usually hold the majority of the fund and have limited liability, and the management company (general partner), which holds a minority stake in the fund and is responsible for operating and executing the investments. The management company aligns its interests with the capitalists through this co-investment.
The 4 main characteristics of a PE fund are as follows:
1. Financial partner, not managing partner:
Normally a private equity does not want to be part of the day-to-day management of the company. The fund's contribution is not to control management but to professionalise it. The evaluation of the management team is usually a key element in the investment decision. Private equity usually aligns its objectives with those of the management team through different mechanisms.
2. Time horizon of the investment:
When a private equity receives capital from its "limited partners", it makes a commitment to repay that investment within a maximum period of time. As a result of this commitment, the private equity fund invests in a company over a specific time horizon, typically between four and seven years.
For this reason, private equity must agree in the shareholders' agreement on exit mechanisms to ensure that it can liquidate its shareholding at the end of the management period.
3. Investment in the form of equity:
A PE fund provides its investment mainly in the form of capital and not so much in the form of debt as bank financing. Thus, the PE becomes a shareholder of the company and has an impact on the shareholding structure. The business project becomes a joint project of the PE fund together with the other owners of the company and the PE fund will have at least the same rights and obligations as any other shareholder.
4. Majority and/or minority participation:
Although historically, private equity was more inclined to take majority positions, it is now open to minority positions as long as they are of relative importance and reasonable exit mechanisms can be agreed upon.
There are different ways for a PE fund to participate in a company, which mainly depend on the company's situation. They can be divided as follows:
The ASCRI study on the ipact of Private Equity on SMEs summarises the following 9 differentiating values:
PE is a basic pillar for SME financing, complementing banking sources.
In addition to funding, the PE also provides the expertise of its teams:
Private Equity contributes to this consolidation in two ways:
Private Equity-backed companies contribute more intensively to job creation. In the period analysed, the aggregate increase was 30%, while in the rest there was a destruction of 2.8%.
The Private Equity intensifies the growth of investee companies. In the period analysed, each investee company increased its sales by €12.2m (3 years after the investment) more than the rest of the companies.
The Private Equity improves the earnings capacity of its investors. An average rate of 7% p.a. in the 3rd year compared to -6.4% p.a. on average for companies under a control group.
Private Equity financing multiplies the investment of its investees, which allows for an increase in production. In aggregate terms, the total assets of the investee companies are growing at an annual rate of 7% compared to 2.8% for the control group.
Venture Capital involves management support that helps to create value, cushion the effects of downturns through investment and seek new markets in which to grow. In the "middle market" segment, companies that received financing after the onset of the crisis in 2009 increased their turnover after 3 years by an average of 7 times more than control groups.
Private Equity investment in themiddle market" segment is spread across almost all sectors depending on the economic cycle and growth expectations. In particular, the technology sector is becoming more prominent every year.
Here are some examples of private equity institutions for your reference:
Providence equity partnes based in Boston (USA) is one of the pioneers of sector-specific private equity firms with international coverage, in its case in software and education in North America and Europe. Some of its current investees are Imaweb, Masmovil, Blackboard,...
Nazca capital based in Madrid is one of the deans of private equity in Spain with an open sectorial approach and a focus on Spanish companies. Some of its current investees are Seprotec, Filmin, IDP, ...
Ufenau based in Switzerland is an example of private equity with a European geographic focus and specialised in one type of growth. It invests in companies that can lead an ambitious growth process through "Buy&build" processes. Normally, they acquire 10 companies in each platform investment. Some of its current investees are Collana IT, MYTY, X1F, ...