Private Equities

Private equities are equity securities of unquoted companies (companies that have not listed their stock on a public exchange). They provide long-term, committed share capital for firms and help them to grow and succeed. Private equity investors (also called financial sponsors or buy-out firms) typically hold their investments with the intent of realizing a return within 3 to 7 years. Generally, investments are realized through an initial public offering, sale, merger, or recapitalization.

Private equity is invested in exchange for a stake in company and the investors’ returns are dependent on the growth and profitability of the business. Private equity in the UK originated in the late 18th century, when entrepreneurs found wealthy individuals to back their projects. This informal method of financing became an industry in the late 1970s and early 1980s when a number of private equity firms were founded. Private equity is now a recognised asset class. There are over 170 active UK private equity firms, which provide several billion pounds each year to unquoted companies, around 80% of which are located in the UK (British Private Equity and Venture Capital Association, Aug 2007).

How does a private equity fund-management firm make money?

If an entrepreneur is looking to start up, expand, buy into a business, buy out a division of the parent company, turnaround or revitalise a company, private equity could help to do this.

The process typically involves a private equity fund-management firm raising a Limited Partnership fund, where private equity investors put money with limited liability. Investors usually cannot lose more than their capital contribution however they receive income, capital gains, and tax benefits. The fund is used to buy majority of stakes in business for long term. The equity fund-management firm will often look for an established and defendable market position with strong cash flow, a reasonable growth strategy and clear exit potential.

The new ownership structure can supply the company with risk capital to accelerate its growth, organically or by acquisition, or to restructure. The private market also shields a company from the demands of shareholders to deliver an instant payback on any investment.

The private equity manager actively helps the company to develop, normally by taking a seat on the board and providing strategic advice on capital markets and financing, market analysis, networking and sourcing other key executives. When the company has developed sufficiently to attract other investors, it may be sold to a larger company, floated on the stock market or sold to another private equity firm, which might be able to bring some other form of expertise to the party - surprisingly, 40% are sold on to other private equity firms (Moneywise, Aug 2007).

While venture capital firms tend to invest in earlier stage growth companies, private equity groups tend to focus on more mature businesses, often contributing both equity and debt (or some hybrid) to the transaction.

What do private equity firms look for in a potential acquisition?

  • Strong management team.
  • Ability to generate cash.
  • Significant growth potential.
  • Ability to create value.
  • A clearly defined exit strategy.

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