Private equity funds are pools of capital targeted at companies that represent an opportunity for a high rate of investment return. They come with a fixed investment horizon, typically ranging from four to seven years, at which point the PE firm hopes to profitably exit the investment. Exit strategies include IPOs and sale of the business to another private equity firm or strategic buyer.
Private equity simply put, is an alternative investment class and consists of capital that is not listed on a public exchange. Private equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies, resulting in the delisting of public equity. Institutional and retail investors provide the capital for private equity, and the capital can be utilized to fund new technology, make acquisitions, expand working capital, and to bolster and solidify a balance sheet.
Private equity investment comes primarily from institutional investors and accredited investors, who can dedicate substantial sums of money for extended time periods. In most cases, considerably long holding periods are often required for private equity investments in order to ensure a turnaround for distressed companies or to enable liquidity events such as an initial public offering (IPO) or a sale to a public company.
A private equity fund has Limited Partners (LP), who typically own 99 percent of shares in a fund and have limited liability, and General Partners (GP), who own 1 percent of shares and have full liability. The latter are also responsible for executing and operating the investment.
How Does Private Equity Operate?
Private equity firms raise money from institutional investors and accredited investors for funds that invest in different types of assets. The most popular types of private equity funding are mentioned below.
Distressed funding: This is sometimes referred to as vulture financing. Money in this type of funding is invested in troubled companies with underperforming business units or assets. The intention is to turn them around by making necessary changes to their management or operations or make a sale of their assets for a profit. Assets in the latter case can range from physical machinery and real estate to intellectual property, such as patents. Some companies that have filed for bankruptcy are candidates for this funding type. There was an increase in distressed funding by private equity firms after the 2008 financial crisis.
Leveraged Buyouts: This is the most popular form of private equity funding and involves buying out a company completely with the intention of improving its business and financial health and reselling it later for a profit to an interested party or conducting an IPO.
Up until 2004, sale of non-core business units of publicly listed companies comprised the largest category of leveraged buyouts for private equity. The leveraged buyout process works as follows. A private equity firm identifies a potential target and creates a special purpose vehicle (SPV) for funding the takeover. Typically, firms use a combination of debt and equity to finance the transaction. Debt financing may account for as much as 90 percent of the overall funds and is transferred to the acquired company’s balance sheet for tax benefits. Private equity firms employ a variety of strategies, from slashing employee count to replacing entire management teams, including the board of the company in order to turn the company around and make it work again.
Real Estate Private Equity: There was a surge in this type of funding after the 2008 financial crisis crashed real estate prices. Typical areas where funds are deployed are commercial real estate and real estate investment trusts (REIT). Real estate funds require higher minimum capital for investment as compared to other funding categories in private equity. Investor funds are also locked away for several years at a time in this type of funding. A recent research finding indicates that real estate funds in private equity are expected to clock in a 50 percent growth by 2023 to reach a market size of $1.2 trillion.
Fund of funds: As the name denotes, this type of funding primarily focuses on investing in other funds, primarily mutual funds and hedge funds. They offer a backdoor entry to an investor who cannot afford minimum capital requirements in such funds. But critics of such funds point to their higher management fees (because they are rolled up from multiple funds) and the fact that unfettered diversification may not always result in an optimal strategy to multiply returns.
Venture Capital: Venture capital funding is a form of private equity, in which investors (also known as angels) provide capital to entrepreneurs. Depending on the stage at which it is provided, venture capital can take several forms. Seed financing refers to the capital provided by an investor to scale an idea from a prototype to a product or service. On the other hand, early stage financing can help an entrepreneur grow a company further while a Series A financing enables them to actively compete in a market or create one.
Exit Considerations
There are multiple factors in play that affect the exit strategy of a private equity fund. Here are some necessary questions to ask:
When does the exit need to take place? What is the investment horizon?
Is the management team amenable and ready for an exit?
What exit routes are available?
Is the existing capital structure of the business appropriate?
Is the business strategy appropriate?
Who are the potential acquirers and buyers? Is it another private equity firm or a strategic buyer?
What Internal Rate of Return (IRR) will be achieved?
Typical Exit Routes for PE Funds
When deciding to exit, PE firms take either one of two paths: total exit or partial exit. In terms of a wholesale exit from the business, there can be a trade sale to another buyer, LBO by another private equity firm, or a share repurchase.
In terms of a partial exit, there could be a private placement, where another investor purchases a piece of the business. Another possibility is corporate restructuring, where external investors get involved and increase their position in the business by partially acquiring the private equity firm’s stake. Finally, corporate venturing could happen, in which the management increases its ownership in the business.
Lastly, a flotation or an IPO is a hybrid strategy of both total and partial exit, which involves the company being listed on a public stock exchange. Typically, only a fraction of a company is sold in an IPO, ranging from 25% to 50% of the business. When the company is listed and traded publicly, private equity firms exit the company by slowly unwinding their remaining ownership stake in the business.
Market Highlights
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GSE INDEXES ⏸ 2022 YTD RETURNS%
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🔼GSE 2022 GAINERS ➖ PRICE ➖ YTD%
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BOPP ➡Gh¢7.65 🔼+15.04%
EGL ➡Gh¢3.20 🔼+14.70%
🔻GSE 2022 LOSERS ➖ PRICE ➖ YTD%
UNIL ➡Gh¢3.88 🔻-34.13%
PBC ➡Gh¢0.02 🔻-33.33%
CAL ➡Gh¢0.65 🔻-25.29%
FML ➡Gh¢3.00 🔻-25.00%
GCB ➡Gh¢3.95 🔻-24.62%
MTNGH ➡Gh¢0.88 🔻-20.72%
TOTAL ➡Gh¢4.00 🔻-20.32%
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COMMODITIES MARKET
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Sources: Bank of Ghana, Bloomberg, GSE, Reuters, Doobia, BBC.
Mark G. Darko, Accra
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