Private Equity Fund

What Is Private Equity Fund?

Private Equity Fund describes the investment operation of pooled funds created by investors. The funds are invested into long-term opportunities with the aim of ultimately selling off at a profit. It may be combined with other forms of investment vehicles.

The private equity firm gets the chance to control the operation of the business where they have invested, which may also be referred to as the portfolio company, and actively manage it to turn it more efficient and profitable, leading to a rise in its market value. The private equity industry is rapidly growing in the current financial market.

• A private equity fund is a pool of money invested in companies to improve operations and increase profitability.
• The fund aims to upgrade the value of the investment made so as to sell it in the future at a profit.
• The fund gets the opportunity to manage and make decisions regarding business operations for the long term and increase its worth and value.
• The firms raise the required capital from partners or investors to pool money in return for a fee and share of the profits.

How Does A Private Equity Fund Work?

A private equity fund explains the pool of money that investors create in order to use it in businesses that require skill and upgradation from their current condition to turn them profitable. Such a fund typically invests in companies that are mature and have reached saturation, thus requiring fresh minds and ideas to give it a boost in its operations. 

The private equity fund for real estate or any other sector invests the money in companies on a long-term basis, and this may be done in combination with other types of investments. The funds may also take an interest in startups or businesses that have excellent growth opportunities in the future. The professionals who put their money into the fund are experts with good knowledge regarding business operations who can successfully turn around the business towards a better future and increase its market value.

These funds are formed as limited partnership firms. The private equity fund investing source may be cash-rich insurance companies, institutional investors, universities, high-net-worth individuals, etc. The term of the fund may be 10 or more years, and investors need to pay some management fee in order to operate the fund. Investors' interests cannot be transferred except for special conditions. The fund is managed by fund managers who also possess the power to make investment decisions with some restrictions in terms of size, geographical area or type of the same.

The portfolio companies where they invest may be some distressed and struggling ones that require immediate financial and operational revamping. The final aim is usually to turn it into a strong and profitable business and sell it off at a good profit.

Structure

Let us study the structure of the fund in detail.

The private equity fund for real estate or any other sector is usually created with a huge amount contributed by different investors and partners to the fund. The money will ideally be illiquid in nature, considering the long-term commitment made by the fund towards the portfolio company. So, the return expected from such securities will be much higher than that of bonds or stocks.

In this arrangement, the rights of the partners are minimal. Mostly, decisions related to investment are made by the manager, who will try to make the most lucrative investment to generate a return. However, partners who may contribute a substantial amount may have some more power compared to others. Therefore, the opportunities must generate good returns, and the investor will reduce their commitment to the fund.

Compared to any other type of funding arrangement, such as venture capital, the risk in the case of private equity is less. This is because venture capitalist primarily invests in businesses that are in their nascent stage or have just started to grow. This involves a greater risk of loss in investment in case the project does not take off as expected.

However, private equity fund investing is for companies that are already growing or have attained the mature stage, reducing the risk to a great extent because the businesses are already established.  It should be noted in this case that money pooled into public companies is less risky than private ones. However, overall, fund managers in private equity have a greater chance of consistently earning higher returns, and they often tend to outperform markets.

Types

There can be various types of deals related to private equity.

The most common one is the buyout, where the fund acquires a company that is in a precarious condition financially and structurally. The fund acquires it with the aim of bringing necessary changes in its working procedures that will make the process more efficient and stronger, leading to cost reduction, boosting its sales and revenue, and restructuring it to increase its market price.

Venture capital is also considered a type of private equity where the fund is put into small and emerging businesses that are in their very initial stages. Such companies usually cannot get good funding from any other source. Venture capitalists tend to invest in them by taking that risk and generating exorbitant returns.

Then, there can also be an acquisition in the form of a carve-out, where the fund may buy a particular division of an organization that is currently not performing well or adding to the liabilities and expenses of the entity. Such investment may be of a lesser amount but involves more risk than a buyout.

Thus, the above are different types of funds related to private equity that one should be aware of.

How To Invest?

Since the private equity fund accounting investment amount in such funds is quite high, the investors normally include pension or endowment funds, insurance companies, or high-net-worth individuals who have huge incomes and liquid assets. However, if an individual does not fall under the above categories but still wishes to invest in private equity, they can indirectly put their money into any of the above.

This kind of investment has grown rapidly over the years due to its relatively high returns. This lucrative investment option has grown with growth in the stock market and tends to perform well when interest rates are low.

Examples

Let us understand the concept of private equity fund accounting with the help of some suitable examples, as given below:

Example #1

Let us assume XYZ Capital Management is a private equity fund that has successfully raised $100 million from its investors and partners. Now, it is planning to put that money into restructuring two companies, AB Industries, which is in the manufacturing sector, and CD & Associates, which is into financial services.

XYZ Capital Management has purchased only the procurement division, which is not able to optimize the procurement and supply chain process, which is why costs are increasing and revenue is going down. The other company, CD & Associates, does not have the funds to upgrade its technology to match the latest market trends.

For both cases, XYZ Capital Management can help revive the businesses to a large extent through financial investment.

Example #2

The eQ Asset Management is a Finland-based company that is engaged in corporate financing. It has successfully raised 158 million euros. Its private equity fund puts money into companies in the lower and middle markets in the Northern European region. It plans to deploy its capital as fast as possible, even though, co-investments or secondary transactions. It wants to diversify its portfolio of investments into different industries spread across various geographical areas. The company has a total of five private equity funds for investment purposes.

Benefits

Let us study some of the benefits of the concept of private equity fund life cycle, as given below:

• Cost reduction – The funds require a lot of planning before acquiring a company to invest in it. Therefore, this leads to adopting ways and means to control the costs that take away revenue, reducing profits. High cost is a major hindrance to the growth prospects of a company. Skilled and experienced handling of operational procedures helps in reducing it, and this expertise is often available with such firms.
• Upgradation and restructuring – These firms help distressed companies make necessary restructuring and adopt innovation and the latest technology, which the portfolio company may not have considered or did not have the required funds to invest into.
• Better growth opportunity – If the business of the portfolio companies starts getting the required boost, necessary expertise, or financial support, due to the private equity fund life cycle, it experiences a bounce back from the downturn and operational inefficiency that it had been experiencing.
• Investment in private companies – It allows the investors to invest their money into a private business that often has very good growth opportunities in the long term.
• Tax saving – Such firms offer tax benefits to the partners of investors who have contributed to the fund.
• Less risk – Since they typically invest in matured companies and the ones with quick growth potential, there is less risk involved related to the failure of business ideas. Therefore, these funds can expect to get good returns over the years.

Private Equity Fund vs Hedge Fund

Both the private equity and hedge funds are involved in making strategic investments for the benefit of the investors as well as the portfolio companies. But there are some notable differences between them, which are as follows:

• The former invest in business organizations that need upgradation in terms of technology, finance, efficiency, and overall operational procedures. However, the latter invests in the financial market by designing investment strategies that take bets in both upward and downward directions, ensuring minimum loss.
• The former is meant for long-term investments, which usually last 10 years or more. But the latter is meant for very short-term investments that may be for a few days or weeks.
• Candidates aspiring to get into the former job should possess specialized knowledge and skills related to various business sectors and their performance, financing, and strategic planning. However, the candidates for the latter should be experts in analyzing market performance, designing investment strategies, identifying short-term opportunities for earning profits, etc.

Frequently Asked Questions (FAQs)

Recommended Articles

This article has been a guide to what is Private Equity Fund. We compare it with hedge fund & explain its structure, types, how to invest in it, example, & benefits. You may also find some useful articles here -

• Private Equity vs Hedge Fund
• Distressed Private Equity
• General Partner in Private Equity