A private equity fund is a pool of capital that will be invested in a company that represents a chance for high rate of return. Private equity funds come with fixed investment horizon that typically ranges from 4 to 7 years. At this point, the private equity firm hopes to exit the investment in a profitable manner. These exit strategies include selling the business to a strategic buyer or a different private equity firm and IPOs.
Accredited investors and institutional funds often compose the primary sources of a private equity fund since they can offer significant capital for a longer period of time. There is also a team of experts in investment from a certain private equity firm that raises and manages the funds.
What is Equity?
Equity is further subdivided to four primary components namely ordinary shares, CCPPO shares, preferred shares, and shareholder loans.
The equity proportion typically accounts for 30 to 40 percent of funding in the buyout. A private equity firm tends to invest in equity stake with 4 to 7 years of exit plan. Equity funding sources include private equity funds, management, investment banks, and subordinated debt holders. Most of the time, the equity fraction is composed of a combination of these different sources.
Two Types of Private Equity Funds
In general, a private equity fund falls into two primary categories: leveraged buyout or venture capital and buyout.
- Leveraged Buyout (LBO) or Buyout
Leverage buyout funds invest in businesses that are already more mature, often taking the controlling interest. Leveraged buyout funds use large leverage amounts of increase the rate of return. These buyout funds have the tendency to be substantially bigger in size compared to venture capital funds.
- Venture Capital (VC)
Venture capital funds refer to pools of capital that often invest in emerging, early stage, and small businesses expected to have high potential of growth but with limited access to some other capital forms. In the viewpoint of small startups that have ambitious innovations and value propositions, venture capital funds are an integral source for raising capital since they don’t have access to bigger amounts of debt. As for the investor’s point of view, even though venture capital funds have some risks from putting investments in an unconfirmed emerging business, they still have the ability to generate some really extraordinary returns.
Common Exit Routes for Private Equity Funds
Once they decide to exit, private equity firms can take any of two paths: partial exit or total exit. In wholesale exit, there could be a trade sale to a different buyer, a share repurchase, or leveraged buyout by a different private equity firm.
In partial exit, a private placement can happen where a different investor buys a part of the business. Corporate restructuring is another possibility in which the external investors can get involved to raise the position they have in the business through partially acquiring the stake of the private equity firm. Corporate venturing may also happen where the management increases business ownership.