Private Equity
Private equity refers to investment negotiations that purchase and manage companies before they are sold. Private equity firms operate these investment funds in the name of accredited and institutional investors. These funds can entirely acquire public or private firms, or give funds in such repurchases as part of a consortium. They do not usually hold shares in firms that are kept in the list of a stock exchange.
Private equity is commonly grouped with venture capital and hedge funds as an alternative to investment. Investors usually have to allocate large sums of money over several years in this asset class, so access to such investments is limited to well-to-do individuals and institutions.
Definition of Private Equity
In a comparison with venture fundings, private equity firms invest in elaborated and solid companies rather than startups and projects. They organise such portfolio companies to boost their value or take benefits before leaving the investment.
Сapital can be used to support new technology, make purchases, broaden active capital, and enhance and consolidate an accounting balance.
Private equity investment comes basically from accredited and institutional investors, who can commit considerable sums of money for a long period of time. Long ownership periods are generally needed for private equity investments to provide support for troubled companies or contribute to liquidity events like a sale to a public company or an initial public offering (IPO).
Advantages and disadvantages of Private Equity
Private equity provides few benefits to startups and companies by giving access to significant money sums from such resources as venture capital instead of spending funds from typical financial instruments, like a bank credit with high interest rate.
If a company is removed or deleted from a market, private funding provides strategies of growth far from the public markets without the necessity of sustaining proceeds for investors. Working with private equity also means to deal with some particular issues and troubles as sometimes it can be quite complicated to eliminate shares in private equity. In contrast to deals on an exchange, a company must look for a purchaser to sell its company or investment.
It may seem that market force can also affect bargain processes in private equities, though only sellers and purchasers may form together a relevant price of stakes for a company. Commonly a vast management system controls and sets rights for investors in terms of state institutions, however the rights of private equity owned by stakeholders are determined by parties negotiations in each particular case.
Types of Private Equity
Distressed fund. In other words — vulture fund, what is frequently available to firms which have submitted an application for Chapter 11 bankruptcy. In this case investors give their fundings for sustaining troubled companies with unprofitable business divisions or holdings to reorganise and expand them by making significant decisions for their framework and work process. After that, they sell their assets to get profits.
Leveraged buyouts.The most utilised type of private equity fundings is a leveraged buyout acquisition of a firm with combined debt and equity to provide the transaction. Debt funding may contain around 90% of the overall funding. This kind of financing implies improving the company and its financial state and then reselling it to an interested party.
Real estate Private Equity. These funds in real estate demand a higher amount of capital for investment in comparison with other types of operations in private equity. Investors’ funds are also attached for a few years in this way of funding
Fund of funds.This form of funding is focused on investing in other funds, basically hedge and mutual fundings provide a loophole to an investor who has no chance to enter the equity fund because of the minimum capital requirements that he can’t get.
Venture financing is a type of private equity, in which investors, also known as angel financing, provide money to businessmen, usually at the startup stage or as seed financing.
Investing In Private Equity
Some shareholders can invest in private equity with help of a Fund of Funds, a Special Purpose Acquisition Company (SPAC) or an Exchange Traded Fund (ETF). A fund of funds keeps the stakes of private partnerships that put in private equities. Private equity funds may also imply to pay extra charges to the fund managers. Investors can trust in the ETF that monitors indices of publicly traded firms putting in private equities, purchasing particular shares through the stock exchange, without any requirements for investing minimum. SPACs are publicly-traded fake companies that carry out private equity investments in underpriced private firms that pose a high level of risk for investors.
Private Equity vs. Public Equity
Due to public markets investors are provided with the rights to put in public equity assets (like stocks and bonds) on an exchange without any pitfalls and obscure details - only liquidity and transparency. Public equity investments are easily accessible for types of investors. Private equity is not traded on a public level. It usually needs a prolonged investment time liability, and ensures a low level of liquidity. Investors in private equity receive accreditation with a certain net worth determined by investment regulations. Investment in private equity is considered to be riskier than investing in the public market as private equity funds are in less control than public investments.
Management of Private Equity Funds
In terms of dealing with private equity, there are limited partners (or in short LP), who have all 99% of stakes in a fund and also keep less liabilities whereas general partners (GP) have only 1% of shares and have all the responsibilities. They are also liable for implementation and managing the investment.
Private Equity historical background
Carnegie Steel Corporation was purchased with leverage by J.P. Morgan in 1901, at that time being the biggest steel-producing company in the United States, for a few hundred dollars, united with Federal Steel Company and National Tube, founded United States Steel — the world’s largest company. The Glass-Steagall Act of 1933 brought an end to this kind of consolidation.
How Private Equity companies earn money
The main source of income for private equity businesses is a management fee. This reward structure for these companies contains a performance fee and a management fee. Some companies charge a 2% management fee each year on operating assets and take 20% of the earnings gained from the sale of a business.
Regulation of Private Equity firms
In 2015, American lawmakers proposed to expand the clarity and openness of the private equity sector, almost because of the amount of income, profits and salaries taken by workers of all private equity businesses. Since 2021, legislators have been promoting draft laws and normative acts to help get more about the inner side of private equity companies and their functioning, including the Stop Wall Street Robbery Act. However other legislators on Capitol Hill are against this proposal, referring to the SEC restrictions on access to company information.
Private Equity perspective
If we take the American PE market, it is kept at a mature stage. Many private companies in the United States at the startup offer their employees shares in the project instead of the salary we are accustomed to, and any employee of the company can sell his share in the company through specialised platforms. Qualified investors from the U.S., in turn, get a convenient service for the purchase of shares in private companies, without legal fees, which are quite expensive in the United States.
The Russian private equity sector t is underdeveloped, the main players are institutional investors (banks, funds, investment companies, business angels). The residents of our country are rather reluctant to buy shares in Russian private companies. Russians are rather reluctant to buy stakes in private companies as the culture of investment in private companies is not developed. Many people in Russia think that if a company sells out, it means it has problems.
Institutional players (not all) often poorly think through their actions in this market. They buy 51% of the company from the founder and then wonder why the project is not developing at the same pace. In this case, the investor did not think about the fact that owning a controlling stake (more than 50%) implies making decisions about the strategic development of the company. However, it is difficult to decide the fate of a project if you do not have a thorough understanding of it.
These statistics are related to problems in the Russian market of direct investments — monetary investments with the aim of participating in the company’s management which owns a controlling stake. Firstly, potential investors believe that the risks are too high, since it is possible that funds may be misused by the person attracting the investment. Secondly, the risks of law enforcement and difficulties in protecting property rights and intellectual property rights are high. The latter is a low level of trust.
