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Private equity investors (also called financial sponsors or buy-out firms) invest in non-public companies and 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 investors (also called financial sponsors or buy-out firms) invest in non-public companies and 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.
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?
Ø Strong Management Team.
Ø Ability to Generate Cash.
Ø Significant Growth Potential.
Ø Ability to Create Value.
Ø A Clearly Defined Exit Strategy.
CREATING VALUE
While private equity firms employ various strategies to create value in their investments (such as the consolidation of a fragmented industry), a common strategy is to acquire a “platform” company and grow the platform through further “add-on” acquisitions. Add-on acquisitions are typically smaller in size, but complementary to, the platform investment. Ideally, the synergies of the combined entity create a more efficient whole, both operationally and financially.
LEVERAGE AND CASH FLOW
Private equity groups typically use leverage (debt) to increase the return on the firm’s invested capital. The amount of leverage employed is normally determined by the target’s ability to service the debt with cash generated through operations. The ability to generate cash allows the private equity investor to contribute more debt to the transaction. Because of the aggressive use of leverage, often, the cash flow a business generates in the early years following the acquisition is almost entirely consumed by the debt service. Furthermore, if the strategy is to grow the business, and it usually is, growth also consumes cash. For this reason, private equity investors are keenly focused on the cash flow of the business.
Because cash flow is the basis for valuation, the ability to improve operations to generate increased cash flow will also yield a greater return on investment upon exit.
EXIT
Private equity groups make money from both the cash flow of the acquired business and from the proceeds generated upon exiting the business. The exit provides the investor a mechanism to monetize the firm’s equity. This is also referred to as “a liquidity event”. The exit provides the financial sponsor with a finalization of the investment and an opportunity to distribute profits. In fact, a significant component of a private equity professional’s compensation is based on this profit distribution, called “carried interest”, or just “carry”. Profits upon exit go to back into the cash account to fund new acquisitions.
Carried Interest
A share of any profits that the general partners of private equity and hedge funds receive as compensation, despite not contributing any initial funds. This method of compensation seeks to motivate the general partner (fund manager) to work toward improving the fund’s performance.
Methods of Accessing Private Equity
(a) Single manager funds
(b) Fund of funds
· Single manager funds
A single manager private equity fund is a portfolio of investments managed by one private equity manager. The fund may focus on a specific style such as venture capital or buyout strategies, and often may specialise in one or several market sectors.
· Fund of Funds
A fund of funds is a portfolio in which the underlying investments are funds, rather than individual securities. A private equity fund of funds, then, invests in a variety of private equity funds. Capital is distributed across a variety of fund managers that directly invest according to their strategy in the underlying investments.
A fund of funds may employ a variety of investment strategies or take a more focused approach. Either way, a fund of funds may offer investors reduced volatility and risk relative to a single manager structure. In addition, the economies of scale achieved through a fund of funds structure may offer investors access to funds that would otherwise be closed to them.
Major Players
ICICI Venture
CHRYS Capital
Sequoia Capital
India Value Fund
Kotak Private Equity Group
Ascent Group
Everstone Capital
To Sum Up We Can Conclude
A private equity investment will generally be made by a private equity firm, a venture capital firm or an angel investor. Each of these categories of investor has its own set of goals, preferences and investment strategies; each however providing working capital to a target company to nurture expansion, new product development, or restructuring of the company’s operations, management, or ownership.
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