Sunday, December 2, 2007

Private Equity - Business concept

The Private equity investing is broadly defined as investing in a company through a negotiated process. PE investments can be divided into the two following major categories:

Venture capital: an investment to create a new company, or expand a smaller company that has undeveloped or developing revenues

Buy-out: acquisition of a significant portion or a majority control in a more mature company. The acquisition normally entails a change of ownership

Private equity firms exit from their investments through one of three ways:

an IPO,
a sale or merger of the company,
or a recapitalization.

Leading investment are committing their own capital or principal money to PE investments. Also various sponsors are floating PE funds to attaract funds from HNIs into PE investments.

Most private equity funds require significant initial investment (usually upwards of $1,000,000) plus further investment for the first few years of the fund.

Limited partnership interests is the dominant legal form of private equity investments.

Once invested, money is locked-up in long-term investments which can last for as long as twelve years. Distributions are made only as investments are converted to cash; limited partners typically have no right to demand that sales be made.

If a private equity firm can't find good investment opportunities, it will not draw on an investor's commitment.

The risk of loss of capital is typically higher in venture capital funds, which invest in companies during the earliest phases of their development, and lower in mezzanine capital funds, which provide interim investments to companies which have already proven their viability but have yet to raise money from public markets.
Consistent with the risks outlined above, private equity can provide high returns, with the best private equity managers significantly outperforming the public markets.

The potential benefits of annual returns can range up to 30% for successful funds.

PE Roots

The roots of PE and venture capital are same. In 1946 when the American Research and Development Corporation (ARD) decided to form to encourage private sector institutions to help provide funding for soldiers that were returning from World War II. They had an operating philosophy that was to become significant in the development of both private equity and venture capital: they believed that by providing management with skills and funding, they could encourage companies to succeed and in doing so, make a profit themselves. ARD succeeded in raising approximately $7.4 million, and they did have one rousing success; they funded Digital Equipment Corporation (DEC). By the 1970s such private participation had permeated into the the private enterprise formation, but till in the late 1970s, the task was being largely carried out by investment arms of a few wealthy families, such as the Rockefellers and Whitneys. In the 1980’s, FedEx and Apple were able to grow because of private equity or venture funding, as were Cisco, Genentech, Microsoft, Avis, Beatrice Foods, Dr. Pepper, Gibson Greetings, and McCall Patterns.

Most private equity funds are offered only to institutional investors and individuals of substantial net worth. This is often required by the law as well, since private equity funds are generally less regulated than ordinary mutual funds. For example in the US, most funds require potential investors to qualify as accredited investors, which requires $1 million of net worth, $200,000 of individual income, or $300,000 of joint income (with spouse) for two documented years and an expectation that such income level will continue.

Private Equity Funds: Business Structure and Operations By James M. Schell
Published 1999
Law Journal Press

Gives attorneys, investment professionals, tax practitioners, and corporate lawyers the tools and guidance needed to handle various aspects of a private investment fund. This book covers a range of issues such as the key economic differences between various types of funds; nailing down maximum tax benefits for the sponsor of the fund; and more.

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