A private equity fund is a collective investment scheme used for making investments in various equities and debt instruments. They are usually managed by a firm or a limited liability partnership. The tenure (Investment horizon) of such funds can be anywhere between 5-10 years with an option of annual extension. One key feature of private equity funds is that the money which is pooled in for the purpose of fund investment is not traded in the stock market and is not open to every individual for subscription.
Since private equity funds are not available to everyone, the money is usually raised from institutional investors (HNIs & Investment Banks) who can afford to invest large sums of money for longer time periods. A team of investment professionals from a particular private equity firm raise and manage the funds, where they utilise this money for raising new capital, future acquisitions, funding startups or new technology, investing in other private companies or making the existing fund stronger. Private equity funds represent an excellent opportunity for a high rate of return.
Venture capital refers to the fund which further invests in small young companies and startups who have limited or no access to the outside financial markets. These young companies are usually in their initial stage of formation but have a high growth potential in the near future. Venture capital funds are an excellent source of capital for emerging companies with ambitious value propositions and innovations. Venture funds do not carry any debt and when invested in a right young startup, they can generate extraordinary returns. VCs have played a significant role in boosting the startups in India.
They are different form VC funds as a leveraged buyout invests money in a larger business along with additional leverage (usually in a form of stake holding), which is placed on the organization to generate favourable and sizeable returns. The money invested is also larger as compared to VCs.
A leveraged buyout takes place when a company borrows a large amount of money in the form of loans and bonds to facilitate its acquisition of another company. The purpose of having a major stake holding in a company for a long period of time is to manage the funds within the company in order to generate a sizeable value. Once a significant value has been created, the PE firms dilute their stake and exit the company.
A leveraged buyout comprises of debt to finance the buyout. The firm undertaking the LBO has to provide a small amount of the financing (typically around 90% of the cost is financed through debt).
The investment objective of a leveraged buyout is to generate returns on the acquisition that will outweigh the interest paid on the debt. For the firm that’s performing the LBO, this is a good option to generate high returns while only risking a small amount of capital.
Private equity real estate funds invest capital in ownership of various real estate properties. Such funds have strategies based on:
Private equity growth capital funds invest in mature corporates with a successful business model to enable them to expand or restructure their operations, enter new markets, or finance a major acquisition. It is usually a small investment as the company which requires growth capital is generally a large profit generating enterprise. Such corporates avail growth capital to fund big expansions, acquisitions or other investments as they are not in a position to use its existing assets to avail conventional means of financing required for growth.
A ‘fund of funds’ (FoF) is an investment strategy whereby investments are made in other funds rather than directly in securities, stocks, or bonds. A fund of funds is advantageous for investors as their money is invested in various fund strategies which diversify risk.
Large amounts of funding: Private Equity Funds are an excellent source of capital as they are free of debts. An emerging business can tap large amounts for seed funding via Private Equity.
Untapped Potential: Private equity is a vastly untapped market with great potential. From unicorn startups to unlisted private companies and much more, there are a wide range of options available in the market.
Active Involvement: As a shareholder, you can hold the professional management PE team completely accountable for protecting your shareholding interests.
Incentives and Returns: PE Firms which hold and manage private equity funds are highly selective and spend a considerable amount of resources to assess the potential companies which they could invest in. This also involves an understanding of the risks involved and how to ease the same.
Recently, there has been an injection of 24 billion USD of private capital in investments in Indian companies in FY 2017-2018. During the past 13 years, around $100 billion of capital has been injected by private equity in India.
The private equity segment has also played a crucial role in the growth and development of many small and medium-size enterprises. All the unicorn startups have received seed funding from private equity firms.
PE firms are also venturing into platform acquisitions in India. This provides them a sizeable entry into a specific sector and carry the potential to roll up. A roll-up is defined as a process where multiple small companies in the same business or market are acquired or merged. Warburg Pincus, KKR, Samara Capital, Everstone, Multiples and TPG among others, have all launched platforms or the roll-up act across business services, media & entertainment, financial services, foods, IT & BPO and healthcare.
| Criterion | Private Equity | Hedge Fund |
|---|---|---|
| Concept | A private equity fund is a collective investment scheme used for making investments in various equities and debt instruments. | They are alternative investments done by pooling funds involving a number of strategies to earn high returns for the investor. |
| Risk | Moderate to High. | High. |
| Structure | Closed end investment funds. | Traditional open ended investment funds. |
| Investment | You have to commit capital which is to be paid in the near future. | You have to release the committed amount immediately. |
| Returns | Returns are based upon a minimum hurdle rate. | Returns are immediate |
| Fee | Private equity fees are two tiered. Tier 1 is of the annual fee of 1.5% on committed investment during the first five years and then 1.0% after five years. | For Hedge funds, it is 1.5% fee for management and 20% fee on the basis of performance. |
| Investment Horizon | Private Equity funds are invested for a longer time period, mainly for 5 years. | Hedge Funds are invested for short time period like yearly, quarterly or some time for minutes or for seconds with no intention to grow. |
| Scope | Private equity has a limited scope of investment such as VC, real estate or buyouts. | Hedge funds invest in tradable securities like equities, bonds, derivatives, futures, commodities, foreign exchange, swaps, etc. |
What is a Private Equity Investment?
A private equity fund is a collective investment scheme used for making investments in various equities and debt instruments. One key feature of private equity funds is that the money which is pooled in for the purpose of fund investment is not traded in the stock market and is not open to every individual for subscription.
How is a Private Equity Fund structured?
The private equity fund structure is typically made up of limited partners (LPs) and general partners (GPs). The LPs are the outside investors who provide the capital and typically consist of institutional investors such as insurance companies, endowment funds, foundations, banks, retirement / pension funds, family investment offices as well as high net worth individuals. GPs are the professional investors who manage the private equity fund and deploy the pool of capital. Most private equity funds are organized as limited partnerships or limited liability companies.
What is the difference between Hedge Funds and Private Equity?
A private equity fund is a collective investment scheme used for making investments in various equities and debt instruments while Hedge funds are alternative investments done by pooling funds involving a number of strategies to earn high returns for the investor.
What is a buyout private equity fund?
A buyout fund invests money in a larger business along with additional leverage (usually in a form of stake holding), which is placed on the organization to generate favourable and sizeable returns.
Can individuals invest in private equity?
Only HNIs with a sizeable investment can invest in a private equity fund.
What is the difference between private equity and venture capital?
Private equity firms mostly buy mature companies that are already established while Venture capital firms, on the other hand, mostly invest in startups with high growth potential. Also, Private equity funds buy 100% ownership of the companies in which they invest, while Venture capital funds invest in 50% or less of the equity of the companies.
What is PCAP in private equity?
PCAP provides a method to transform a private equity fund that relies on private capital from limited partners into a publicly funded and traded fund that relies on permanent capital raised in the public markets. A PCAP is a publicly traded limited liability company formed by a PE management team.
What is a fund structure?
Every fund has a specific structure which regulates the entire functioning of the fund. For example - A private equity fund structure is typically made up of limited partners (LPs) and general partners (GPs). Similarly, hedge funds are partnerships formed between fund managers and investors.
What is an LP in private equity?
A private equity firm is called a general partner (GP) and its investors that commit capital are called limited partners (LPs). Limited partners generally consist of pension funds, institutional accounts and wealthy individuals.
What is MOIC in private equity?
MOIC is a helpful measure to assess private equity performance. It can be thought of as the Total Value to Paid-in Capital. Multiple on Invested Capital (multiple or MOIC). Absolute gains are typically measured as a Multiple on Invested Capital (MOIC).
