Private Equity: A Breakdown

Private equity (“PE”) is a strategy that invests in businesses that are underperforming or need additional capital. PE is focused on improving operations and then selling the companies to realize the value created. However, risks arise from the use of debt upfront to acquire companies, while the timeframe for investors to realize any gains can be over a period of several years. Risks are mitigated by diversifying investments across several transactions.

Firms that manage private equity funds drive value from the control they exercise over a target company. Investors benefit from selecting managers with expertise in the companies they target, which may be across several industries at the largest firms or more focused at specialized firms. Combining a manager’s investment knowledge and operational expertise with investors’ patience has the potential to drive higher returns than the public markets.

Structuring Private Equity Funds

The number of publicly traded stocks has fallen by roughly half in recent decades through mergers and bankruptcies, making private equity an attractive option for investors seeking to access the full spectrum of potential opportunities to reach their goals. Private equity managers typically raise pools of funds from institutional investors and high net worth individuals. Funds are often structured as private partnerships, with the management firm as the general partner that sources investments, plus limited partners that invest their own capital but have a limited ability to restrict investments the private equity firm makes.

Once a fund has been raised, the manager will seek targets that may be underperforming due to poor management or that may be able to unlock new growth opportunities when paired with the fund manager’s operational expertise. Targeted businesses can be units of large corporations or stand-alone companies. They can also be public corporations or private companies. In the case of private companies, additional capital may help them transition from a subscale mom-and-pop business to mature companies with more robust product offerings and broader sales distribution networks.

A private equity fund may have an investment lifecycle of up to 10 years or more — they may raise funds and put capital to work in target companies during the first half of this period and then in the second half apply their expertise to create value and distribute the sales proceeds as the fund is wound down. Individual investments in the fund may have a holding period of three to five years or more, depending on the rate of improvement in each business and the market conditions for an IPO or a sale to another private buyer or corporation.

Private equity may provide greater capital appreciation than publicly traded stocks. With fewer regulatory requirements than public entities, private businesses are not at the mercy of quarterly earnings results which drive short-sighted decision making at public companies. And by having the ability to directly own and control their portfolio companies for long periods of time, private equity managers can reap the rewards of their value creation efforts and wait out adverse market conditions when preparing to exit their investments.

Managers can diversify their fund portfolios by acquiring several businesses, reducing risk from their use of debt in each acquisition. Using debt improves the financial returns of successful investments via these transactions (known as leveraged buyouts). To navigate the risks from leverage, manager due diligence (prior to investing in a company) may include identifying companies with stable cash flows, manageable capital requirements, and reasonable growth opportunities. Private equity managers also structure transactions to ensure direct operational control and thereby execute their strategies for improvement.

Investors in private equity funds usually have limited rights, but often funds have limitations on the size or industry concentrations of their investments.

Evolving Value Drivers Transform Private Equity Returns

Private equity previously acquired a negative connotation due to past practices that were perceived as greedy. Early phases of private equity investing included buying companies with debt then selling off units, or buying business units whose worth was undervalued within a corporation (with the goal of selling at a higher multiple). Paying down debt and seeking a higher multiple to realize returns often led to cost cutting that negatively impacted employees and their communities through layoffs and facility closures.

As private equity has matured over time, value drivers have changed materially. In stark contrast to the austere tactics of the past, managers today seek to improve operating performance by increasing revenue and expanding profit margins through proactive intervention, partnership, and value creation. In addition to applying its expertise, the fund manager can accelerate an existing management team’s strategy with additional capital or replace poor management with talent from their professional networks.

Management teams are aligned with the fund manager through financial incentives. The discipline of private equity keeps portfolio companies focused on realizing operational improvements and generating stronger cash flows, rather than pursuing inefficient, non-core strategies.

Revenue improvements and margin expansion are increasingly being achieved through technology to scale businesses by expanding geographic markets, reaching new customers, and gaining cost efficiencies. With the growth of big data, applying data analytics is a new source of value creation.

The Private Equity Investing Landscape

Private equity managers range from large integrated firms that can acquire corporations worth billions of dollars, to specialized firms that can invest in niche markets, to even smaller firms that can be opportunistic and acquire just a few businesses.

The largest managers have funds that are diversified globally and across industries. This gives them the ability to have insight that smaller firms lack. In addition, they create their own ecosystem that can share best practices, where portfolio companies can become customers of one another and the fund manager can be a vendor of shared services that help contain costs.

Firms that specialize in niches like frontier technology or biotech often have portfolio companies with investment needs related to getting their initial products to market. By accelerating product development to create a first mover advantage, these firms have the potential to generate outsized returns.

Smaller firms have the opportunity to identify attractive opportunities that are not big enough for the larger firms to put capital to work. They also have the ability to partner with each other to make larger acquisitions than they could alone while still diversifying their risk.

An increasingly popular strategy is growth investing, which targets industry disruptors that have already achieved positive cash flows. By employing similar strategies for increased revenue and margin expansion (as mentioned above), fund managers accelerate portfolio companies’ product and service development to achieve industry-leading positions in their markets.

Poolit Provides Individual Investors Unparalleled Access to Private Equity

Historically, private equity was only accessible by institutional investors such as university endowments and pension plans, or high net worth individuals considered to be qualified purchasers: having a net worth of over five million dollars excluding home equity. Even for investors meeting that high bar, access to the best firms is difficult to obtain without going through expensive channels like private banks.

Poolit offers accredited individuals the opportunity to invest in these previously inaccessible private equity funds via a mobile wealth management platform with industry-low fees. Our platform plans to provide broad exposure to high quality private equity opportunities and will have no minimum investment.

To get early access and be the first to know about new private equity investments on Poolit, join our waitlist at:


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