In this modern century, private equity can be described as the monster conduct that CEOs across the globe dismay. For some competent investors out there, every company’s outbreak is an opportunity. An opportunity for building a private equity-based investment. How? This question is mainly answerable via the definition of Private Equity. To begin with, by definition, Private Equity is an investment move. It is when one investor or group of investors incorporate a limited partnership company into its private possession. Further, make improvements for the main purpose of reselling it. This leads to a high-end profit acquaintance in the form of private equity returns.
However, it is noteworthy to mention that being an investor even in the PE business is not that risk-free. For example, in 2001, private equity investors invested up to $93 Billion into an Indian company. This had led to a great deal of PE-returns in the starting stage, I .e.., 25%. Further, from 2006-2009, the gross return rate on PE reduced from 25% to only 7%. Consequently, the investors divided the limited profit and relinquished the investment plan.
Are you a beginner in the investment industry? Join us on this journey of Private Equity and everything you need to know about it.
What is Private Equity?
Private Equity or PE is a financial term. It defines the act of acquisition of a company into private ownership. Further, the investors rebuilt and enhances the company’s worth physically, statistically and financially. The main motive remains “to resell it when the market is boosting.” It is one of the forms of investment funds. It is noteworthy to mention that the companies taken in the name of PE remain invalid for public trade. It means that it must be valid for purchase by a private equity firm without dealing with any Board of Directors, shareholders, and public owners.
What is a Private Equity Firm?
By definition, a Private Equity firm stands for an investment management company. It acts as an independent and high-end investor or group of investors. They are also called financial backing. These companies invest in companies that fall under the Private Equity investment guidelines. To the reader’s surprise, PE firms hustle and bustle to build a perfect PE stratagem based on the following important factors. These are also known as the types of private equity.
What are the types of Private Equity?
LBO or Leveraged BuyOut
Leverage Buyout refers to the complex combination of debt and equity while the acquisition of a company that is not publicly traded or is a public company. This buyout can be of different forms such as Management buyout, secondary buyout, and management buy-in. To summarize, leveraged buyout also simply refers to the total borrowed money that allows the private equity firms to assemble the cost of acquisition of a non-publicly traded company.
LBOs highly depend on the cash-flow statements of the company. If the company does not parade any financial stability, the private equity firms lose interest in a leveraged buyout of such companies.
It is one of the most common types of private equity. It is also known as expansion capital or simply, growth equity. Growth capital falls into the category of minority investment. It includes a private equity firm that invests in a mature company with requirements for growth capital. In this form of private equity, the control of business remains on the same hand, I .e.., business’s ownership is not acquainted. However, the private equity firm only acquaints operational decisions, market decisions, and others.
It is another type of private equity that allows PE firms to invest in start-ups and still-in-development companies that have a considerably good success rate potential in the upcoming years. But, it is noteworthy to mention that this form of PE is one of the riskiest ones. It is because VC processes under the hope of success in the future based on current tech-advancement, employment rate, and unique business model.
In exchange for venture capital, the private equity firms charge or demand an equity stake in the business in order to receive returns in the form of profit upon the constant growth of the company.
Note: The concept of PE changes with its types. For instance, LBO depicts the acquisition of the company, Growth capital depicts the acquisition of operations of the company, and venture capital depicts the acquisition of a part of the profit as a return on investment.
What are secrets to effective Private Equity Investment?
Organic Growth: major justification
For the most part, beginners in private equity fundraising and return often consider “buy and sell” as the main motive of this financial mechanism. However, it is not. A business is accountable under the private equity business model when it is not performing well.
Thus, the major justification for a PE stratagem must be acquiring the business for operating it. Hence, when a business is acquired under the PE strategy or by a private equity firm; it will lead by upscaling output and pushing sales statistics upward on the graph.
Indeed, a private equity firm or PE investors finally resell or exit the business when it is doing good in the market. In this way, these investors get their hands upon at least twice or thrice profit above the actual cost of acquisition.
Zero Public Relations; worst idea!
In the past few decades, private equity firms have held on to one of the most common private equity characteristics. That’s right! PE firms tend to avoid media regarding their current strategy and next move concerning the changes in the acquired business. Is it a good idea to not communicate with the public? Well. in this modern age, it is not a good idea. Sometimes, when a PE firm acquires a business and holds on to these communication barriers, the shareholders of the company panic and resell their shares. This can be a bad sign.
What to do? To avoid such consequences, it is important to communicate with the media and communicate the story of acquisition. If not, you can also communicate the idea of advancement in the business. For example, what are your plans for the acquired business? Will all the operations go on? And what are the long-term plans for the business?
Non-Publicly traded business acquisition only; think again!
Times are gone when PE was only allowing the acquisition of non-publicly traded companies. Indeed, in the past, the investors were not open for discussion based on “making acquired companies publicly traded” because it makes the trading complex. But, not anymore. From 2001 to 2007 private equity growth reports, the public companies bought based-on leveraged buyout lead to approximately 85% growth. On the other hand, the private companies bought based-on growth capital showed only a 15% growth in 2007.
Thus, the growing interest of modern age’s private equity investors into public companies and government companies is reasonable. As a matter of fact, the contribution of private companies in private equity real-time statistics is the same. For example, high-end growth in the early stage of acquisition. However, eventually, the growth rate decreases and private equity firms consider that it is time to exit the business via reselling. This cycle is universal.
Unfair Tax Advantages, not your fault!
When it comes to processing effective PE investment, you cannot depress your plan based on the accusations that come from the public and other common investors in the business and finance industry. This accusation mainly revolves around the fact that Private Equity firms and investors enjoy a few unfair tax advantages. This accusation makes these investors feel like they are doing something illegal. As a matter of fact, some investors get their hopes down and become unfocused.
To overcome this and process effective investment in private equity fundraising is important. Hence, a PE investor must accept the fact that these tax advantages have driven by the corporate capital gains. Thus, this concept gives a fair chance of gaining tax advantages to public companies as well. Apart from this, a few tax advantages are nothing valuable for the risk that the private equity firms take.
Marketplace will not evolve until your EXIT!
One of the greatest things about a marketplace is “Change.” However, among the private equity firms, a few private equity characteristics are famous. One states that “the best time to buyout a business is when the marketplace is stable.” This is one of the real-time private equity myths. From Sensex to equity prices; the marketplace keeps changing. Thus, while designing an effective PE strategy, it is recommendable to keep the marketplace aside and not count it as the main factor.
Instead, the investors should focus on different plans. Further, review operations that has considered beneficial during the fluctuation in the marketplace. To begin with, investors can countdown the major factors of growth. And, how marketplace fluctuation will affect their respective growth. More often than not, the following tricks help to stabilize the PE growth design during such crisis:
- Change the organization structure.
- Sell assets that are above their depreciated price value in the market.
- Inspect cash-flow statements to review the similar situations in the past, and how business managers have coped up with the same.
- Calculate the resale value of the acquisition business and examine the profit rate.
Focus on the performance of the company
Private equity investors wait for a business to resale until the business starts to perform well via buying and selling strategy. But, in-between this race to resell the business, the investors lose upon one fact. It is that they have also invested their time, efforts, and business techniques into helping the business’s growth. Thus, an investor or a PE firm must not fall for the first opportunity that comes in the way.
However, it must wait for the business to upgrade up to its highest value in the market. They must not rush. Sometimes, a start-up grows into a large-scale company. Thus, in the meantime, the investors grow highly affectionate of their performance and find it difficult to resell it.
To track the performance of the company, you can follow-up the performance chart based on the following factors:
- Total successful deliveries Vs. lost deliveries
- Total revenues Vs. total sales
- Satisfied customers Vs. customers skipped to competitor’s product
- Actual units produced Vs. planned production
- Net profit Vs. profit per sales
You can also categorize and calculate performance based on the following subheadings of business:
- Financial performance
- Marketing performance
- Operational performance
To calculate performance based on the above factors, you can focus on the following calculations:
What are the gross margin and net margin of the acquisition business?
- Percentage revenue from sales
- Current ratio
- Quick ratio
- Return on Investments
- Time efficiency
- Production cost
- Customer satisfaction
- Energy efficiency
- Traffic on online website
- Sales trends
- Business cost recovery
Compare growth signals and liquidity signals
This technique has remained effective for private equity fundraising in the best way possible. More often than not, investors do not find a way to decide whether to allow the business to grow or liquefy it for profit. To decide better, an investor can run the comparison test by sorting out various common growth signals and liquidity signals. How to do that? Let’s find out:
What are the common growth signals?
- Industry performance
It refers to finding out the approximate industry revenue. Further, research for markets that are best-fit for your business resale.
- Performance of the business
- Business model.
What are the common liquidity signals?
- CEO’s plans: Presence of retirement plans or plans to retire soon in the next 2-3 years.
- Position of major Equity owners
- Consolidation in Industry
These were the seven secrets to effective investment fund stratagem in the PE firms. Connect with us for in-depth discussion and learn.
Private Equity Epilogue
To summarize, PE is one of the real-time leading growth techniques. It is not only successful in the private sector companies. But, also growing in governmental and publicly trading companies. For the most part, private equity does not put a full-stop on a business, but it helps the business to grow, perform better, and fund it until it is time to Exit. In private equity firms, one business is the acquisition by many PE firms to keep it growing and funding. It is definitely a clever financial concept that comes from the 1800s, however, in 2020; it is escalating.