6
PRIVATE EQUITY | DEMYSTIFY
HOW PRIVATE EQUITY WORKS
PRIVATE EQUITY: Private Equity (PE) is a term given to investment monies that are most often aggregated into funds for investing predominantly into private companies. These investment monies are derived from pension funds, insurance companies, sovereign wealth funds, high net worth individuals and families and individual investors. Typically, the funds are closed end investment vehicles that have a 10 year life. This is an important factor as where a fund is in its life-cycle does influence investment behaviors. Often funds have extension provisions that can be invoked under certain circumstance so they can last longer than 10 years. A circumstance may be market driven (ie Global Financial Crisis) or particular to that fund (investments that are not right to be exited when the 10 years are up). Typically, funds look to be invested for 3-5 years and divested within 7-8 years if possible. PRIVATE EQUITY HOUSES A PE house is really a generic term applied to businesses that invest PE investment monies on behalf of the funders (pension funds, insurance companies etc.): they are advisers to the fund and are most normally a separate legal entity with a very different ownership group. The PE house could be referred to as the fund manager – in fact the PE house will have a contract with the fund to manage the investment monies. Often PE houses are also referred to as General Partners – known as ‘GPs’. This is because of the partnership law
under which many funds are structured where there is a general partner (the PE house/fund manager) and limited partners (the pension funds, insurance companies etc.) – known as ‘LPs’. The fund’s terms will invariably require the PE house to invest its own money in the fund (they co-invest) and provide for fees and returns due from the fund to the PE house. Typically, the PE house will charge a fund management fee (a percentage of the funds under management) to cover the operational running costs of the PE house (employing people, rent, marketing costs etc.) and a carried interest, or ‘carry’. The carry is often agreed as 20% of the returns of the fund over a threshold return. Historically, that threshold return has been 8% - the long term return on the equity capital markets. The carry is split up amongst the, probably senior, team members of the PE house. In that way, the investment managers, executives and partners are all aligned with the success of each investment in the portfolio. Each team member will be asked to co-invest in the fund. The term PE is used interchangeably for situations with different investment strategies from higher risk, often early stage investment, Venture Capital, through to multi-fund fund managers that might themselves be quoted, like Blackstone. Businesses like Blackstone manage many funds with different remits (large cap, real estate, special situations etc.) that you or I could invest in.
Made with FlippingBook HTML5