What is Private Equity
Private equity (PE) is a form of long-term funding by taking shares or stakes in privately owned companies, aiming to improve governance and operational efficiency, as well as business expansion, in order to increase the company’s worth. The global private equity market size hit approximately $6.5T by 2022 and is forecasted to grow at a CAGR of around 6% over the next few years. Large funds, institutional investors, and high-net-worth individuals usually make these investments.
Types of Private Equity Investment
Private equity investments can be categorized based on their objectives and stages. Venture capital (VC) has long been the most common and is primarily aimed at young startups. VC gross investments were approximately $150 billion in startups across Silicon Valley in 2022, with companies such as Uber and Airbnb benefiting from early-stage VC funding, which helped them grow into unicorns.
Growth equity targets profitable companies that need further growth. In China, for example, Pinduoduo was able to get off the ground through private equity and grow into a public company from there.
Mature company takeovers happen through leveraged buyouts (LBOs). A prominent example is the 2007 buyout of Hilton Hotels by Carlyle, which had a price tag of close to $26 billion. The deal ultimately netted Carlyle billions in profits.
Distressed investments target companies facing financial distress. Investors step in with capital injections and management improvements to get them back on track. For instance, Kodak transformed its business with private equity support by moving towards digital imaging technology.
Characteristics of Private Equity Investment
Private equity investments are known for poor liquidity. Exits typically take 5 to 10 years and can occur via an IPO or sale. Over 70% of private equity funds in the US take more than seven years to exit.
Private equity offers high return potential but also requires more cash amidst low liquidity. Private equity funds return, on average, 15-20% annually according to PitchBook, much more than the S&P 500 index, which averages only around 10%. One of the best examples is Blackstone, where their PE portfolio has historically returned well over 20% since its inception.
Aside from providing capital, private equity investors are engaged in company management. For example, the Carlyle Group used industry experts to help turn around their portfolio companies, leading to significantly increased profitability.
How to Start Investing in Private Equity
Before embarking on an investment in private equity, one must first understand the market and industry trends. About 34% of global private equity investment continues to flow into the technology sector—more than any other sector. This has made technology a hot topic for 2023. Therefore, interested investors should stay up to date on trends in technology.
Choosing the right investment institution is crucial. Newbies are frequently recommended to start with large, established private equity funds. For instance, KKR’s fund offers a 16% annual return, which can help first-time investors offset many uncertainties by working with KKR.
Investments need to be diversified, as this is another important way to reduce risk. According to a study by Harvard Business School, investors who spread their money across 10 or more companies reduce the probability of failure by about 40%. This is achieved by creating baskets of investments in different sectors and regions.
The right investment also needs to have an exit strategy. Around 80% of private equity funds exit through IPOs or mergers. As an investor, you need to consider a prospect’s growth and their potential exit paths before investing to ensure a smooth exit in the future.
Potential Risks in Private Equity Investment
Despite the large returns possible, private equity investments also carry unique risks. The first is that market conditions can directly interfere with the performance of investment projects. For instance, global private equity returns fell by about 30% during the 2020 pandemic, with significant disruptions in the tourism and hospitality sectors.
Bbout 50% of an investment’s success is dependent on the company’s management abilities and strategic execution. Data suggests that around 30% of private equity investments fail to deliver expected returns due to poor management decisions. For example, the Carlyle Group bought a large retailer in 2015, but the investment failed because the management couldn’t keep up with market changes.
