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Private Equity

  • Private Equity is medium to long-term finance provided in return for an equity stake in a business.

Private Equity investments typically support management buyouts and managing buy-ins in mature companies, as opposed to Venture Capital which provides funding for early-stage and younger companies.

As model private equity is a proven driver of sustainable business growth. This is achieved through operational expertise, sound management and, importantly, through the close working relationship between the private equity backer and the company management team.

As opposed to publicly listed companies, which can often have thousands of shareholders, Private Equity Investment Managers will work closely with the management team of the business they have bought into to support and enhance the running of the business.

This ‘hands-on’ approach means the Private Equity Manager will work to enhance the value of the business by being involved multiple areas of operation, from the top-line growth, efficiency savings, cash generation and procurement, to supply-chains, marketing and sales, improving reporting and human resources.

Private Equity firms will typically look to hold investments for between four and seven years, at which time they will look to sell, or ‘exit’, their stake, either on the stock market, to a corporate buyer or to another investor.

All private equity and venture capital firms in the UK are regulated by the Financial Conduct Authority (FCA). The industry set up an additional self-regulatory regime in November 2007, in response to the increased demands of its investors and the self-recognition of the industry for it to do more. The Guidelines for Disclosure and Transparency in Private Equity and the supporting Private Equity Reporting Group (PERG) provide a set of rules and established oversight and disclosure comparable to those faced by FTSE 350 companies.

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Funds And Returns

Private Equity firms raise money from institutional investors, insurance companies and family offices. The money raised is usually put into a fund which is structured as a limited partnership and the investors into the fund are known as Limited Partners. The fund is then managed by the Private Equity firm. The capital is then used to acquire minority or majority equity stakes in companies. Private Equity firms will also, typically, invest their own money into the funds they manage. This reassures their investors that they have ‘skin in the game’ and that their interests are aligned to those of the investors.

The fund will typically have a limited lifespan of around 10 years, at the end of which, they will have to return the investors original money with the addition of any returns made on the investment. This will generally require the investments in the fund to be sold. Returns are made to the Limited Partners first and only when these returns pass a specific point does the Private Equity firm receive a return.

What Does A Private Equity Investor Look For When Making An Investment?

A Private Equity firm’s main goal is the create and add value to the companies that they have bought. As such they will look for high quality management teams with a credible plan to grow their business.

The Private Equity Managers will then work with the company’s management team to improve the performance of the company by refining the strategy, improving the business plan, making operational adjustments and improvements and strengthening corporate governance.

A desire to grow the business and meet long term goals coupled with a disciplined approach to corporate governance means that the Private Equity investment really tried to add value to the business – which they aim to realise in the future.

Benefits Of Private Equity

Private equity-backed companies have been shown to grow faster than other types of companies.

This is made possible by the provision of a combination of capital and experienced personal input from private equity executives, which sets it apart from other forms of finance. Private equity can help you achieve your ambitions for your company and provide a stable base for strategic decision making.

The private equity firms will seek to increase a company’s value to its owners, without taking day-to-day management control. Although you may have a smaller “slice of cake”, within a few years your “slice” should be worth considerably more than the whole “cake” was to you before.

Private Equity Versus Senior Debt

The provider of debt (which is generally a bank) is compensated by interest and capital repayments of the loan over a set period of time. The debt is usually secured on business assets or by personal assets of the Directors or Shareholders on the company. This gives the Lender recourse to those assets in the event the debt is defaulted on. They can put the business into administration which may lead to the liquidation of the company’s assets. If the Directors or Shareholders have offered Personal Guarantees or offered personal security for the loan the Lender may (in worst-case scenarios) bankrupt those Directors and Shareholders.

By contrast, Private Equity is not secured on any assets – although part of the non-equity funding package provided by the private equity firm may seek some security. The Private Equity firm is an equity shareholder in the company and just like the other shareholder the Private Equity firm will face the same risk of failure as the other shareholders in the business. The private equity firm will also be rewarded by the company’s success, generally achieving its principal return through realising a capital gain through an “exit” which may include:

  • Selling their shares back to the management
  • Selling the shares to another investor (such as another private equity firm
  • A trade sale (the sale of a company shares to another company)
  • The company achieving a stock market listing

Private Equity Compared To Senior Debt

Private Equity Senior Debt
Medium to long term Short to long term
Committed until ‘exit’ Not likely to be committed if the safety of the loan is threatened
Provides solid, flexible, capital base to meet your future growth and development plans Overdrafts are payable on demand; loan facilities can be payable on demand if the covenants are not met
Good for cashflow as capital repayment, dividend and interest costs (if any) are tailored to the company’s needs and to what it can afford A useful source of finance if the debt to equity ratio is conservatively balanced and the company has good cash flow
The returns to the private equity investor depend on the business’ growth and success Requires regular good cash flow to service interest and capital repayments
The more successful the company is, the better the returns all investors will receive If the business fails, private equity investors will rank alongside other shareholders, after the banks and other lenders, and stand to lose their investment. Depends on the company continuing to service its interest costs and to maintain the value of the assets on which the debt is secured
If the business runs into difficulties, the private equity firm will work hard to ensure that the company is turned around If the business fails, the lender generally has first call on the company’s assets
A true business partner, sharing in your risks and rewards, with practical advice and expertise (as required) to assist your business success If the business appears likely to fail, the lender could put your business into receivership in order to safeguard its loan, and could make you personally bankrupt if personal guarantees have been given Assistance available varies considerably

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