Private Equity Investment Management

In this article, we focus on the management of private equity portfolios by private equity firms.

Private equity is the most sought after investment market today. With a highly integrated approach to funding a wide range of companies in various stages of their business, investors are increasingly seeking out private equity for quick turnaround profits.

In this article, we focus on the management of private equity portfolios by private equity firms. Before that, let’s touch upon the concept of private equity investments.

Private Equity Investments

Private equity investments are focused on either startups or established businesses. Unlike public investments that are focused to raise massive money for operations, private equity plays a nurturing role both in terms of funds as well as business mentorship. But how does equity work? What drives equity investments? And how do investors benefit from this? Let’s take a look.

What are equity investments?

The process of investing to buy shares in a company is known as an equity investment. This happens in two ways – private and public. Private equity investment entails purchasing shares of private companies, not listed in the stock market. While dealing with shares that are publicly traded fall under the category of public investments. Since private equity is not openly traded, it is handled by private equity firms.

The basic idea behind equity investment is to purchase company shares at the present date (when the company is new or not delivering expected profits), at a low price per share. Gradually, as the company grows and generates profits, shareholders sell their percentage at the new equity value which is usually quite high. Investors profit from the price differential. Any equity investment aims to achieve a positive ROI. The reputation of an investment professional at a private equity firm or the stockbrokers at any stock exchange rests on their capacity to gauge the best investment option that will fetch the maximum profits in a given investment period.

The simplest equity investment is a common share. This simply denotes a piece of the company. Other types are preferred shares and convertible notes. Based on the stage of a company and the percentage of ownership, investors are granted various classes of shares. Investors can either directly purchase shares from the stock exchange, or engage with private equity firms. In the latter case, by purchasing shares of the equity firm, investors can get access to the entire pool of profits from the assets under their management. The chances of massive profits are higher in this case, compared to investing in one company directly. Also, risks are diversified.

Let’s now discuss some basic advantages of investing in equity.

What are the benefits of equity investments?

Equity investments are a much-preferred mode compared to other debt/loan instruments. The private equity market is being flooded by investors by the day. The lure of exponential profits over the short term draws individual and institutional investors alike to try a hand at high rates of return. Here are some basic benefits of equity investment:

  • Capital gains and dividends over the principal amount ensure a high chance of positive ROI.
  • Investors have a chance to diversify funds for a basic amount of investment
  • Equity investments, especially the private ones, bring in the much-needed guidance and industry expertise of the investors. Apart from money, this is a crucial aspect of any growing business or the ones in trouble.
With this basic idea about equity investments, let’s now explore how private equity firms manage them. Since equity investments are always massive money, sourcing and managing them to reap the highest possible profit requires a streamlined approach. Here is how this works.

Private Equity Firms

Private equity investors are either high net worth individuals who are established founders and entrepreneurs themselves, or institutions sitting on massive funds such as the pension fund, endowments, etc. It is difficult for them to individually seek out companies to invest in. This is where private equity firms come in, providing a consolidated approach to private equity investments. Let’s take a closer look.

What is a private equity firm?

Private equity is not traded publicly on a stock exchange. They are managed by private equity firms, otherwise known as financial sponsors. These are business houses with massive pools of money sourced from several high net worth individuals and financial institutions. This money along with the firm’s own money made from profitable exits is used to further invest in businesses that show a promise of high-profit margins in the future.

Typically, private equity firms are structured to have two types of partners – limited partners, who invest and are entitled to 99% of the profits, and the general partners who run the firm and are responsible for executing the investments.

Additionally, these firms hire a highly incentivized team of investment professionals who are entrusted with the ground responsibility of handling the investment portfolios in terms of sourcing, acquiring, deal signing, managing, and exit. PE firms gain by charging a percentage of the profits at every exit. This is usually in the range of 20%. Also, they charge the investors an annual performance fee of about 2% for all the assets under their management.

How private equity firms work?

Private equity firms acquire a company through auctions. Extensive research and due diligence are done by the investment team before signing a deal. Every investment entitles the PE firm to a considerable controlling position in the management of the acquired company. Based on the amount of funding and the stage at which they enter, this position could be a board seat or a complete takeover of the company. With the influx of a substantial amount of funds and a considerable say in the company operations, PE firms start working on increasing the value of the newly acquired company.

Business restructuring is at the core of private equity investments. Private equity firms are specialized in implementing growth plans, process improvements, and the introduction of new technology, increasing operational efficiency and productivity. In the case of established companies, they may also take tough decisions of shutting down underperforming business units and downsizing resources. All these actions are directed towards pulling up the business from a slump and ensuring profits. Once the acquired company reaches a profit-generating stage, PE firms sell their shares for high-profit margins and re-distribute the gains back to their investors.

What’s the role of a private equity firm?

Private equity firms work with investors with deep pockets and the capability to hold the funds for an investment horizon of at least 5 – 10 years. Thus, PE firms have a mandate to generate profits within this period, without losing investor’s money. The stakes are quite high and require a battery of processes to ensure precision. This is how meticulously it is done:

  • Raise Capital – The foundation of any private equity firm is the funding pool they hold. Hence the investment teams at PE firms strive hard to source funds from dependable sources. More the funding commitments from individuals and institutions alike, and the more diverse the industry experience of these investors, the better for the firm. They can easily play around with their funds and diversify investments across multiple industries.
  • Sourcing acquisitions – Companies seldom announce their sale. A process is in a place where financial intermediaries such as investment banks step in to facilitate deals between the private equity firms and a company. In the initial stages, anonymity is crucial. Thus PE firms develop a dynamic network to stay in the loop with the market developments. They must hold a good reputation as well for companies to approach them.
  • Due diligence – Extensive background research and due diligence is done before closing a deal. This happens in stages throughout the process of vetting an acquisition proposal.
    • The first stage of due diligence aims at deepening understanding of the target company. Private equity firms estimate the ROI based on the basic financial projections provided by the target company. At this stage, the firm may also invite investment banks to check the possibilities of debt financing.
    • The next stage of due diligence happens when the negotiations have proceeded to a point when the private equity firm has made the first bid. At this point, the target company provides confidential documents via virtual data rooms. Now the PE firm and the target company collaborate to assign tasks and exchange information through the VDR portal. The PE firm has to further verify the authenticity of all these documents.
    • The final stage of due diligence is done when the PE firm has narrowed down on a company and issued the preliminary investment memorandum. Usually, after this point, the firm solely focuses on this target company, setting everything else to the back burner. By this stage, the investment team at the private equity firm and the company management enter negotiations daily.
  • Close deal – After a satisfactory due diligence process, the private equity firm deliberates on the proposal and decides to invest in the company. Once the firm and the target company mutually agree on the final buying price and other terms of the merger agreement, in consultation with the legal team and investment banks party to the process, the acquisition deal is signed.
  • Managing the acquired company – After an acquisition, the private equity firm becomes a part of the company management. Based on the type of deal, whether venture capital (for startups), growth funds (for an established corporate), or leveraged buyout (for a mature business acquiring another business/ product line, or intellectual property), the firm’s involvement varies. However, the PE representative must ensure that the business is restructured in a way that all processes align with a high return on investment strategy.
  • Exit – Once the acquired company has started making profits, the exit process begins. At this stage, private equity investment management is all about ensuring the maximum value at exit. This might entail initiatives such as cutting costs, reducing debt using the funding transaction, optimizing working capital, etc. At an exit, the company is either acquired by another private equity firm or enters an IPO.
This is how managing one company turns out at a private equity firm. Now imagine the vast responsibility involved in managing multiple assets. This is why PE firms adopt the portfolio approach to streamline their approach. We discuss this further in the following section.

Private Equity Management

Private equity investment management is all about designing strategies to ensure that all the portfolio companies under a private equity firm’s management adopt the best approach to ensure maximum profits. This management approach introduces best practices as per industry standards to guarantee a high return on investments for every penny invested. Let’s take a look at how this works.

What is private equity portfolio management?

Portfolio management at a private equity firm involves a well thought out strategy to ensure maximum support to all the acquired companies. On the other hand, these strategies are aligned with sufficient participation of investors in the process. Some of the important steps in private equity portfolio management are:

  • Private equity firms play an important role in guiding the senior management of portfolio companies to identify the optimum operating and financial strategies as per industry standards. These strategies in turn become a measure of performance for the businesses.
  • Exciting incentive plans are designed by private equity firms for all the stakeholders – senior management, investment team, key employees, and service providers so that even after the acquisition, these key players feel comfortable and stay motivated to contribute their best to drive growth.
  • Private equity portfolio management also involves scheduling periodic meetings with the stakeholders within the firm and the acquired companies. These regular meetings help evaluate a company’s growth metrics and spot any deviations early in the process. If necessary, the required course correction can be adopted as well.
  • The representatives of a private equity firm also closely track the human resource management of acquired companies. Besides, with a fresh influx of funds, the supply chain evolves and requires close monitoring in terms of cost reductions. These are factors that can pose a massive burden at the time of exit and must be checked at every step of growth in all portfolio companies.

Manage Your Private Equity Investments on Eqvista

Private equity management software is the best way to proceed with handling equity. Considering the high stakes involved with massive funds, using a sophisticated tool that unifies all aspects of private equity management under a single platform is beneficial. Eqvista is one of the leading service providers in this category. Issuing, tracking, and managing equity has never been simpler.

Eqvista offers a host of other services related to company formation and management. To discuss more, reach us today!

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