The language of investments is both confusing and alluring and contains many different dialects, one of these belonging to Private Equity. In this two-part article, we will unpack the language of private equity by explaining some of the key terms associated with this asset class to help shed some light on these types of investments.
Private equity investment funds invest in companies in various stages of maturity ranging from early-stage startups, small to medium enterprises, fast growing medium to large enterprises and maturing large companies. The type of fund is determined by the stage of growth of its investment assets. Types of private equity funds are: Venture Capital, Growth Private Equity, Buyout or Distressed Assets Funds.
Venture Capital (VC) funds invest in companies at the earliest stage of growth, focusing on startups and early-stage companies. Investments are high-risk but can yield significant returns if the company succeeds. Venture capital investments range from an idea to proof of concept, product-market fit, early sales but not profitable, then turning profitable as sales growth continues ahead of costs. Due to being early stage there can be a high failure rate, but also extreme successes across a VC company portfolio.
Growth private equity funds: Funds at this stage invest in more mature companies looking to expand or restructure. These investments are considered less risky than VC but still offer considerable growth potential. This includes mid-sized companies that have emerged from the early stages, may have been operating for some time, and are in a stage of strong growth requiring additional capital. They may be growing at 15% to 50% revenue per year. Failure rates tend to be lower than VC.
Buyout funds: This stage involves acquiring established companies, often using leverage. Buyout funds target firms that can be improved through operational efficiencies, strategic direction, or financial restructuring. A buyout transaction may be a mature company that has been around for many years; an unloved division of a larger company that is sold off; or a mispriced listed company that has fallen out of favour. The existing management may be retained or changed depending on what the private equity firm decides to do. While the mature companies themselves are lower risk, there can be additional risk through financial engineering of deal structures and high use of debt.
Distressed Assets funds: These funds focus on companies facing financial difficulties. The goal is to buy low and turn the business around, but this strategy comes with higher risks. One strategy is to break up a company and sell off the parts. another strategy is to renegotiate its financing, perhaps through administration, and relaunch with a new capital structure.
Primary Funds: This refers to investments made directly into new private equity funds. Investors commit capital to the fund at its inception, which is then used to invest in portfolio companies.
These Primary funds invest in companies directly and aim to assemble a portfolio of underlying companies in a segment of private equity that could be venture capital, growth private equity or buyout. They start off investing once they have capital committed by investors, and most often aim to invest over an average of three years, but this can vary from two to four years depending on market conditions and available investments that meet the fund manager’s criteria.
Secondary Funds: Secondary funds purchase interests in existing private equity funds from current investors looking to liquidate their holdings before the fund's maturity. This can provide liquidity to sellers while allowing buyers to acquire interests at potentially discounted prices and later in their investment term.
Secondary investments are ‘second hand’ fund or company investments that have been progressed by a primary fund holder and may be sold by an investor or a fund manager. These include:
Co-Investments: Co-investments occur when investors invest directly in a portfolio company alongside a private equity fund. This allows investors to leverage their relationships and gain exposure to specific deals without committing to an entire fund.
Large superannuation funds like to have co-investment rights alongside their investment in primary funds, as co-investments have reduced fees or no fees at all as long as there is some primary fund commitment alongside.
Investors in private equity and many other alternative investment funds are otherwise known as a ‘limited partner’ or ‘LP’. The fund manager is otherwise known as a ‘general partner’ or ‘GP’. These terms LP and GP are part of the fund structure legal arrangements known as a ‘limited liability partnership’ or ‘LLP’. In Australia there is a certain type of limited liability partnership known as an ‘ESVCLP’, an ‘early-stage venture capital limited partnership’. Under Australian law these funds have certain tax benefits if they comply with some prescribed rules.
Private equity funds typically progress through several stages:
In Part B we explore return expectations and risks; return calculations and the J-curve. Click here to go to Private Equity Jargon Explained: Part B.
All information on this website is general in nature and is not intended to be advice. It does not take into account your financial circumstances, goals and objectives. Before acting, you should consider its appropriateness having regard to your own circumstances.