How Private Equity Investments Work and Where They Come From?
Private equity does not fall on any of the standard categories of investments. We can call them alternative investments, and their capitals are not included on the list on the public exchange. Hence, the investors on these funds have direct investments in private companies. Some may be involved in public company buyouts that lead to a public equity delisting. Furthermore, these investors are the ones that shell out capital for private equity. The capital can also be used for new technology, acquisitions, working capital expansion, and a more solid balance sheet.
Private equity and partners
Private equities have both limited and general partners. As the name suggests, limited partners have limited liabilities and own almost all of the shares (99%) in a fund. The remaining one percent of shares in a fund belongs to general partners. They have total liability, and they are the ones who should execute and operate the investment.
Pros and cons of private equities
These investments are primarily from institutional and accredited investors who shell out a massive amount for long periods. Long periods will most likely need these investments because companies who are having rough patches need turnaround assurances. Private equities may also be required for events that need liquidity, like a company going public or a company being put up for sale.
The good thing about private equities is that they are beneficial for new companies. As we mentioned a while ago, private equities provide liquidity, and this is what new companies need instead of the typical financial mechanisms like bank loans or public market listings. New companies can also benefit from investments like venture capital. In another scenario, a company may be delisted for some reason, but it can still grow using an uncommon strategy through private equities.
Private equities also have their fair share of disadvantages. Let us enumerate some:
- Liquidation. Liquidation may be more complicated because an order book matched with buyers and sellers is not readily available.
- Shares pricing. The buyer/ seller negotiation dictates the share’s prices and not the market.
- Shareholder rights. Negotiations also dictate the rights of the shareholders, and it is on a case-to-case basis.
Where do they get the money?
We already mentioned that the money comes from institutional and accredited investors, but here is a more detailed list:
- Distressed funding
- Leveraged buyouts
- Real estate
- Funds of funds
- Venture capital
How do they make money?
Management fees are the most accurate answer for this question. A private equity firm may charge a fee, and in that fee, management and performance fees should be present. Just for us to get an idea, some may charge 20% of the company’s total profits and a 2% annual management fee on managed assets.
We thought you should know.
There was a lack of transparency issue around 2015 on private equities. This is because most private equity firm employees have massive paychecks and salaries. In 2016, few states wanted to know more about what is happening inside private equity firms, but Capitol Hills’ lawmakers asked SEC for limited access to information. So, if you are interested in private equities, make sure to research well and ensure that the people you are dealing with can be fully trusted.