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PRIVATE EQUITY INVESTMENT STRATEGIES

COMMON SUBCLASSES OF PRIVATE EQUITY

While most private equity transactions involve investments in private companies, they can range from the financing of start-up entities to infusing growth equity into an expanding company to buying out mature public or private enterprises. What is common to most private equity investments is that the investor group often acquires a large or significant ownership stake in the company through a highly structured
and negotiated transactions.

PRIVATE EQUITY INVESTMENT STRATEGIES

Private equity is an asset class that involves using equity securities and sometimes along with debt capital to acquire shares of privately held companies or those of public companies that will eventually be delisted from the public stock exchanges. As the below figure illustrates, private equity investment can occur at virtually every stage of a company’s life cycle.

 

The following are the private equity strategies that PE investors generally adopt. 

1. GROWTH CAPITAL

Growth capital (also called expansion capital and growth equity) is a type of private equity investment made in relatively mature companies with proven business models that are looking for capital to expand or restructure their operations, add a new product line, enter new markets, or finance a significant acquisition without a change in the control of the investee company. Typically, these are minority investments, and companies that take on growth capital are more mature than venture-funded companies. Such companies generate revenue and profits that may not be enough to fund big expansions, acquisitions or other investments. By selling part of the company equity to a private equity investor, the primary owner doesn’t have to take on the financial risk alone but can take out some value and share the risk of growth with partners.

 

 
2. VENTURE CAPITAL

Venture Capital typically involves less mature companies, start-up companies, or companies in early-stage development with little to no track record of profitability. Venture Capital investments are usually applied toward new technology, new marketing concepts, or products that don’t have a proven track record or steady revenue streams. Most VC investments are in rapidly growing companies, with a heavy concentration on the technology or life sciences sectors. Venture Capital is most suited for businesses that face large up-front capital requirements that alternative sources cannot finance, such as debt. Venture capital investments are made with the goal of generating outsized returns by identifying and investing in the most promising companies and profiting from a successful exit. There are several stages of VC investing, which often mark financial and/or operational milestones for the VC-backed company.

 

 
3. LEVERAGED BUYOUTS (LBOS)

Leveraged buyouts refer to a strategy when a company borrows a significant amount of capital (from loans and bonds) to acquire another company. The companies involved in LBO transactions are typically mature and generate operating cash flows. Private equity firms make buyout investments when they believe that they can extract value by holding and managing a company for a period of time and exiting the company after a significant value has been created. Leveraged buyouts typically utilize debt to finance the buyout, and the firm performing the LBO has to provide a small amount of the financing (typically around 90% of the cost is financed through debt).

The goal of a leveraged buyout is to generate returns on the acquisition that will outweigh the interest paid on the debt. For the firm that’s performing the LBO, this is a way to generate high returns while only risking a small amount of capital. Oftentimes a financial sponsor is involved and the assets of the company being acquired are used as collateral for the debt. Private equity firms will then either (1) sell off parts of the acquired company or (2) use the acquired company’s future cash flows to pay off the debt and then exit at a profit.

 

 
4. MEZZANINE FINANCING

While some companies might take on growth capital to finance their expansions, mezzanine financing is an alternate way. Mezzanine financing consists of both debt and equity financing used to finance a company’s expansion. With mezzanine financing, companies take on debt capital that gives the lender the right to convert to an ownership or equity interest in the company if the loan isn’t repaid in a timely manner and in full. Companies that take on mezzanine financing must have an established product and reputation in the industry, a history of profitability, and a viable expansion plan.

Mezzanine Capital is often used by smaller companies unable to access a high yield market. This strategy provides these companies with the opportunity to access additional capital – beyond what traditional lenders are willing to provide.

 

 
5. PRIVATE EQUITY REAL ESTATE (PERE)

Private equity real estate involves pooling together investor capital to invest in ownership of various real estate properties. Investing in private equity real estate involves the acquisition, financing, and ownership (either direct or indirect) of property or properties via an investment fund. Based on the degree of risk involved, PERE uses four common strategies to invest that are:

  • Core- A typical core investment is characterised by low leverage (40% – 50%), stable and predictable income, new or like new construction, high end finishes, and no major structural or operational issues. In addition, core investments typically have an excellent location with full or near full occupancy with credit tenants on long-term leases. 
  • Core Plus- Properties with a good – not great – location, stable income, high-quality tenants, slightly dated finishes, low to moderate vacancy rates, and 50% – 65% leverage. Core plus real estate may have some tenant leases that are coming up for renewal in the near term, which adds to the vacancy risk. 
  • Value Added- A typical value-add property has a fair to good location, dated finishes, medium to high vacancy levels, and some amount of deferred maintenance that must be addressed. The goal of a value add investment strategy is to purchase the property for a good price and to invest some amount of money in renovations and physical improvements to bring the property up to market standards.
  • Opportunistic- Opportunistic carries the highest risk of the four real estate investment strategies. The Opportunistic investment strategy focuses on finding, leveraging, and rectifying structural weaknesses relating to a property to produce outsized investment returns.
6. DISTRESSED AND SPECIAL SITUATIONS

Distressed and Special situations funds specifically target companies that need restructuring, turnaround, or are in any other unusual circumstances. Investments typically profit from a change in the company’s valuation as a result of the special situation. Examples of special situations include: a large public company spinning off one of its smaller business units into its own public company, tender offers, mergers and acquisitions, and bankruptcy proceedings. Besides private equity funds, hedge funds also implement this type of investment. The term ‘distressed’ includes, but is not limited to, the following sub-strategies:

  • Distressed-to-control or loan-to-own: where the investor acquires new debt securities, anticipating that he or she will gain control of the company’s equity following a restructuring.
  • Rescue lending: providing liquidity to stressed companies in times of heightened market turbulence in return for preferential investment conditions.
  • Special situations (or turnaround): where an investor provides debt and equity investments to companies undergoing significant challenges. Special situations may include mergers and acquisitions, bankruptcy, and more.
7. FUND OF FUNDS

This type of strategy involves investing in a fund whose primary purpose is to invest in other private equity funds rather than directly in securities, stocks, or bonds. By investing in a fund of funds, investors are granted diversification and the ability to hedge their risk by investing in various fund strategies.

8. INFRASTRUCTURE

The term infrastructure equity refers to investing in the equity of infrastructure assets to gain ownership and control. These “real assets” typically include power projects, electricity infrastructure, roads, airports, seaports, bridges etc. Most of the leading private equity funds have dedicated funds and strategies for investing in infrastructure assets. Private market managers use their stable and patient capital to invest in new and existing infrastructure assets.

9. SECONDARIES

The private equity secondary market (also often called private-equity secondaries or secondaries) refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. The market provides liquidity to private equity investors, allowing them to sell their investments in private equity funds and liquidate equity stakes in private companies. The Secondary market is the only way for individual LPs to exit early from their private equity investments. Private equity is an illiquid asset class, with investors required to commit capital to private equity funds for ten years or more. The development of a secondary market was therefore both necessary and inevitable.

10. IMPACT INVESTING

Impact investing is an investment strategy that aims to generate specific beneficial social or environmental effects in addition to financial gains. Impact investing provides access to a diversified portfolio of private equity investments that seek to achieve compelling financial returns together with a demonstrable and measurable positive social and economic impact. Investors who follow impact investing consider a company’s commitment to corporate social responsibility or the duty to positively serve society as a whole. Impact investing directs capital to enterprises that generate social or environmental benefits. Impact investments seek to address the world’s most pressing challenges in sectors such as sustainable agriculture, renewable energy, the blue economy, nature conservation, microfinance, and affordable and accessible basic services, which include housing, healthcare, and education.

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About the author

Dileep K Nair

Mr Dileep is currently the managing partner of Unifinn Capital Global and an advisor to the investment banking and corporate finance world. He is a mentor, entrepreneur and business advisor with an overall 19 years experience, 12 plus years of banking and finance experience and 7 plus years experience in investment banking and corporate finance, with relevant experience in handling private equity transactions, private debt, venture capital, angel investing, M&A, other growth capital transactions and real estate financing transactions.

dileep.nair@unifinn.com

https://unifinn.com

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Comments (15)

[…] Private Equity (PE) is another source of investment capital that invests in the equity capital of privately held companies, I.e. companies that are not publically traded.  Private Equity actually derives from high net worth individuals and institutional investors that acquire equity shares of privately held companies or acquire a controlling stake in publically traded companies to make them private, eventually becoming delisted from public stock exchanges. These companies are not listed or traded on any stock exchanges. The PE capital can be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Now private equity has gained a great amount of influence in today’s financial marketplace. […]

[…] Private Equity (PE) is another source of investment capital that invests in the equity capital of privately held companies, I.e. companies that are not publically traded.  The term “private equity” denotes shares of owner‑ ship in companies that are not (or not yet) listed on a stock exchange. Private Equity actually derives from high net worth individuals and institutional investors that acquire equity shares of privately held companies or acquire a controlling stake in publically traded companies to make them private, eventually becoming delisted from public stock exchanges. These companies are not listed or traded on any stock exchanges. The PE capital can be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Now private equity has gained a great amount of influence in today’s financial marketplace. […]

[…] Private Equity (PE) is another source of investment capital that invests in the equity capital of privately held companies, I.e. companies that are not publically traded.  Private Equity actually derives from high net worth individuals and institutional investors that acquire equity shares of privately held companies or acquire a controlling stake in publically traded companies to make them private, eventually becoming delisted from public stock exchanges. These companies are not listed or traded on any stock exchanges. The PE capital can be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Now private equity has gained a great amount of influence in today’s financial marketplace. […]

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