How Private Equity Investment Works

Private Equity

Private equity is a type of capital which institutions and high-worth individual use to invest in and acquire equity ownership in certain companies.  Private equity firms help raise funds and manage these types of monies as they work to provide significant yield for their clients.  The typical private equity investment yield term is four to seven years.

Private equity funds may be used to purchase shares in private companies. They may also be used when a public company is delisted and go through a private deal.  The minimum amount required for a private equity investment will vary depending upon the firm and the amount of capital being raised.  Some funds will require millions of dollars to get in while others will take a minimum of $250,000.

BackgroundPrivate Equity

Private equity is attractive to many in corporate America, including several from the Fortune 500.  Working in private equity is exciting and often attracts the best performers from top legal and accounting firms.  These individuals often have the required skills to complete a deal or work in portfolio management.

Private equity firm fee structures can vary but typically consist of a performance fee and a management fee.  These firms generate massive returns for their clients and a reasonable performance fee might be 20% for the firm. In the middle market, defined as $50M to $500M, an associate can bring in low six figures, plus bonuses, while senior management will earn more than $1M annually.  This makes it clear why private equity  continues to attract the brightest and the best.

Responsibilities

Private equity firms perform two critical functions: portfolio oversight and deal origination/transaction execution.

Portfolio oversight includes supporting the various portfolio companies and their management teams.  Private equity professionals advise and guide management through financial management and strategic planning and can help institutionalize new procurement, accounting and IT systems which help increase the value of the investment.

A private equity firm’s responsibility with deal origination is to create, maintain, and develop close working relationships with investment banks, mergers and acquisitions intermediaries, and other similar transaction professionals.  They do this to secure both high-quality and  high-quantity deal flow. When prospective acquisition candidates are referred to a private equity firm for an investment review, this is a deal flow.  Some private equity firms have internal professionals tasked with identifying and reaching out fo company owners as a way to generate transaction leads.  Sourcing leads is one of the best ways to raise funds in this highly competitive landscape.

Additionally, using internal specialists to source leads helps reduce the costs of transactions by removing the middleman fees charged by investment banks.

Transaction execution consists of assessing the history, the management, and historical financials, and the forecasts for a prospect.  It also includes conducting valuation analyses and then sending a recommendation to the investment committee. When the investment committee approves going after a certain acquisition target, the deal professionals will write up and submit and offer.  Transaction execution also includes performing due diligence before finalizing a deal.

Private equity firms help identify private investment opportunities in companies and help raise the funds to close the deal.  This is a particularly attractive investment for corporations and high-net-worth individuals.