Private Equity
Private Equity is a financial investment that has specific technical characteristics and is designed for the long term. It represents an effective tool for portfolio diversification.
Definition and main principle
Private Equity involves taking equity stakes in unlisted companies at various stages of their development.
It brings together the expertise of fund managers, analysts, and company executives with a shared objective of creating value.
As a key driver of economic development, Private Equity is now recognized for its positive impact on company growth, job creation, and the emergence of new generations of business leaders.
Objectives of Private Equity
The main objectives of investing in private equity reflect a strategic approach combining diversification and long-term value creation.
Objectives | Description |
|---|---|
Portfolio diversification | Investing in private equity helps diversify a financial portfolio thanks to its low correlation with traditional stock markets. This diversification enhances the overall risk‑return profile of the investment. |
Long-term value creation | Investments in private equity are made over the long term, with a commitment period often ranging from 5 to 10 years. This timeframe makes it possible to support companies’ growth, implement a value‑creation plan, and optimize the valuation by allowing flexibility in the timing of the company’s exit. |
The different Private Equity strategies
Private Equity encompasses several investment strategies tailored to different stages of a company’s maturity and needs, each aiming to create value through specific approaches.
Strategies | Description |
|---|---|
Venture Capital | Targets young innovative companies, often in the technology or life sciences sectors. Provides private funding to develop high‑growth‑potential activities. |
Growth Capital | Invests in established and profitable companies to finance their organic growth, international expansion, or strategic acquisitions. |
Buyout | Acquisition of mature and profitable companies, often through Leveraged Buyout (LBO) transactions. Objective: to develop these companies by accelerating organic growth or through acquisitions. |
Turnaround / Distressed Capital | Invests in financially distressed companies with the goal of turning them around before resale or an initial public offering. |
How a Private Equity investment works?
Private Equity relies on three key mechanisms: the capital commitment, capital calls and distributions, and performance measurement. These elements structure the investment and enable its monitoring over time.
1. Capital Commitment
The investor (LP – Limited Partner) commits to providing a predetermined amount to a fund, known as the capital commitment. Two operating methods exist: a simplified one in which 100% of the commitment is called at subscription, or a progressive one in which the commitment is drawn down over time. In the latter case, the investor agrees to make the funds available whenever the management company (GP – General Partner) issues a capital call. Typical investment period: 3 to 5 years.
2. Capital Calls and Distributions
Capital calls
Except in the case of funds that are 100% called at subscription, capital calls are made progressively as the fund:
undertakes new investments,
covers fund-related expenses,
or supports existing portfolio companies.
Actual payments are therefore staggered over time.
Distributions
Distributions represent the amounts returned to the investor upon:
the disposal of a portfolio company (trade sale, sale to another fund, or IPO),
or the payment of exceptional dividends.
Distributions generally occur in the second half of the fund’s life.
3. Performance assessment
The performance of a private equity investment is assessed using the Internal Rate of Return (IRR), which measures annualized returns while accounting for the timing of cash flows, and the Multiple on Invested Capital (MOIC), which compares the exit value to the initial investment.
Private Equity Investment Approaches
Private equity investments can be made through different types of intervention, each offering varying levels of management involvement, diversification, and risk exposure.
Type of investment | Description |
|---|---|
Direct investment | The investor directly manages their own holdings in unlisted companies, exposing the portfolio to the specific risk of each business and requiring a high level of expertise. |
Private Equity Funds | They generally take direct stakes in around twenty companies. Management teams are most often specialized by industry sector, by type of investment strategy, or even by geographic region. Performance dispersion among management teams is very high; therefore, selecting the right managers is a key driver of future performance. |
Private Equity Fund of Funds | They provide an easy way to access a highly diversified allocation. Through a leverage‑of‑diversification mechanism, an investor indirectly participates in the financing of several hundred companies. Given the illiquid nature of private equity, the need for broad diversification is crucial. Investing in fund‑of‑funds therefore helps spread the risk associated with this type of investment more effectively. |
Private Equity : advantages vs. risks
Like any investment, private equity offers advantages but also carries specific risks that must be clearly understood to ensure prudent and well‑informed portfolio management.
Private Equity - Advantages | Private Equity - Risks |
|---|---|
Potentially high returns | Illiquidity |
Active value creation | Capital loss |
Diversification | Leverage dependence (LBO - Leveraged Buyout) |
Access to unlisted companies | Low valuation transparency |
Alignment of interests | High fees |
Operational and strategic support | Operational and macroeconomic risk |
Glossary
Term | Définition |
General Partners (GPs) | Managers responsible for investment selection and management. |
Limited Partners (LPs) | Investors providing the capital to private equity funds. |
Leveraged Buyout (LBO) | Acquisition technique using financial leverage. |
Multiple de Capital Investi (MOIC) | A metric that measures the multiple of invested capital realized upon exit. |
Taux de Rendement Interne (TRI) | Annualized rate of return that accounts for the timing of cash flows. |