What is Private Equity?
Private Equity is a financial investment with specific technical characteristics and is designed for the long term. It represents an effective tool for portfolio diversification.
Definition and fundamental principle
Private Equity refers to investments in unlisted companies at various stages of their development. It involves acquiring equity stakes in these businesses with the objective of creating value over the medium to long term.
This investment approach leverages the expertise of fund managers, analysts, and company executives to support the growth, transformation, or turnaround of the companies involved.
Objectives of Private Equity
The main objectives of private equity investment reflect a strategic approach combining diversification and long-term value creation.
Objectives | Description |
Portfolio diversification | Investing in private equity allows for diversification of a financial portfolio due to its low correlation with traditional stock markets. This diversification optimizes the overall risk/return profile of the investment. |
Long-term Valuation | Private equity investments are made over the long term, with a typical commitment period ranging from 5 to 10 years. This duration enables support for the growth of companies and optimization of valuation before the sale of stakes. |
The Different Private Equity Strategies
Private equity encompasses several investment strategies tailored to different stages of company maturity and needs, each aiming to create value through specific approaches.
Strategies | Description |
Venture Capital | Targets young innovative companies, often in technology or life sciences sectors. Provides private financing 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 Capital | Acquisition of mature and profitable companies, often through Leveraged Buyout (LBO) transactions. Objective: restructure or develop these companies. |
Turnaround / Distressed Capital | Invests in financially distressed companies with the goal of restructuring them before resale or initial public offering. |
How a Private Equity Investment Works
Private equity relies on three key commitments: subscription, capital calls and distributions, as well as performance evaluation, all essential to its operation and monitoring.
Subscription Commitment
- The private equity investor makes a subscription commitment to a fund, agreeing to meet capital calls issued by the management company over a period generally ranging from 3 to 5 years.
Capital Calls and Distributions
- Capital calls are made progressively as the management company identifies investment opportunities. Distributions, corresponding to the return of invested capital, usually occur in the later years through the sale of stakes (resale, initial public offering, or sale to another fund).
Performance Evaluation
- The performance of a private equity investment is assessed through the Internal Rate of Return (IRR), which measures the annualized return taking into account the timing of cash flows, and the Multiple on Invested Capital (MOIC), which compares the resale value to the initial investment.
Modes of Intervention in Private Equity
Private equity investments can be made through different modes of intervention, offering varying levels of management, diversification, and risk exposure.
Type of Investment | Description |
Direct Investment | The investor directly manages their stakes in unlisted companies, exposing their portfolio to the specific risk of each business and requiring deep expertise. |
Private Equity Funds | Invest in around twenty companies, offering sectoral and geographical diversification. The selection of managers (General Partners) is crucial for performance.
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Private Equity Fund of Funds | Invest in multiple private equity funds, ensuring broader diversification and reducing risks specific to each fund. |
Risks Associated with Private Equity
Like any investment, private equity carries specific risks that must be well understood for prudent and informed portfolio management.
- Capital Loss Risk: In case of failure or underperformance of the invested companies.
- Liquidity Risk: Investments are often illiquid, with long investment horizons.
- Interest Rate and Credit Risk: Depending on the financial structures of the companies and the leverage used.
Glossary
Term | Définition |
General Partners (GPs) | Managers responsible for selecting and managing investments. |
Limited Partners (LPs) | Investors providing capital to private equity funds. |
Leveraged Buyout (LBO) | Acquisition technique using financial leverage. |
Multiple on Invested Capital (MOIC) | Indicator measuring the multiple of invested capital realized upon exit. |
Internal Rate of Return (IRR) | Annualized rate of return taking into account the timing of cash flows. |
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