Private Equity Firms: Strategies For Sourcing Deals

Private equity firms are investment partnerships that buy and manage companies before selling them. They raise money from investors, such as pension funds and high-net-worth individuals, and use this capital to acquire stakes in private companies or take control of public companies. The underlying reason for private equity investing is to achieve returns on investment that may not be possible in the public market.

Private equity firms have a range of investment preferences. Some are strict financiers or passive investors, while others consider themselves active investors, providing operational support to management.

There are several ways in which private equity firms find investment opportunities. They can create, maintain and develop relationships with M&A intermediaries, investment banks and similar professionals to help find high-quality deal flow. Some firms hire staff to search for and reach out to company owners to find transaction leads. Investment banks often compete with private equity firms to buy good companies and finance nascent ones, so private equity firms must develop strong relationships with transaction and services professionals to secure a robust deal flow.

Researching top private equity firms

Private equity firms are investment partnerships that buy and manage companies before selling them. They are generally not open to small investors and require a significant capital outlay.

When researching top private equity firms, there are several key factors to consider:

Investment Minimums

Private equity firms typically have high investment minimums, which can range from a few hundred thousand to several million dollars. This is an important consideration as it will determine whether you are able to invest with the firm. Some firms have dropped their minimums to as low as $25,000, but these investments are still out of reach for most people.

Areas of Expertise

Different private equity firms have different areas of expertise. Some firms specialise in specific industries, such as technology or energy, while others focus on certain types of deals, such as distressed investing or growth equity. It is important to research the firm's expertise to ensure it aligns with your investment goals and interests.

Fundraising Schedules and Exit Strategies

Private equity firms raise client capital to launch private equity funds, which have a finite term of around 10 to 12 years. It is important to understand the firm's fundraising schedule and exit strategy before investing. Some common exit strategies include selling the company to a competitor, an initial public offering (IPO), or a secondary buyout to another private equity firm.

Track Record and Performance

When researching private equity firms, it is crucial to look at their track record and performance. This includes analysing the returns they have generated for their investors and assessing the success of their previous investments. You can also look at the firm's portfolio companies and how they have performed under the management of the private equity firm.

Management and Fees

It is important to understand the management structure and fee schedule of the private equity firm. Private equity firms typically charge a management fee, which is often set at a percentage of the fund's assets, as well as a performance fee based on a percentage of the profits. It is also worth noting that private equity firms often have a general partner (GP) who makes all the fund's management decisions and contributes a small percentage of the fund's capital.

By considering these factors, you can make an informed decision when researching and selecting a top private equity firm to invest with.

Looking for private equity exchange-traded funds (ETFs)

Private equity exchange-traded funds (ETFs) are a way to gain exposure to private equity investments without going through a traditional firm. Private equity ETFs invest in publicly listed private equity companies, including business development companies and other financial institutions.

ETFs that track these companies allow investors to benefit from their success without needing to meet the minimum investment requirements of private equity funds or be an accredited investor.

Two of the most popular ETFs available today are the Invesco Global Listed Private Equity Portfolio (PSP) and the ProShares Global Listed Private Equity ETF (PEX). PSP is the largest private equity ETF, with assets totalling over $267 million as of February 2022. It provides access to approximately 70 publicly listed private equity companies worldwide, including business development companies and financial institutions. The fund has a high distribution yield of 11.34% and an expense ratio of 1.44%.

The ProShares Global Listed Private Equity ETF (PEX) aims to provide investors with results that mirror the performance of the LPX Direct Listed Private Equity Index. This index includes approximately 30 publicly listed private equity companies that invest in and lend capital to privately held companies. The fund has a high expense ratio of 3.31% and offers a distribution yield of 14.31%.

Other popular private equity ETFs include those offered by Morgan Creek Capital Management and Proshare Advisors LLC.

Understanding the different types of private equity investments

Private equity firms can use their investors' contributions in a few different ways to generate profit, depending on the types of deals the firm specializes in. Here are some of the most common types of private equity investments:

Buyouts

A buyout is when a private equity firm buys a target company with the hope of selling it later at a profit. The target company can be public or private, but if it's public, it will be taken private through the purchase. Often, private equity firms use capital from the fund, as well as borrowed money, to complete the deal. This is known as a leveraged buyout.

In a buyout, the private equity firm might identify a company with room for improvement, buy it, make improvements, and then sell the company for a profit. This is similar to flipping a house.

Venture Capital

Venture capital involves identifying early-stage startups looking to raise cash in exchange for equity in the company. The goal here is to invest in companies with high growth potential, which can later be sold at a profit or taken public through an initial public offering (IPO).

Distressed Investing

Distressed investing is a specialization in which private equity firms invest in struggling companies with critical financing needs.

Growth Equity

Growth equity is a type of investment in which private equity firms fund expanding companies beyond their startup phase.

Sector Specialists

Some private equity firms focus solely on specific sectors or industries, such as technology or energy deals.

Secondary Buyouts

A secondary buyout involves the sale of a company owned by one private equity firm to another. This type of deal was initially assumed to be a distress sale but has become more common due to increased specialization by private equity firms.

Carve-outs

A carve-out is when private equity investors buy a division of a larger company, typically a non-core business that the parent corporation is looking to sell. Carve-outs tend to be more complex and risky, and they often fetch lower valuation multiples than other types of private equity acquisitions.

Knowing the advantages and disadvantages of private equity

Private equity firms are investment partnerships that buy and manage companies before selling them. They are often grouped with venture capital and hedge funds as an alternative investment. Private equity funds are managed by a general partner, typically the private equity firm that established the fund. The general partner makes all the fund's management decisions and contributes 1-3% of the fund's capital. In return, they earn a management fee and may be entitled to a share of the profits.

Advantages

• Private equity can provide access to large amounts of funding, with deals often running into millions or billions of dollars.
• Private equity firms are more hands-on than other investors and will help re-evaluate the business to maximise its value.
• There are generally no usage restrictions on how the funds are used, as long as it benefits the business.
• There are no monthly repayments to investors, allowing the business to focus on its operations and growth.
• Investors have a vested interest in seeing the business grow and may offer their skills, expertise and contacts.

Disadvantages

• Acquiring private equity from investors can be a time-consuming and challenging process, as businesses need to present a compelling case for investment.
• Private equity firms often demand a majority stake in the business, which may result in the original owners losing control of their company and its management.
• Private equity firms have a specific and limited definition of value, focusing on the financial value of the business rather than broader concerns such as relationships with employees and customers.
• The exit strategy of private equity firms may not align with the original owners' plans and could involve selling the business or an IPO.

Exploring alternative ways to invest in private equity

Private equity (PE) is a form of investment that takes place outside of the public stock market, allowing investors to gain an ownership stake in private companies. While PE has typically been the domain of institutional investors and high-net-worth individuals, there are alternative ways for smaller investors to gain exposure to this asset class. Here are some alternative ways to invest in private equity:

Publicly Traded Private Equity Firms

Some private equity firms have chosen to list their shares on public stock exchanges, providing an opportunity for individual investors to buy shares in these firms. Examples include The Blackstone Group (BX), Apollo Global Management (APO), Carlyle Group (CG), and Kohlberg Kravis Roberts (KKR). By investing in these publicly traded private equity firms, individuals can gain exposure to the performance of their underlying private equity investments.

Mutual Funds and Exchange-Traded Funds (ETFs)

Mutual funds are restricted from investing directly in private equity due to regulations regarding illiquid securities holdings. However, they can invest indirectly by purchasing shares of publicly listed private equity companies or through special purpose acquisition companies (SPACs). These funds are known as "funds of funds" and offer greater diversification and potentially lower risk compared to direct private equity investments. ETFs are another option for individual investors, as they can be purchased over a stock exchange without minimum investment requirements. Examples include the ProShares Global Listed Private Equity ETF (PEX).

Private Equity Crowdfunding

Private equity crowdfunding allows individual investors to contribute smaller amounts of capital to private equity investments through online platforms such as Wefunder, AngelList, and SeedInvest. This method provides access to a wider range of investors and allows for diversification across multiple private equity deals. However, it is important to note that these investments can be highly risky and require thorough due diligence.

Venture Capital Funds

Venture capital (VC) is a subset of private equity that focuses on investing in young companies in less mature industries. Private equity firms with a VC focus seek to identify companies with high growth potential and provide guidance to inexperienced management teams. While VC investments are typically reserved for accredited investors, there are some VC funds that have lower minimum investment requirements, making them more accessible to a broader range of investors.

Direct Investment in Private Companies

While this option may not be feasible for most individual investors due to the high minimum investment requirements, there are some private companies that offer investment opportunities with lower thresholds. These opportunities can provide direct exposure to the performance of the company and may be a viable option for investors with a higher risk tolerance and a long-term investment horizon.

Frequently asked questions