Understanding Private Equity:

In contrast to venture capital, private equity firms and funds primarily invest in well-established companies rather than startups. Their focus revolves around managing portfolio companies to enhance their value or extract value before eventually divesting the investment years later.

The private equity sector has experienced rapid growth, spurred by increased allocations to alternative investments and the robust returns exhibited by private equity funds since 2000. In 2021 alone, private equity buyouts reached a staggering $1.1 trillion, marking a twofold increase from the previous year.

The average duration of holding for a private equity portfolio company stood at approximately five years in 2021. As of December 2022, there were over 15,000 companies with private equity as their primary investor type.

How Private Equity Operates:

To secure investments in companies, private equity investors raise capital from limited partners (LPs) to establish a fund. Once the fundraising target is met, the fund is closed, and the capital is strategically invested in promising companies. Private equity investors may choose to invest in stagnant or distressed companies that still exhibit growth potential.

Upon selling a portfolio company to another entity or investor, private equity firms typically generate profits and distribute returns to the LPs who invested in the fund. Some companies backed by private equity may also undergo an initial public offering (IPO).

Main Strategies for Private Equity Investments:

Here are the three primary strategies for private equity investments, with an acknowledgment of the evolving landscape amid current market uncertainties:

  1. Buyout: A buyout involves an investor acquiring a majority stake in a company, often executed through a leveraged buyout (LBO). LBOs constituted 66% of all private equity deals in 2021, with a median deal size of $101 million. Investors in LBOs purchase a controlling stake using a blend of equity and substantial debt, working to improve profitability during the interim period.
  2. Growth: Investors may opt for a growth strategy by acquiring a minority stake in a company, focusing on further expanding the business. This approach, akin to venture capital investments, involves no debt and only a minority stake is exchanged for capital. Growth financing represented 11% of all private equity deals in 2021, with a median deal size of $30 million.
  3. Mezzanine: Mezzanine is a distinctive strategy bridging the gap between debt and equity. When a company receives mezzanine financing from a private equity group, it assumes debt with embedded equity, allowing the conversion of debt into equity. Mezzanine deals often accompany leveraged buyouts, offering a flexible financing structure with potential equity conversion.

These strategies illustrate the dynamic and adaptable nature of private equity investments, evolving to meet the challenges and opportunities in the current market landscape.