Private equity funds are investment vehicles that pool capital to invest in companies with the potential for high returns. These funds have a defined investment horizon, usually spanning four to seven years, after which the private equity firm aims to exit the investment profitably. Common exit strategies include initial public offerings (IPOs), selling the business to another private equity firm, or transferring ownership to a strategic buyer.
Each fund follows a predetermined investment strategy that may include venture capital, leveraged buyouts, or growth capital, with the primary goal of selling or exiting investments for a return that exceeds the initial price paid. Private equity funds typically charge both a management fee and a performance fee, known as carried interest. However, these investments can be riskier than others due to the inherent characteristics of private equity markets. In this article, we will explore the meaning of private equity mutual funds, how they work, their types, and their advantages.
What is a Private Equity Fund?
Private equity funds are pools of capital to be invested in companies that represent an opportunity for a high rate of return. Common types of private equity funds include venture capital funds (VC), hedge funds, insurance companies, pension funds, and other alternate investments. This investment strategy is limited to a limited number of wealthy institutions and high-net-worth individuals (HNIs). Private equity fund investment comes with a lock-in period, which can range from 3 years to 10 years.
One of the main reasons why wealthy individuals and institutions opt for this investment is because it usually provides its investors with a return that is higher than that of the public market. As per a McKinsey report (June 2022), the total Assets Under Management under the private equity fund market is Rs. 11.7 trillion.
Types of private equity firms
Private equity firms can be broadly divided into two primary categories: Venture capital firms and Buyout firms.
- Venture Capital Firms: These firms invest in early-stage companies with high growth potential. They typically provide funding in exchange for a minority equity stake, aiming to capitalise on the company’s future success.
- Buyout Firms: These firms focus on more mature companies that they believe can be enhanced through operational improvements or restructuring. They usually acquire these companies through a combination of debt and equity, often taking a controlling interest in the process.
The right type of private equity firm for you depends on your investment goals and risk appetite. If you’re seeking higher-risk, potentially higher-reward investments, a venture capital firm could be a suitable choice. On the other hand, if you prefer a more conservative approach, a buyout firm may align better with your investment strategy.
Top 3 examples of private funds
Some of the popular private equity fund examples you may have heard of include:
Blackstone Group:
It primarily invests in:
- Real estate private equity
- Healthcare private equity such as Crown Resorts and Service King.
The Carlyle Group:
This private equity fund group has invested in a wide array of companies belonging to various sectors. Some of their mentionable investments are in Acosta and Memsource.
Apollo Global Management:
This private equity owns a wide range of brands including CareerBuilder and Cox Media Group.
How do private equity funds work?
Generally, a private equity firm or an investor group invests a pool of money in a prospective private company or a company group, which has a high potential of growing rapidly. Private equity fund invests in companies that need money to grow their operations/profit. These funds also invest in companies that are financially struggling. The money infused by the private equity funds helps struggling companies get back on their feet and eventually grow. In return, the private fund gets a stake in the management of the company. However, they only invest in such companies if the management of the private equity fund believes that the founders and promoters of the company can use the money to grow the company.
The main motive of private equity investors is to get a decent return from the private companies in which they are investing. They give money so that the struggling company can expand their business, make money, and in turn give them a profitable and high return exit after the lock-in period ends.
The decision-making works or management of private funds are done by the “general partners.” They not only decide where to make profitable investments but also manage the money of the fund.
But how do they raise money for investing? These private equity companies seek funds from limited partners. They also set goals for fundraising. When these companies achieve their fundraising goals, they close the round. Then they use this fund to invest in prospective companies that are looking for private capital to grow.
Once the companies turn around their fortune, the private equity funds withdraw their fund and holdings. In return, they get a hefty profit share during exit.
What are the benefits of private equity funds?
- Debt-free funding
They provide financially struggling companies with debt-free capital. While emerging companies get a large amount of seed money for expansion and growth, the PE funds stay invested for a certain period to get a higher return at the time of exit after the company turns around its fortune. - High growth potential of the untapped market
The private funds usually invest in companies belonging to untapped markets. This gives them the potential to make good money. The private companies where PE funds usually invest are financially struggling firms, startups with high upward potential, unlisted companies, and more. - Higher returns
If you are a shareholder of a private equity fund, you can expect a higher return than an investment made in the public market. As PE funds invest in emerging businesses, the growth potential is extremely high. That’s why, in the long run, you can expect a significant return. The probability of getting higher returns increases as these private equity funds are run by experts who follow strict processes in choosing companies. This not only mitigates the risk to investors but also protects the rights of shareholders.
How are private equity funds managed?
Private equity funds are overseen by a general partner (GP), usually the private equity firm that created the fund.
The GP is responsible for all management decisions regarding the fund and typically invests 1% to 3% of the fund's capital to demonstrate commitment. In exchange for their management role, the GP typically receives a fee, often 2% of the fund’s assets, and may also earn 20% of the fund’s profits above a specified threshold as performance-based compensation, referred to as carried interest in the industry.
Limited partners (LPs), who are the investors in the fund, have limited liability. While they do not have a direct role in managing the fund, they retain the right to vote on significant matters, such as the sale of a portfolio company.
Final words
Private equity funds utilise multifarious investing strategies including venture capital, leveraged buyouts, turnaround situations, and growth capital. These PE funds explore the untapped markets to get higher returns to their investors.
Explore 1,000+ mutual fund schemes at the Bajaj Finserv Platform. Use the SIP Calculator or Lumpsum calculator to plan your financial goals better and compare mutual funds to pick ones that are best suited for your portfolio.
