Private Equity Pt. 3
Types of Funds and Types of Strategies
Between Private equity funds a binary distinction is made between strict and active investors. Strict investors purchase their desired investment without actively making alterations and instead rely on existing factors that are believed to increase the investments value. Using the example of a privately owned company, a strict investor would not have management make any changes based on their newly acquired share, and instead let the company operate as it was before the investment.
An active investor however would make changes that they believe will increase the value of the company. For clarity purposes, the following is best exemplified with a private company investment. Private Equity General Partners may fill C-suit positions or take board positions in the company, to gain relevant control. Additionally they can bring in their personal expertise in operational efficiencies and synergies which would significantly increase the companies profitability. In more general cases the inexperience found among the management of a start up can be guided by the more experienced General Partners. Active investing attempts to manage risk and generate value in the short to median term. They can help institutionalise new accounting, procurement and IT systems if needed.
Another differentiation between PE firms may be in the financing of a fund. As mentioned previously, private equity structures involve outside investors wealthy enough for a very notable investment, thus becoming an investor in PE is largely inaccessible for the average person. For most private equity firms this is the case, however others have public shares listed on stock markets. Firms themselves are traded as the company, where they finance investments with money raised publically. Companies that have found success with this approach include Blackstone Group (NYSE:BX) and The Carlyle Group (NASDAQ:CG).
When it comes the strategies behind the investments made, 7 are identified as the most common ones. These represent the different methods used to acquire the desired private equity.
Venture Capital entails investing into a small, young company, in an underdeveloped market with no track record of profitability. The intention is to initiate long term growth potential, expand the industry, and take a dominant position within it. Active investing serves this method of acquisition well, as a large shareholder position will allow the private equity firm to assist with its experience and other forms of less quantifiable support.
This strategy is relatively simple and involves the financial components of the real estate industry. Private equity firms often will either buy existing property or invest for equity in a developing property. In both cases it is possible for the PE firm to take an inactive or active role.
Growth capital investments focus on mature companies with proven business models that are looking for capital to expand or restructure their operations, enter new markets, or finance a major acquisition. Here there often exists the opportunity to both take an active investor position to initiate change or to serve solely as a financial injection which the company can use to further gain in value.
This refers to a very specific form of growth financing, structured as to consist of both debt and equity financing. Companies take on debt capital that gives the lender the right to convert said debt to an ownership or equity interest in the company if the loan isn’t repaid in a timely manner and in full. This will allow a Private Equity firm to take both an active and inactive investor role.
This strategy is often applied to mature and large companies, that have a sufficient record of assets and revenue. A private equity firm uses debt to purchase an otherwise extremely expensive steak in a company, as collateral for this loan the purchased company’s assets are used (or the share of it). The purchaser will only have to invest a small amount of money to finance the loan. This means that in the future, a private equity firm can either, sell off parts of the acquired company, or use the acquired cash flow as a means to pay off the debt and gain profitability thereafter.
Special Situation aka Distressed PE
The target company of this type of investment is one in need of restructuring, turnaround, or is in any other unusual circumstances. Here most definitely, active investing can be used to generate a quick turnaround in the company’s valuation, although passive investing would result in a significant opportunity through the new cash injection. Examples here would include; a large public company spinning off one of its smaller business units into its own public company, tender offers, mergers and acquisitions, and bankruptcy proceedings.
Fund of Fund
As the name implies, investments of this type enter all kinds of asset management funds. This allows the private equity firm to greatly hedge a large portion of their risk by investing across fund strategies. The downside of this strategy is attributed to the additional fees when investing in other funds.