What is Private Equity?

What is private equity?

Private equity is an investment asset class known for investing in private companies to deliver higher returns than afforded by public markets. But what is private equity, exactly? Can you invest in private equity? Let’s find out.

How does private equity work?

Private equity firms invest in privately held businesses, with the goal of growing revenue, increasing profitability, and ultimately selling at a higher valuation. While private equity funds were historically the domain of institutional investors, they have become increasingly accessible to individual investors.

However, not everyone can invest in private equity. Since the committed capital to private equity has to be invested for the long-term, access for individuals is usually exclusive for accredited investors, who are defined by authorities as qualified to invest based on certain criteria, such as their net worth, income, assets, or experience.That said, there are more platforms available now for retail investors to invest in private equity.

The Private Equity fund cycle typically follows four key stages: fundraising, investment, management, and exit.

• Fundraising: Private equity firms raise money for the funds from investors, which can include institutional investors, high-net-worth individuals, family offices, and others. These investors commit their capital to the fund to be invested over a multi-year period.

• Investment: Once a fund has been raised, the private equity firm, or the fund manager, deploys the capital into investments in various opportunities, also referred to as portfolio companies.

• Value creation and management: The private equity firm takes an active role in managing its portfolio companies’ businesses. This means working closely with the company’s management to improve operational efficiencies, for instance, implement new strategies to generate revenue, make operations more efficient, expand overseas, cut costs, or all of the above. Essentially, a PE firm doesn’t only provide the money, but also guidance and help in running a good and profitable business.

• Exit: There are many ways to exit. A PE firm can file to take a private portfolio company public through an initial public offering (IPO) on a stock exchange, merge with another company, or sell the company to another buyer. How and when to exit depends on market conditions and the performance of the company. Successful exits can generate substantial returns for the PE firm and its investors.

What are the fees involved? How do fees work?

Have you ever heard of “two and twenty”? That is referring to the traditional fee models that ivnestors pay pPrivate equity firms funds typically charge. “Two” (2%) comes from management fees, and “twenty” (20%) comes from carried interest, We’ll explain.

Management fees are a fixed percentage of the total committed capital or assets under management, which is typically 2% per annum during the initial investment period of three or five years.

Carried interest or, “twenty,” this refers to the private equity firm’s share of the profits from the investments made by the fund. As the carry depends on the performance of the investments, PE firms have strongly incented io grow the portfolio companies.

For example, a fund manager raises $100 million. The investment generates $100 million in profits. The PE firm therefore gets 20% of $1300 million, or $2060 million in carried interest, plus the management fees incurred over the investment period. The rest are earned by the investors who have pooled money in the funds.

Is private equity profitable for investors? 

Institutional investors such as pension funds and endowments have been allocating more investment capital to private equity in the past two decades because of the potential to generate high returns. Sometimes, private equity firms have used a mixture of equity and debt to acquire, grow and exit companies with great success -- these are called leveraged buyouts, a private equity strategy. ore sovereign wealth funds, insurance companies, pension funds, and various other institutional investors actively investing compared to a few decades ago.

Fast forward to today, private equity is becoming increasingly accessible to accredited individual investors and everyday retail investors. However, individuals may face some obstacles when investing in private equity. Notably, assets are illiquid in private equity, so investors need to be prepared to lock up their money for a multi-year time period.

Still, the demand for private equity is increasing among investors who would like to tap on returns higher than what they can get on the listed markets.

Explore how you can invest in private equity through Arta Finance.

With Arta Finance’s suite of alternative investments, you can sign up and invest in minutes. For example, if you wish to get exposure to a private equity fund, Arta allows you to initiate your commitment to one. Simply sign the subscription documents and fund your investment, and Arta ensures the fund manager puts your money to work.

Take your first step to invest in private equity today.