The Private Equity industry has grown rapidly amid increased allocations to alternative investments. A source of investment capital, private equity comes from firms that buy stakes in private companies or take control of public companies with plans to take them private and delist them from stock exchanges. Private equity can also come from high-net-worth individuals eager to see outsized returns.
The underlying reason for private equity investing is to achieve returns on investment that may not be achievable in the public market. Partners at PE firms raise and manage funds to yield favourable returns for shareholders, typically with an investment horizon of four to seven years.
Private equity firms have a range of investment preferences. Some are strict financiers or passive investors wholly dependent on management to grow the company and generate returns. Because sellers typically see this as a commoditized approach, other PE firms consider themselves active investors. That is, they provide operational support to management to help build and grow a better company.
Active private equity firms may have an extensive contact list and C-level relationships, such as CEOs and chief financial officers within a given industry, which can help increase revenue. They might also be experts in realizing operational efficiencies and synergies. If an investor can bring in something special to a deal that will enhance the company’s value over time, they are more likely to be viewed favourably by sellers.
For more established companies, PE firms tend to think they have the ability and expertise to turn underperforming businesses into stronger ones by finding operational efficiencies and increasing earnings.
This is the primary source of value creation in private equity. However, PE firms also create value by aligning the interests of company management with those of the firm and its investors.
