Q. What is Private Equity?
Ans. Firms that invest in Equity of Private Companies with an aim to exit at higher valuations in the future. Investors will invest in an idea or technology or a struggling company. Investors will provide their management & skills in the hope of turning the firm profitable & then selling it at a higher valuation. Planify is the largest private equity Marketplace in India.
Examples of Famous Private Equity Firms:
Planify Capital Ltd.
Motilal Oswal Ltd.
IDFC Private Equity
ICICI Venture Fund
Four Asset Classes for Investment:
1. Equity Investment -> Stock Market, IPO
2. Fixed Income Investment-> Bonds, Debentures, Fixed Deposits
3. Commodities-> Gold, Silver, Copper, Wheat, Crude
4. Alternative-> Real Estate, Currency, Crypto Currency, Private Equity
Private Equity falls into the Alternative Class of Investments.
Structure of Private Equity:
1. Four people come together & establish a fund, say ‘ABC Fund’. These 4 people are General Partners. They plan to use this fund in investing in particular ideas and technologies. Other than funds, they'll bring connections experience etc.
2. For raising funds, they'll contact big institutions like LIC, Pension Funds & High Net-worth Investors.
3. They'll invest funds in different businesses. The main motive is to make the companies achieve higher valuations & then exit or sell them to someone else.
Characteristics of Private Equity with Examples:
|Particulars||Amount Invested ||Exit Value (After 5 years)||Profit/Loss|
|Company A||Rs. 150 Cr. ||Rs. 550 Cr.||Rs. 400 cr.|
|Company B||Rs. 20 Cr.||Rs. 70 Cr.||Rs. 50 Cr.|
|Company C||Rs. 120 Cr.||Rs. 30 Cr.||Rs. (90) Cr.|
|Company D||Rs. 95 Cr. ||Rs. 350 cr.||Rs. 255 Cr.|
|Company E||Rs. 85 Cr.||Rs. 220 Cr.||Rs. 135 Cr.|
|Total||Rs. 500 Cr.||Rs. 1220 Cr.||Rs. 720 Cr.|
1. Private Equity charges higher fees. Common Fees Structure is 2 & 20 i.e 2% of Asset under Management every year will be fees & 20% of profits above a certain limit for which a benchmark is set.
Taking the above table as an Example:
Assuming benchmark as 900 Cr.
2% of 500 Cr. (Total investment) x 5 years= Rs. 50 Cr. (Fees)
1220Cr. -900 Cr. = Rs. 320 Cr.
320 Cr. - 50 cr. = Rs. 270 Cr.
20% of 270 Cr. = Rs. 54 Cr.
Total Fees= Rs. 50 + Rs. 54= Rs. 104 cr.
2. Information Edge on a day-to-day basis as they're involved in the management
3. High Risk = High Returns
4. Illiquid Investments due to Investments in different companies which reduces liquidity on hand
5. Less Regulated & Inaccessible to retail investors
Four Types of Private Equity Funds:
1. Venture Capital - Invest in Equity at an early stage of the company, generally having negative cash flows to earn profits in the future. If they provide seed capital, they're known as Angel Investors.
2. Growth Capital- The Growth Capital funds already set private companies which fall short on required assets. Due to the lack of required assets, such companies cannot use conventional means to raise funds.
3. Leverage Buyout- Borrow Equity of the company using borrowed funds. In Normal investments, this is a disaster. Generally, these companies have the capacity to generate consistent cash flows but are struggling due to Bad markets etc.
4. Distressed Buyout- Invest in loss-making companies which have the potential for a turnaround.
For e.g. Vedanta Group purchased Videocon. It can help Vedanta expand itself into other portfolios like Electronics, Telecom etc.
Exit Strategies: There are 5 Exit Strategies-
1. Secondary Sale- One P/E sells its shares to another P/E firm at a higher valuation is a Secondary Sale. That P/E firm might sell to another and so on & so forth. One major product Planify offers is related to the Secondary Sale of Shares.
2. Repurchase via Promoter- If Private Equity funds invest in a company & are able to turn it profitable & sustainable, then promoters suggest buying back at a higher valuation.
3. Initial Public Offer- Private Companies offer their share to the public.
4. Liquidation- When market conditions are bad or there are no buyers for the company & Private equity funds don't want to invest for a very long period. Then, instead of selling, they liquidate them by dividing these companies into parts & sell each.
5. Strategic Acquisition- Selling it to a firm that is already in that business.
For Example: A private Equity Firm invested in a Restaurant Business & was able to turn it profitable with 20 branches. Now, during exit, they sell it to another existing Restaurant chain. This is a Strategic acquisition for the buyer.