What does private equity mean?

In a low interest rate, low growth environment, investors are seeking out less conventional ways to make money. One of these strategies is to invest in private equity. In this article we discuss what private equity means and the advantages and disadvantages of these investments.

Definition

Private equity are investments which are not listed on the public markets. Investors who are seeking returns that are higher than what is on offer on the listed markets, may look at these alternative investments. Investors who are institutional or who are high net worth individuals, pool their capital together into a fund. The funds are used to invest in companies which are not publicly listed. The time horizon of private equity investments is long term as it can be from five to seven years. These investments look to buy majority stakes in mature private companies and implement a strategy to add value to the company by rectifying the operational inefficiencies to make the company profitable. The private equity fund looks to make money for its investors through its exit strategy. This strategy could involve the private equity fund selling the company to a third party or the fund can initiate an initial public offering to return investors their initial investment with a profit.

Advantages

  • Historically, private equity returns have been higher than publicly listed equities.
  • Private equity performance is calculated on absolute return which means it seeks to make a positive return regardless of what is happening in the equity market.
  • In a low growth environment, private equity investments have become popular as these funds are investing into small companies which potentially have higher growth prospects than listed products.
  • Investors can diversify their portfolios by investing in a non-listed investment.

Disadvantages

  • Investors in private equity funds will have their capital tied up in these funds for five to seven years.
  • Private equity investments are under less regulation than listed investments.

How does private equity differ from venture capitalists?

Venture capitalists invest in the early stages of a start-up. Private equity funds invest in companies that are already operational and mature. These investors are looking to buy into established business but rectify the operating inefficiencies to make them more profitable.

Venture capitalist are looking to purchase 50% or less of equity in these start-up companies whereas the private equity funds are looking to buy a majority of ownership of mature companies so they have total contract of the firm.

Lauren Hua is a private client adviser at Fairmont Equities.

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