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Arman Salavitabar, CFA

Arman Salavitabar, CFA

Founding Partner, FundFront

Knowledge

Bringing Opportunities to Market: Strategies for Private Equity Firms

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Private equity (PE) firms significantly impact the investment world by pooling capital to invest in privately held companies, driving growth, and generating returns for investors. To bring these opportunities to market, PE firms employ various strategies. This paper explores three primary methods: traditional funds, holding companies, and direct investment platforms.

Traditional Funds

Structure and Mechanics

1. Capital Raising

Private equity firms begin by forming a fund, typically structured as a limited partnership (LP). The PE firm acts as the general partner (GP), while institutional and accredited investors become limited partners (LPs). The GP raises capital commitments from LPs, who pledge to invest a specified amount over the fund’s life.

2. Fund Lifecycle

  • Investment Period: Lasting typically five to seven years, during which the GP identifies, evaluates, and acquires portfolio companies.
  • Harvesting Period: Following the investment period, the fund enters a phase where the focus shifts to maximizing the value of investments and preparing for exits.

3. Fee Structure

  • Management Fees: Typically 1.5% to 2% of committed capital annually, covering operational costs.
  • Performance Fees (Carry): GPs usually receive 20% of the profits above a predefined hurdle rate, aligning their interests with the LPs.

4. Investment Process

  • Deal Sourcing: GPs leverage networks, intermediaries, and market research to find potential investments.
  • Due Diligence: Rigorous analysis including financial, operational, legal, and market assessments to evaluate potential acquisitions.
  • Acquisition: Structuring the deal, negotiating terms, and closing the transaction.

5. Portfolio Management

  • Strategic Guidance: GPs work with portfolio companies to implement growth strategies, operational improvements, and governance practices.
  • Monitoring and Reporting: Regular performance reviews, financial reporting, and compliance checks ensure alignment with investment objectives.

6. Exit Strategies

  • Trade Sale: Selling the company to another business.
  • Secondary Buyout: Selling to another PE firm.
  • Initial Public Offering (IPO): Listing the company on a public stock exchange.
  • Recapitalization: Restructuring the company’s capital, often to return capital to investors.

Holding Companies

Structure and Mechanics

1. Capital Structure

Holding companies raise capital through a combination of equity and debt. This structure provides greater flexibility in financing acquisitions and operations compared to traditional PE funds.

2. Ownership and Control

  • Equity Stakes: Holding companies acquire majority or significant minority stakes in subsidiary companies.
  • Centralized Management: Unlike traditional PE funds, holding companies take an active role in the strategic and operational oversight of their subsidiaries.

3. Investment Process

  • Target Identification: Similar to traditional funds, holding companies identify potential acquisitions through market research and industry networks.
  • Acquisition Financing: Leveraging both internal capital and external financing options such as bank loans, bonds, and equity issuance.
  • Deal Structuring: Crafting flexible deal terms that align with long-term strategic goals.

4. Portfolio Management

  • Operational Integration: Implementing synergies and efficiencies across the portfolio, such as shared services, centralized procurement, and technology integration.
  • Performance Monitoring: Continuous assessment of subsidiary performance, with a focus on long-term value creation.

5. Exit Strategies

  • Long-Term Holding: Holding companies often maintain ownership for extended periods, allowing for sustained value creation.
  • Strategic Divestitures: Selling underperforming or non-core assets to streamline operations and focus on key growth areas.

Direct Investment Platforms

Structure and Mechanics

1. Platform Development

Private equity firms create or partner with digital platforms to offer direct investment opportunities to qualified investors. These platforms provide a seamless interface for investors to access, evaluate, and invest in private equity deals.

2. Investment Process

  • Deal Sourcing: Utilizing technology and networks to identify investment opportunities.
  • Due Diligence: Streamlined processes for evaluating potential investments, often with the aid of data analytics and AI.

3. Investor Onboarding

  • Qualification: Ensuring investors meet regulatory and accreditation requirements.
  • Education: Providing resources and tools to help investors understand the investment process and risks involved.

4. Transaction Execution

  • Digital Interface: Investors can review deal details, perform due diligence, and execute transactions online.
  • Secure Payment Systems: Ensuring the secure transfer of funds and ownership documentation.

5. Portfolio Management

  • Performance Tracking: Investors can monitor the performance of their investments through the platform.
  • Reporting: Regular updates and reports on portfolio companies and overall investment performance.

6. Exit Strategies

  • Liquidity Options: Platforms may offer secondary markets or other mechanisms for investors to exit their positions before the end of the investment term.
  • Strategic Exits: Facilitating traditional exit routes such as sales, buyouts, or IPOs through the platform.

Conclusion

Private equity firms employ a variety of strategies to bring investment opportunities to market, each with distinct structures and mechanics. Traditional funds offer a time-tested approach with a defined lifecycle and fee structure. Holding companies provide flexibility and long-term capital for strategic oversight and operational integration. Direct investment platforms leverage technology to provide streamlined, accessible investment opportunities to qualified investors. By understanding these mechanisms, PE firms can effectively manage investments, optimize returns, and meet the evolving needs of their investors.

Written by:

Arman Salavitabar

Arman Salavitabar

Founding Partner, FundFront

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