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What is private equity?

Discover the definition of private equity and understand its objectives, history, critique and benefits from a business perspective
David Friel

/ Last updated on 15th October 2017

The term private equity refers to a set of capital assets that are not available for public exchange. Private equity funds may more comprehensively be explained as investments that are made discreetly and directly in a private company, without being brought to public knowledge.

Related: A guide to venture capital

Private equity investments also include the allocation of capital assets for the purchase of public companies, which consequently lose their status of public equity institutions after the purchase. In other words, after a company is subjected to private equity investments, it no longer qualifies to be listed as a public equity on the stock exchange.

Private equity objectives

The primary purpose of private equity investments concerns the investors’ intent to gain higher rates of return by acquiring considerable or complete control over a business or a company.

Private equity investments and funding initiatives are commonly undertaken by institutional and retail investors, whose interest and objectives may be diverse and many.

The ultimate objectives may relate to the accomplishments associated with the discovery of modern and latest technology, strengthening a balance sheet, increasing working capital of a company or business or simply expanding a business network by making fruitful acquisitions.

Private equity practices and endeavours

A private equity firm operates through a combined effort of a group of partners, responsible for formulating decisions and assuring their practical implementation. The main goal is to ensure that the shareholder clients can benefit the most out of profitable rates of return.

Private equity investments and acquisitions entail the investors’ capabilities to allocate a considerable amount of assets for an extensive period of time. A typical investment period lasts for four to seven years on average. However, the general capital requirements are determined by a variety of factors, including the definition and type of companies involved, as well as the relative amount of funds accrued by a private equity firm.

Expansion and progress

Private equity is one of the most complex fields in the finance sector. A high level of expertise and experience is required to gain useful insights into the field and form judicious and rewarding decisions.

Undergoing extensive evolution over the past decade, private equity industry is now considered one of the most sophisticated aspects of the financial sector. Considerable extension has been observed in the magnitude of private equity markets since the 1970s, which has led to the increasing importance of the field. Today, private equity firms are a dominant and dynamic segment of the financial markets, attracting influential and leading performers from the global corporate world.

The history of private equity

The birth of private equity is a result of developments made in the venture capital and development capital industries in the UK.

The primary objectives behind the emergence and growth of the private equity market are considered as requirements and needs of the businesses that comprised the British corporate industry during the pre-private equity era, which were to lead to their growth and expansion.

Emergence of private equity markets

As a consequence of regulatory changes in 1981, the corporate sector in the UK felt the need to employ modified growth tactics and methodologies, eventually giving rise to private equity market. The emergence of private equity markets highlighted the need and significance of buy-outs, which formed the basis for a new set of principles that defined the young market.

This innovation led to the excitement and anticipation surrounding corporate industries, and businesses began to actively contribute towards private equity investments. During the 1980s, a rapid and steep growth was observed in the magnitude of private equity investments and capital funds.

Dominance of 3i

Despite a considerable growth of the private equity market as well as active participation from various corporate segments, the monopoly of 3i in the private equity sector during that era cannot be neglected.

3i served as an investment company, operating under the joint ownership of the UK Government and clearing banks. The company made use of the funds that were mostly provided by banks and insurance companies, under the title of captive funds.

The decline of private equity

The steep growth of the private equity market in the UK was hampered by the recession that struck the UK during the 1990s. Consequently, a rise in the ratio of investment failures was observed, which put a damper on till now unhindered and highly-progressive growth of the private equity sector in the UK. A sudden and drastic decline was also observed in the banking market, which eventually led to the drawing away and lack of interest of various parties in private equity.

Parallel to the rapidly emerging impacts and consequences of recession, the captive fund market too underwent a considerable development. Captive fund managers got increasingly involved in conducting buy-outs of their own companies and business entities, emerging as independent participants in the UK market. In the wake of these developments, 3i was now recognised as an investment trust in the UK stock market.

The consequential impacts that were experienced as a result of the 1990s’ recession led to a considerable reduction in the amount of captive funds in the UK market.

Resurgence of the private equity market

Private equity funds and trends have shown significant transformation since the impacts of the 1990s’ recession began fading away.

New changes were introduced at the turn of the century, and private equity funds began to expand in terms of size and diversity. Today, private equity funds are mostly attributed as a characteristic aspect of the international market.

How you may benefit from private equity investments

Private equity is considered as one of the most effective ways to enjoy high returns on investments.

This is probably the prime reason why investors have been highly interested in making private equity investments since the concept of private equity funds was introduced. Despite its entailing high risks, private equity is still considered as a worthy investment model, favoured by the majority of market participants.

Diverse investment opportunities

Private equity provides participants with diverse and numerous investment opportunities and can serve as one of the most effective aspects of financial investments. Today, private equity investments have the potential to lead a business towards global acclamation and recognition. Such is the extent of investment potential through private equity funds.

Investment opportunities – in the case of private equity investments – seem to be neverending. Private equity investors can invest in unlisted companies, start-ups, private business entities, unloved stocks of large corporations and organisations, as well as other unloved companies.

Improving value and selling potential

Private equity investments are usually focused on improving the market value of the company they invested in. Since the primary purpose of the allocation of private funds is a resale of the company, private equity firms are usually concerned with adding value to the company as a buying asset, making it an alluring prospect for the potential buyers.

As a result, private equity firms and investors are more inclined towards the application of measures and solutions aimed at producing long-term results.

Economic innovation

It has been observed that private equity-owned companies have a more liberated mindset when it comes to economic innovation. These companies give due importance to economic innovation, as an important factor that contributes towards improving a company’s value.

Funds and pensions

Private equity investments also provide an opportunity for the investors to have access to sizable and reliable funding assets when required. The returns from private equity investments can be used to contribute to a pension programme, financial aid funds for education and research, and for various other purposes.

Private equity in the present era

Despite various changes and influences, private equity continues to hold a strong position for itself in the marketplace. It has emerged as an important factor that contributes towards economic development and influences economic change on a large scale.

Funding SMEs

Today, the need for private equity is felt more than ever before, among various circles. As enterprises and small and medium-sized businesses begin seriously sharing the responsibility of creating jobs and providing employment, they need to be adequately funded. In the present day and age, private equity investment and funding is believed to be one of the most effective ways of funding these business entities, eventually ensuring the overall well-being of the entire economy.

Economic support

Private equity is a global and expansive phenomenon today. It includes undertakings that have a direct or indirect impact on the global and national economies. Working as an operative force behind economic growth, private equity is an active participant in creating job opportunities, generating profitable returns on investment and adding value and worth to a business entity.

Primary objective

Over time, private equity might have expanded to include more considerable and large-scale objectives, but its fundamental principles continue to remain the same, with very minor modifications. Making a business entity a more valuable and worthy selling prospect continues to work as the driving dynamic that motivates private equity investments.

Growing popularity

Most businesses now seem to be more inclined towards private equity investments, considering it a favourable aspect that is to benefit their companies and business entities.

The popularity of private equity is on the rise in the present age, and the concept of private funding for creating value for a business seems to be being rapidly accepted by various active market participants and leaders.

Critics’ take on private equity

Despite its tremendous growth and popularity, private equity too has been subjected to a considerable amount of criticism, pertaining to various schools of thought.

Primarily, private equity is excessively criticised for its operative mechanism and individual investment procedures. Considering two aspects of private equity that have faced the most criticism, it’s better to elaborate further on this subject with respect to their distinctive perspectives:

Criticism of individual investments

Criticism on individual private equity investments is primarily directed towards banking on considerable debt funds to carry out the acquisition of a company, organisation or any other business entity. These investments are further criticised for devising complex structures to be used as mechanisms and tools for reducing or eliminating tax payments.

A common practice in private equity is the establishment and application of procedures and measures that are to garner long-term results.  Some investors and firms, however, have deviated from the established practices, showing a tendency to implement measures focused on delivering short-term results. This aggressive approach concerned with private equity investments has been criticised widely as an inadequate anomaly.

Private equity investors and firms have also been criticised for taking the liberty to invest insufficiently in new products and procedures, as well as the lack of communication between stakeholders before and after acquisitive endeavours.

Criticism of private equity firms

Private equity investments are widely criticised for discretion of funding and concealing information from public knowledge. Concerns have also been raised regarding minimum regulatory assets and capital requirements for making investments in various business entities. As is the case with individual private equity investments, private equity firms have also been criticised for favouring procedures and practices that lead to tax evasion.

Related: Pros and cons of filing for IPO

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