Private Equity for Beginners

Private equity covers a broad scope and beginners will surely be confused and overwhelmed. Private equity for beginners seems challenging to understand but if they begin to take some effort and time to dig deep, they will surely gain clearer and better insights.

What is Private Equity Really?  

If you are a beginner, you definitely need to start with private equity’s definition. What is private equity really? Private equity is a common term used to describe funds of all types which pool money from many different investors to be able to amass millions or billion dollars that are eventually used to obtain stakes in particular companies.

Technically speaking, venture capital is considered private equity but the latter is frequently associated with funds luring for revenue-generating and mature companies that need revitalization and probably even tougher choices just to become worth even more.

While the venture capital usually goes to younger companies that are involved in cutting-edge yet unproven technologies, the funds referred to as private equity become more attracted to already established businesses like service  businesses, manufacturing businesses as well as franchise companies.

Investors in Private Equity

Beginners need to learn that investments are done in exchange of particular equity percentage of said investment. There are instances that this particular type of investment is actually done to obtain complete or major control of companies in anticipation of much higher returns. Aside from making good investments in private companies, private equity investors at times purchase out public firms or companies which results to delisting.

Investors in Private Equity

Private equity fund utilizes money that was invested by labor unions, pension funds, universities, insurance companies, large and wealthy individuals and families.

History of Private Equity

For beginners in private equity, understanding its history is crucial. Private equity came to existence through the leverage buy-outs in the late 1970s. This took place because of Michael Milken, the creator of LBOs for utilizing this as leverage. They used to leverage companies with debt capital and equity capital so as to purchase them. Private equity firms today are actually nothing but what the LBOs in the past.

How Private Equity Works?

There are times that private equity companies will purchase out a particular company outright. The founder will probably stay on to manage the business or maybe not. Other strategies for private equity include purchasing out the founder, giving expansion capital or recapitalization for struggling businesses, and cashing out the existing investors.

Private equity is likewise linked with leverage buyout wherein funds borrow additional money in order to enhance its purchasing power utilizing assets of acquisition targets as collateral.


Are founders becoming crotchety? Are original investors asking for payday? Is business losing mojo and in need of serious overhaul or cash infusion? If yes, private equity is a way to go. Private equity funds might likely come in with fresh ideas or maybe new managers who may provide the business with second wind.


Young and new companies that are on their early stages do not actually fit well to private equity investment strategies. Also, private equity funds’ ultimate goal is making the company worth over than it was before to be able to produce return for investors.

The role of founders in businesses, workforce and even the long-term success of businesses can be secondary to these goals. You therefore need to be ready for some mercilessness.

The Twist

A type of private equity fund known as the search fund is now gaining increased popularity. Rather than pooling cash to invest in business, investors throw some hundred thousand dollars behind would be entrepreneurs searching for best business that they can acquire and run. If future CEO finds the suitable target, investors will then pitch on the millions needed to finally make the purchase.

This can be the ideal answer for business that’s not just in need of investments but for top new executives that can turn the things around.

Private Equity Structure

Private equity fund is mainly structured as closed-end investment vehicle. Private begins as limited partnership by general partner or fund manager. Fund manager carry out the regulations and rules that governs the fund. Remaining investments are made by investors like pension funds, families, universities and many other investors. Every investor is considered limited partner in this fund. Therefore, liability of limited partner equates into its capital contribution. There are some PE firms with institutional sponsors or captive units or other companies’ spin offs.

The limited partners make agreed commitment for set period that’s investment period that can be about 4 to 6 years. Once portfolio investments are realized, that’s the underlying company sold either to strategic investor or financial buyer or it may have gone public through IPO; funds tend to distribute proceeds back into the limited partners.

Private Equity Fees

Similar to hedge funds, the private equity is known to charge the following fees:

  • Management Fee

This is an expense that is consistently paid by restricted partners. It is figured as a specific percentage of the total AUM. For instance, if the AUM is 500bn than 2%, administration or management fee will be about $10bn. The requirement for this charge is actually for covering the managerial and operational costs of fund, for example, compensations, and bargain charges paid to advisors, investments banks, travel costs and so forth.

  • Performance Fee

This is the share of the net profit that is apportioned to the General Partner.  This too is a sure percentage or rate of all the profits made. For instance, 20% of total profit gained. In most instances, a general partner can acquire it upon achieving hurdle rate. For instance, the limited partner might ask that performance fee gets paid only if return is more than 10% p.a. So the performance fee will be received by the general partners upon earning the 10%.

Private Equity Deal Structuring

Private equity will fund and support a company in various ways. The common stock and the convertible preferred stock are two essential ways by which a certain company is properly invested. The private equity deal is organized and structured after transactions with investee and set down in term sheets.  In most instances, the financing will have hostile anti-dilution provision. It shields the investor from later stock issues at lower price than what the investors originally paid.
Private equity deal structuring can actually be done in different ways such as:

  • Common Stock

Investee and the investor concede to a specific sum that will be provided as assets or funds and the stock percentage, the investor will get.

  • Preferred Stock

Numerous private equity firms are constantly quick to utilize mostly Preferred Stock arrangements to fund in a certain company. These investments in Preferred Stocks can be changed Common Stock at holder’s option.

  • Debt Financing w/ Equity Kicker 

Debt financing with equity can be utilized by investees who are as of now profitable and operational and have achieved break-even. For instance, if the investee needs about $100,000 to make him overcome the hurdle and make his organization or company gainful, the investee can actually structure the amount of $100,000 in a credit loan  provided that the loan would be about 3-5 years and after that it will give the investor 10% of his organization in common stocks. The quantity of the shares depends on the loan size and the company’s value.

  • Convertible Debt

In case financing is carried out by means of convertible debt, investor has all the right to change on their own choice to Common Stock of organization or a company. For the most part, investors should practice their right to change or convert when investee decides to go public with the goal that they can gain decent returns for their investment ventures.

  • Reverse Mergers

When a current privately owned business is converged into already-existing public company with trading symbol, reverse merger is believed to occur.  Public companies are typically known as “shell companies”. A shell company is characterized as an open or public company that is no longer working as a business yet in existence and has trade symbol. The business of this public entity clearly has fizzled and that organization is bankrupt, however, public shell or public entity exists still. This is said to be the key factor in Reverse Merger.

  • Participating Preferred Stock

This is comprised of two components- common stock and preferred stock.  The preferred stock gives a privilege to owners to get a specific amount of money that is normally pre-determined. This entirety of cash contains original investment in addition to accrued investments. This money is given if company is liquidated or sold. The common stock on the other hand is the extra continued ownership in the organization or company.  Same as the preferred stock, even the participating preferred stock can be changed to equity not resulting to activated participating feature when company makes Initial Public Offering or IPO.

  • Multiple Liquidation Preference

In this preferred stock arrangement, holder of particular round of financing has the privilege to get multiple of original investments when a company is liquidated or sold.  This multiple can actually be two times, thrice or even six times. The multiple liquidation preferences enable investor to change into common stock if company functions well and is capable of generating higher returns.  

  • Warrants

Warranties are subsidiary securities giving the holder the privilege to buy company shares. This purchase is made at pre-determined cost. For the most part, warrants must be issued by the investee so as make the bonds or stocks more alluring to different potential investors.

  • Options

Options provide investor the privilege to buy or sell stock shares at a particular cost within particular timeframe. The most commonly utilized are stock purchase options.

  • Full Ratchets

Full Ratchets is a system of securing investors for down rounds in the future. So, full ratchet arrangement or provision would express that if an organization in future issues stock that is at a lower cost for every share than the existing preferred stock, the price conversion of existing preferred stock in that scenario will be adjusted downward for lower and newer price. As a result, there is an increase in the number of shares of the previous investors.

These are the ways on how private equity deal structuring is done.

Attracting Private Equity-Essential Tips to Follow

Companies in different sectors and of all sizes are usually in need for capital infusions at certain point of their existence. Nowadays, there are various interesting ways for different companies to raise funds that they actually need. The private equity can be of great help for those companies searching for ways to substantially grow, tap into completely new markets, obtain another entity, exit for great sum in the future or simply utilize capital to accelerate other well-planned goals. However, attaining investments from private equity company can be more challenging as compared to getting these from other resources. Firms or companies hoping to significantly leverage on this potential option need to be on top of their game.

The following are helpful tips on how to lure private equity:

Staff Wisely

Most investors are regularly as keen on individuals behind a business as they are the cash that the business creates. In numerous private equity offers and deals, the investing company will work intently close by the organization to enhance tasks and boost productivity and profitability. Truly, there might be few circumstances in which there’s a straight buyout. In any case, for regular types of investment deals, the investment company will be investigating the employees and leadership team to guarantee that there is confidence and trust on how the firm is run.

Grow Market Reach

Private equity companies wanted to see that a company they intend to put resources and investment into has a ton of development potential. One approach to show this is by broadening and growing the company’s market reach. This can be proficiently accomplished through dabbling in a variety of items, entering another market segment or focusing on an alternate kind of client base. In addition to demonstrating numerous possibilities, taking part in ambitious expansion plans additionally helps in showing that leaders are courageous and bold, which is a decent method of attracting interests of those savvy investors.

Keep up Meticulous Records

Any trustworthy investor will require an organization to uncover a huge amount of data about its activities, practices, and funds, so having highly meticulous records is an absolute necessity. Indeed, even a little investment venture will include a genuinely itemized review of an organization’s dealings, so each detail should be managed properly. Having well-organized and efficient records will both impress forthcoming investors and encourage progress of investment deals when or if it emerges. To guarantee records are carefully kept up, it is a smart thought to set up a corporate repository from the earliest starting point of the company’s existence and to keep an eye on the association of imperative documentation all the time.  In case online database is used like virtual information room, this can simply become the starting stage for deal room in times that due diligent investigations are necessary.

Establish Stronger IP Protections

Successful and profitable companies for the most part have a scope of both intangible and tangible assets. It is obviously simpler to safeguard the tangible assets by putting away things in a safe area, acquiring protection through insurance, and taking different measures to defend any physical things. Obviously, companies also have intangible assets and resources, which at times is some type of Intellectual Property or (IP). This Intellectual Property can be somewhat harder to distinguish and accordingly protect, however organizations must guarantee that they do as such to ensure protection of the IP value. For a few organizations, losing this IP might mean losing the business. What’s more, with regards to acquiring funds from private equity firms, there will be unwavering expectations that proper applications and filling have been properly submitted.

Outline Exit Plan

For majority of private equity firms, investment is actually intended to keep going for five or more years and afterward the objective is to liquidate through massive sales or maybe through IPO launching. Company leaders usually have comparable plans, yet getting a private equity investor in order to fork through the capital expected and needed to come up into that point will need some very serious persuading. Consequently, it is critical for those company leaders wanting to go that particular point and route to integrate coherent and effective exit plan to their overall strategic plan and business model.

These are actually just few of the essential pointers and insights that individuals especially the beginners should learn. If they wish to learn more and gain deep knowledge about private equity, the can just go online and search and browse for relevant information. There are articles and many other write-ups focusing on private equity for beginners that they can read and referenced into. The internet offers plethora of information that even beginners can easily learn and understand. Also, there are ways and tips that can help you in case you wanted to attract or lure or attract private equity investments.