Private Equity Funds basically relate to a cumulative investment plan, which includes investment making in different equities in accordance to a single investment strategy linked to a private equity. Private Equity Funds lie in a category similar to limited partnerships, involving a fixed time period of ten years, which can be extended on annual basis. A fund of Private Equity Funds is known as Private Equity Fund of Funds.
Private Equity Funds reduce the involvement of the investor and relieve him of keeping a continuous watch on the share market or looking for an appropriate area to invest, like in shares. A private equity firm makes use of its veteran professionals to invest in suitable areas and implement expert strategies to multiply the investor’s money. A single private equity company under which funds have been purchased operates a string of different private equity funds. In short, one can be assured of the fact that an investment in Private Equity Funds is a safe mode of multiplying one’s hard earned money, unlike investing directly into the stock market. However, even private equity funds are subjected to ups and downs depending on the stock market conditions.
The company in which a Private Equity fund makes capital investments is called a Portfolio company. Usually, a majority of Private Equity Funds are framed under the category of limited partnerships, abided by an array of terms made under the limited partnership agreement, denoted as LPA.
Private Equity Funds generally include a General Partner (GP) which assists in raising capital from institutional investors including pension plans, insurance firms, universities, foundations, endowments and individual sources. These investors serve as limited partners (LPs) under the fund. However, the capital investments made by the Portfolio Company are financially backed by the capital facilitated from LPs. In some cases, capital raised is partially financed and in some cases it is substantially financed by debt. The Portfolio Company is the main source for redeeming such a debt and virtually serves as a money machine.
A LBO- Leveraged Buy-out is the term used in cases where investment transactions made by Private Equity Fund is leveraged using debt financing. In majority of the cases, commercial banks serve as the optimum source of LBO financing. However, one can also opt for other sources such as Hedge funds and Mezzanine funds.
Investment Features and Key Considerations:
An investor must always make the below mentioned fundamental considerations before investing in Private Equity Funds:
- One should make sure that the structure of the prospective Private Equity Funds should be unbiased. It should not be partial towards the tax position.
- The structure of the Private Equity Funds should be such that the investor should be granted with the limited liability benefit.
- The main point of consideration under a Private Equity Fund is that it should not include an additional tax. Such considerations have triggered almost all Private Equity Funds to be transparent. This principle is depicted from the fact that all the capital investment made into a Private Equity Fund is deemed to be a similar investment directly diverted in the portfolio companies. The UK limited partnerships follow a transparency structure as mentioned above.
Benefits and Risks Associated with Private Equity Funds:
Private Equity Funds involve myriad forms of terms and conditions under them. Hence, it is advisable that the investor should always scrutinize and weigh all the pros and cons before investing in a particular fund.
- Capital investments made in Private Equity Funds facilitate the opportunity to access the skilled advice of adept investment professionals. The assistance extended by these veterans witnesses one’s money going in safe hands and under robust vigilance.
- Besides offering benefits for the investor, Private Equity Funds are beneficial at the company’s end as well. Private Equity Funds assist a big publicly held firm in overhauling its business outlook and refurbish it. In addition, Private Equity Funds permits multinationals to keep a hand on a minority stake, as a result of which performance can be boosted. Apart from this, Private Equity Funds facilitate an opportunity to publicly operated companies to entrap its over-regulation towards listed firms.
- With the best private equity managers significantly outperforming the public markets, Private Equity Funds can provide high returns.
Private Equity Funds have some associated potential risks and come with certain stern guidelines mentioned under it. These guidelines are framed in a view to clearly describe the eligibility criteria that needs to be fulfilled by the investor prior to investing in these portfolios.
- Some Private Equity Funds can only be purchased by institutional investors or individuals with heavy pockets and bank balance. These individuals need to show their assets. One further necessity included under Private Equity Funds is that the investor should not be new to the private equity investment. In such a case, the individual seeking to make sophisticated investment will have to make a commitment outlining that the investor would make large chunks of capital for a boosted time period.
- As these vehicles involve a long term commitment and are subjected to mark vulnerability, the assets will not be considered as liquid. Besides, the investor should well discern the risk that he might fully or partially lose his capital investment if the market crashes. By their nature, investments in Private Equity Funds tend to be riskier than investments in publicly traded companies.
- The limited marketability and transferability offered in Private Equity Funds can be a deterrent.
- The tax considerations involving Private Equity Funds are intricate.
- There is a stark absence of effective regulation and safety in Private Equity Funds.
- Investors in Private Equity Funds are passive and rely on the manager to make investments and generate liquidity from those investments. Typically, governance rights for limited partners in Private Equity Funds are also minimal.
- If a private equity firm can’t find suitable investment opportunities, the investor’s commitment to a Private Equity Fund is drawn over time and the investor may potentially invest less than expected or committed.
Investments in limited partnership interests which are a dominant legal form of Private Equity Funds are referred to as illiquid investments. Once invested, it is very difficult to achieve liquidity in Private Equity Funds.