Find answers to some of the frequently asked questions about the private equity industry.
Venture capital firms have similar business models as those found in private equity. However, their focus varies: venture funds largely invest capital in start-up and young companies with little or no track record. Private equity and buy-out funds focus on investing capital in more mature businesses that demonstrate the potential for growth in value and enhancing their performance over a prolonged period through structural, strategic management and operational improvements.
A very important point to understand about private equity is that all investments centre on improving the business and ultimately increasing its value over the long-term. Private equity investors succeed only when the companies they own succeed. If a private equity company fails to succeed, it not only loses its own money, but also that of its investors, ultimately damaging its ability to raise future funds.
In contrast, hedge funds typically have a much shorter time horizon. They act as pools of capital that usually invest in stocks, bonds or commodities and aim to capitalise on short-term gains, using complicated trading strategies and derivative financial instruments. Hedge funds usually have holding periods of weeks or months, not years.
Virtually every company, public or private, has a capital structure made up of equity (stock) and debt (bank loans, bonds, etc.). When a private equity firm looks to acquire a company, the financing will comprise the equity (capital) raised from investors as well as loans or 'leverage' from a number of other sources, primarily banks.
To succeed in improving the performance of a portfolio company a private equity firm needs to supply a great deal more than just financial creativity. Developing organic revenue growth is key to securing increased value within a company. To further enhance a company's performance it is also crucial to undertake substantial operational improvements, cost and waste reductions, improving the company's competitiveness, product repositioning and ability to enter new markets, as well as the development and execution of a sound business strategy.
In today's globalised world, private equity investment activity is increasing substantially. CVC's success in investing in some of the world's most prominent companies and developing their long-term value has helped to fuel the economy, create wealth and drive innovation. Empirical evidence shows that private equity portfolio companies create economic value by operating more efficiently. Academic studies have shown that private equity investment and leverage has an overall positive impact on the financial performance and efficiency of companies, especially since the transitional capital invested fills a critical gap when capital markets are fragile.
Ultimately, leveraged buy-outs of portfolio companies generate greater productivity, promote employment and salary growth, and have a positive effect on employee relations within the company. Superior returns from private equity investments strengthen pension funds that provide benefits for millions of employees. According to research carried out by Preqin, by 2008, the total net profits distributed to investors worldwide by private equity funds raised throughout 2007 were over US$1.1 trillion.
At the end of the holding period, an exit from a portfolio company is usually sought through: an initial public offering (IPO) or flotation of the portfolio company on the stock market; a 'trade sale' of the company to a strategic acquirer through a merger or acquisition (M&A); or a 'secondary sale' to another private equity house.