Private equity (PE) investments have come to the fore recently. This is due to the boardroom squabble between Mrs Bukky George, founder, and CEO of online retail pharmacy Healthplus and its investors.

In 2018, HealthPlus announced a partnership with London-based Alta Semper Capital. Alta Semper was expected to invest US$18 million into HealthPlus. The funding was to enable the company expand its retail footprint and enhance its competitive position.

Private Equity as an Asset Class

PE firms invest capital into private companies . Private equity is a general term used to describe all kinds of funds that pool money from a bunch of investors in order to amass millions or even billions of dollars that are then used to acquire stakes in companies.

Private equity comes from high-net-worth individuals and firms that purchase stakes in private companies or acquire control of public companies with plans to take them private, eventually delisting them from stock exchanges.

The PE industry is comprised of institutional investors such as pension funds, and large firms funded by accredited investors. The fee structure for private-equity firms varies but typically consists of a management and performance fee. A yearly management fee of 2% of assets and 20% of gross profits upon sale of the company is common, though incentive structures can vary considerably.

Investors seek out PE funds to earn returns that are better than what can achieved in public equity markets. Partners at firms raise funds, typically with an investment horizon of between four and seven years.

Types of PE Firms

PE firms have a range of investment preferences. Some are strict financiers or passive investors wholly dependent on management to grow the company and generate returns.

Sometimes a private equity firm will buy out a company outright. Maybe the founder will stay on to run the business — but maybe not. Other private equity strategies include buying out the founder, cashing out existing investors, providing expansion capital. They can also recapitalize a struggling business.

A type of private equity fund called a search fund has been gaining popularity recently. Instead of pooling money to invest in a business, the investors throw a few hundred thousand dollars behind a would-be entrepreneur who searches for the best business to acquire and run. If the future CEO finds a suitable target, the investors then pitch in the millions needed to make the purchase.

Active PE firms have an extensive contact list and C-level relationships. These relationships can help increase revenue. They may also be experts in realizing operational efficiencies and synergies.

Among other support work, they can walk a young company’s executive staff through best practices in strategic planning and financial management. Additionally, they can help institutionalize new accounting, procurement, and IT systems to increase the value of their investment.

Exit Strategies

A PE fund’s ultimate goal is to make the company worth more than it was before. Sentimentality, the workforce, the role of the founders in the business, even the business’ long-term success — they can all be secondary to this goal. So be prepared for some ruthlessness.

One popular exit strategy for private equity involves growing and improving a middle-market company and selling it to a large corporation for a hefty profit.

The Bottom Line

With funds under management already in the trillions, private-equity firms have become attractive investment vehicles for wealthy individuals and institutions. Understanding what private equity exactly entails and how value is created in such investments is important. Especially as the asset class is gradually becoming more accessible to individual investors.