Private Equity
Private equity (PE) investments are direct investments in companies that are not publicly listed on a stock exchange. They therefore involve private equity capital that is invested in companies. These investments are primarily made by specialized firms known as private equity funds.
Structure and Process of a Private Equity Fund
When a new private equity fund is launched, it first raises capital from investors, which is committed to the fund on a long-term basis for a period of about 10 years. This money is then used to acquire stakes in companies. As a rule, these are larger, unlisted companies. As part of an investment, private equity funds typically implement measures designed to increase the company’s value. After approximately three to seven years, the fund divests the acquired stakes and uses the proceeds to repay investors their capital and distribute any profits generated.
Common Strategies in Private Equity
The most common strategies in the private equity sector are summarized here:
1. Leveraged Buyout
Leveraged buyouts (LBOs) are used to acquire stable companies that are well-established in the market. In addition to the private equity fund’s equity capital, debt financing is also utilized. This has the advantage of concentrating the expected profits on a smaller equity base. Following the acquisition, measures such as cost-cutting programs or strategic growth initiatives are implemented to increase the company’s value. Leveraged buyout investors typically have clear expectations regarding the minimum required company size and profitability of the target company. Investments are therefore made only in medium-sized and large companies. The company sizes relevant to LBO investors start at around 10 million euros in revenue, but there is largely no upper limit. Leveraged buyout transactions in the billions are also possible.
2. Growth Equity
In the context of growth equity, investors provide funding to companies that are already established in the market. This capital is then made available to implement specific, capital-intensive expansion plans. For example, a company that has so far operated only in the German market could use growth equity to begin its international expansion. Growth equity investments for established companies can, if necessary, exceed the 100-million-euro threshold by a significant margin.
3. Venture Capital
Venture capital is a subset of private equity. In this context, equity capital is invested at an early stage in startups or young companies. Although these companies are often not yet profitable, they have realistic prospects of significantly expanding their business through economies of scale. Venture capital investments are often significantly smaller in the early stages than other private equity investments. Typical amounts range from six-figure sums to smaller millions. It is only in later financing rounds, when the company’s success becomes increasingly likely, that higher investment amounts are reached.
Exit
Since private equity funds hold investor capital for only a limited period—typically about 10 years—the investment must ultimately be sold. Therefore, after implementing the planned strategy—which aims to significantly increase the company’s value—the private equity investor will eventually divest from the investment. The holding period for an investment is usually between three and seven years. The target return (IRR) in the private equity sector is typically between 15% and 20% per year. Another key metric for private equity investors is the multiple of invested capital (MOIC). Here, the final proceeds are measured as a multiple of the original investment. It is common to aim for a Multiple of Invested Capital of 2x to 3x. If the goal is to achieve a Multiple of Invested Capital of 2, an initial investment of 20 million euros must ultimately yield at least 40 million euros.
So-called impact investors represent a newer form of private equity.