In today’s market, “private equity” refers to any money invested with non-public companies which expects a yield for the use of the capital. Also, private equity can refer to buying public companies with the intention of making them private in the future. With either definition the idea is simple, private equity provides funding to companies that do not want to go public. As we will explain later, by choosing to not go public, there are a number of benefits these companies can receive by utilizing private equity. Now that we’ve covered this fundamental concept, let’s define the term private equity firm.

By definition, a “private equity firm” is a company which pools money to invest in non-public corporations, hoping to profit from growth. Since the private equity investors’ give legal authority to the manager, they can use their expertise to make the best investment decisions.  In most cases, this involves a detailed analysis of the companies they are prospecting, in addition to whatever diversification strategy they implement. To help you understand what we mean, we will give you an example. One on hand, private equity firm “A”  invests ONLY in biotechnology companies, diversifying amongst corporations at different stages of growth. On the other hand, private equity firm “B” ONLY invests in in the energy market, looking for late stage venture capital opportunities. Either way you slice it, the point is, each private equity manager has their own niche and strategy.  By defining their niche, and becoming an expert in that specific area, the private equity firm can create its unique formula for success.

Private equity firms invest in every major industry, assisting both small and big corporations. Though they do help many small companies, the real economic impact comes from their assistance in “late-stage venture capital’ opportunities.  By “late stage venture capital”, we mean companies which possess strong growth but not enough liquidity to reach their bigger goals. In many cases, you can have a company with huge potential, but not enough money to meet their product demand. By giving these companies thefunds to invest, it allows them to grow to their potential, adding money, ideas and jobs into the economy.  The great part is, private equity creates a positive economic cycle, keeping new companies flowing into the market at all times. In addition, they provide seed capital for new innovations which better the lives of everyone. If you take a good look around you, many of the biggest companies in the world have been funded through private equity. In fact, technology firms of all kinds are receiving private equity funding right now! For example, even Palm, the once-dominant PDA and smart-phone provider received $325 Million from Elevation Partners. The reality is, deals like this happen every day, and most people never appreciate the critical role of private equity.

In summary, if there weren’t private equity firms around, the markets would be a very scary place. Companies would either have to go public, or bang their head again the “glass ceiling” forever. With private equity funding now available to many businesses, this option has removed the pressure to go public. As most eventually learn, being in the spotlight isn’t the best choice for some products. With stock markets now recovering, it has become a perfect environment for private equity firms to profit. Hopefully this new trend continues, because as you now know, private equity is a market that can make or break any economy.

InsideTrade LLC Staff
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Before the crisis, the private equity market had been flourishing since its “MVP year” of 1978.  In this year, venture capital investments SKYROCKETED from a measly $39 Million in 1977, to an astounding $570 Million in 1978.  You may be asking yourself, “What could cause a 1000%+ increase in private equity investing in just one year”?  Well, that’s a question with a two-part answer. First, the government lowered the capital gains tax from a maximum of 49% to 28%, leaving investors with HIGHER net profits.  Second,  the government removed some of the strict legislation from ERISA, allowing pension funds to become major investors in private equity funds.  As a result of these new laws, institutional investors began piling into the private equity markets and things were great, until it all came to a screeching halt in late 2007.

Once market sentiment changed during the HEART of the financial crisis, it was almost impossible to find investors for private equity.   Unfortunately, with little to no faith in the economy, MOST of these investors left the market, protecting themselves from future risk.  Though this was the case in almost EVERY investment market, as you can see in the graph below, it was especially true in the private equity industry. Scroll down and take a look!

When you first glance at the chart, you have to be amazed by the HUGE drop in equity from Q4 2007 to Q2 2009.  Believe it or not, $178 Billion was raised by private equity funds in 2008, and ONLY $12 Billion was raised in 2009!  That’s a 93.3% DROP in money raised over just one year! As you can see, raising money in the private equity markets is almost impossible when there’s poor market sentiment.  The reason for this is simple, steady growth is what interests private equity investors, not “value hunting” during unstable times.

The reality of the current economy is this, there has been a massive financial disaster that has affected every market world-wide, and though it seems to be coming to an end, it may take years to fully resolve.  Now in the aftermath there is still plenty of hope, but the fact is, many investors are badly scarred from these recent events.  Despite all of the “fear” in the market, remember this, if you time things right in a depressed economy, you CAN “turn dust into diamonds” while it recovers.  To illustrate this critically IMPORTANT point, we have provided another chart below!

As you can see, private equity has rebounded faster than any other market, and it is VERY likely this will happen again.  Though it can be quite volatile at times, volatility isn’t always a bad thing. Remember, the smart investor buys during the “overcast”, and inexperienced investors wait until the sun comes out.

In summary, despite the turmoil from the recent crisis, the private equity market has a bright future for decades to come.   With the information and charts we have provided, you now see how private equity funds can either become rich or insolvent from a financial crisis.  It all depends on the strategy, timing, and expertise of the fund manager, just like every other investment…

InsideTrade LLC Staff
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With all of the wealth that now exists, you may ask, “Where do all of these high net worth individuals invest their money”?  Well, though most choose fixed investments (ex. Bonds, CD’s, Treasuries, etc.) for a portion of their portfolio, there are a rising number of investors seeking diversification within alternative investments.  Though other investments such as managed forex and futures trading have made a huge impact all over the world, the private equity market is the most important for one reason: it is the lifeblood of the global economy.

Before we get any further, let’s take a look back 20 years ago, and examine the beginning of a huge shift in the private equity markets. It the early 1990’s, it was a time for great opportunity and unparalleled growth within many parts of the world.  At that time, technology companies were popping up everywhere, the internet had just started to become popular, and many other new businesses had great ideas, but not enough funding.   As you will learn, this became a ripe environment for private equity firms, which lead to immense growth in the industry.

By the end of the 1990’s, investors had caught on to the trend in the private equity industry, and responded by allocating a large amount of assets. Once a market with a few billion dollars of participation, private equity had now become a multi-trillion dollar investment arena. Though this was great for investors, this growth had far more implications worldwide.  Now, with the help of private equity firms, much of the wealth which was generated over these years could go back into funding new ideas in the economy.  With over 2.5 Trillion dollars invested in private equity funds, things were good for investors, firms, and the world, until the financial meltdown of 2008.

Once the financial crisis had hit, and private equity had reached its peak, the economy started to tumble fast.  With a looming credit crisis, and limited funding access from private equity firms, the entire world economy started to feel the pain. No matter what the company or idea was, without funding there became little chance for new growth.  Once the private equity funded companies  stopped growing, investor sentiment dramatically changed.  Just a few months ago, investors had been lining up to invest with private equity firms, and now, they were nowhere to be found. Since very few people were willing to invest in late stage venture capital or pre-ipo companies, this lead to a cycle of economic stagnation that persisted until consumer sentiment improved.

In today’s investment world, the financial markets have turned around, spurring a change in the private equity industry.  Once a “sellers market” in 2008 and early 2009, we have now entered a “buyer’s market” that has lasted for over six months, and may persist for quite some time.  As a result, many companies are now considered undervalued and even more are underfunded.  Though we are not out of the woods yet and growth is slow, this shift in investor sentiment has lead to a rebirth of interest in private equity firms.

When you observe the massive growth in the 1990’s and recent years, it is safe to say that private equity will continue to be one of the biggest markets in the world.  With a profit potential far beyond traditional investments, and seemingly endless companies in need to funding, it has become a CRITICAL solution for investors, illiquid companies, and the world economy.

InsideTrade LLC Staff
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As with every other investment market, there are people in the same business, but with completely different approaches. In the private equity market, it is no different. In fact, each private equity fund has its own strategy, and their unique formula is what makes them different from other funds.

In this article we will explain private equity investment strategies by providing examples, allowing you to understand how each private equity fund creates their niche.  In addition, we will provide a chart which will help explain private equity diversification, while also listing common investment strategies. What are you waiting for?  Scroll down and take a look!

Examples of Private Equity Strategies

Private Equity Firm 1: This private equity firm ONLY invests in pharmaceutical, healthcare, and information technology companies.  Also, they invest ONLY with companies that are considered to be “late stage” venture capital opportunities.  By creating a strict set of rules, the firm reduces risk and focuses on perfecting their niche.

Private Equity Firm 2: In this equity firm, the manager will only invest with companies in the Biotechnology Industry.  Though he is strict with that requirement, he will invest with companies at ALL different stages of their development.  By investing with companies at different stages of their development, they can diversify amongst the varying strategies.  In this case, the private equity fund manager is an EXPERT in Biotechnology, so he feels comfortable analyzing any opportunity in that market.

Private Equity Firm 3:  This private equity firm invests with other private equity firms, not directly with companies.  In most cases, this is referred to a private equity “fund of funds”, which is becoming the most popular structure in the private equity market.  By investing with other private equity firms, which then diversify within other firms, this firm achieves a more balanced yield for their investors.  The key to success with this strategy is simple, making educated decisions which focus on growth BUT diversification.

To help you understand the strategies of private equity firms even better, we have provided a chart below.  In this chart, you will see a diversified investment strategy from a successful private equity firm.   In most cases, top private equity firms will have a strategy that is very similar, since proper diversification is the goal of any fund manager.

Despite the information in the chart above, remember, this is just an EXAMPLE of diversification and every private equity firm has their own “secret sauce”. As you would expect, each private equity manager has an EXPERTISE, and certain markets they know best. In short, their duty is to follow information affecting their investment, perfect their niche, and keep the investors happy.  Unfortunately, many fund managers fail to do one of these three things, and for that reason, they never make it to the top.

In summary, private equity is a market with great promise, but finding a manager whose “secret sauce” tastes good year after year is tough to do. Remember, patience and education will be your best tools in finding a private equity investment. Though there are good private equity firms around, you MUST be aggressive AND diligent if you want to find one…

InsideTrade LLC Staff
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Before we get to the private equity fund diagram, let’s define some key components you need to remember . Scroll down and take a look!

Key Components of Private Equity Investments

Private Equity Investors:  Typically, investors in private equity funds are high net-worth individuals, institutions, or other large companies.  In this case, they are considered “Limited Partners” in the fund, and though they do incur financial risk, they do not incur liability. With the potential of higher yields, many have flocked to the private equity markets to take advantage of the growing trend. Generally, yields for private equity funds can exceed almost any traditional investment, hence the recent influx of interest.

Private Equity Fund:  In most instances, private equity funds are “Limited Partnerships” owned by a “General Partner” (Equity Firm Manager), and “Limited Partners” (Equity Fund Investors).  In short, the General Partner manages the fund based upon the details of the Partnership Agreement. This agreement covers terms, fees, liabilities, and other conditions which must be met by both the General Partner and Limited Partners.  In effect, the fund is really a tool to allow the investment process to occur. Without it, there would be far less security for investors, and increased liability for fund managers.

Private Equity Firm:  The private equity firm is known as the “General Partner” of the private equity fund.  Within the Partnership Agreement, the investors agree to let the firm manage the investment, and in return, it can charge additional fees to the investors. By taking on the role of General Partner, the firm has unlimited liability for the debts and obligations of the Limited Partnership, but also has a strong control in its investment decisions. In short, the General Partner is the intermediary between investors with capital and businesses seeking capital for growth.

Private Equity Investments:  In the diagram below, you will see the term “Investments” listed in the three boxes at the bottom. This represents the companies the “General Partner” has chosen to invest in.  Typically, these companies are highly profitable, but unable to grow further due to low cash reserves or inadequate funding. In most cases, private equity firms will choose to diversify by investing in several different companies, keeping risk and exposure minimized for their investors.

Now that you understand the components of a private equity investment, let’s take a look at the diagram below to help connect the dots!

To summarize, the Partnership Agreement allows private equity investors and fund managers to define their relationship and liability in the form of a contract.  Once the investors allow the “General Partner” to manage their account, they transfer liability but also assume risk by doing so.  After the General Partner receives the money from the investors, they invest in companies which they feel have the highest potential for growth, and often diversify to reduce risk.  In all reality, this process may sound simple, but it is very complicated as we’ll explain in future articles.

With private equity’s impact on the investment world, it’s always good to understand the moving pieces of the industry and how they work together.  Who knows, you may become a private equity investor some day, or even better, you may choose to start your own private equity fund.  No matter what your position is, if you just keep on learning, education will protect and direct you on your path to success.

InsideTrade LLC Staff
(412) 235-2855

]]> http://insidetradellc.com/blog/how-private-equity-fund-investments-work/feed/ 1 http://insidetradellc.com/blog/private-equity-firms-bad-for-the-economy-video/ http://insidetradellc.com/blog/private-equity-firms-bad-for-the-economy-video/#comments Wed, 23 Dec 2009 07:15:46 +0000 InsideTrade Staff http://insidetradellc.com/?p=1234 Hello Everyone,

We have provided this video to give you an educated perspective on the facts on private equity, and its link to economies worldwide.  As with every profitable investment market, private equity has been given unfair scrutiny by the media, which has created a false stigma in the public.  To help clarify these misconceptions, we have provided a video outlining the role of private equity in the Australian economy.

To review some key points before viewing the video, take a quick look at the section below. It always helps to remember if you have something to read, and watch at the same time.

Key Points in Private Equity Video

1. Private Equity Firms have Been Given a Negative Reputation as Vultures in Many Economies
2. The Negative Focus on the Private Equity Market has been Misdirected and Unjust
3. Books like “Barbarians at the Gates”, Depicting Private Equity Firms as Heartless Animals, have Created a False Stigma for the Private Equity Markets
4. Critics of Private Equity Firms Focus on the Short Term Effects on Companies, and do not Understand Strategic Restructuring, which can Grow the Firm to Eventually Hire Even More
5. Across the Economy, the Private Equity Market Adds Jobs, Liquidity, Spending, and Opportunities for Long Term Growth for Countless Underfunded Companies
6. Some Companies are Best Suited for Private Equity Funding, Versus Going Public to Raise Money
7. The Media can Turn Concerns into a Negative Reputation Very Easily Since Private Equity is Involved in So Many Areas of the Economy
8. Private Equity Firms are Becoming Less Private and More Transparent in Response to the Recent Financial Crisis and Media Attention
9. Any Market with Threats Scares Price Down, which can Make it Very Profitable for Some Firms in the Private Equity Market
10. Private Equity Firms can Use the Current Credit Crisis as an Opportunity to Offer Lending and Buy into Undervalued Companies

Scroll down and press play to get started. We hope you enjoy the video!

InsideTrade LLC Staff
(412) 235-2855

In this article, we will cover a more advanced topic that has become rather common in the private equity industry.  By supplying it’s definition, applications, benefits, and more, you will learn everything you need to know about the new trend, the Private Equity Fund of Funds.

The “fund of funds” strategy has become popular in recent years for one reason: it can DRAMATICALLY reduce volatility for fund managers and their investors.  You may say, “How can a fund of funds investment produce a more stable yield for investors?” Well, since this is a great question, we will take a few minutes to answer it in detail.

By definition, a “private equity fund of funds” is an investment structure that pools capital from investors and allocates it other private equity funds, instead of investing directly with those requesting the capital.  Once a “fund of funds” has invested with several smaller private equity firms, these smaller firms seek out opportunities for growth on their behalf.  By diversifying with multiple private equity funds, who each diversify with several small companies, a fund of funds can take advantage of inverse relationships in the markets.

To help you understand the “private equity fund of funds” concept a little better, we have provided a diagram below. Scroll down and take a look at the picture, along with the explanation which follows it.

In the picture above, you can see that the “Private Equity Fund of Funds” is spreading it’s capital amongst “Private Equity Firms A-J”.  Once the capital is on the books of firms A-J, they will invest with different companies, strategies, risks, and goals.  At the time when the yields are paid, the Private Equity Fund of Funds takes out it’s management fee and returns the net profit to the investor.  In many cases, the “Investor” may reinvest the profits with the fund of funds, which restarts the same cycle all over again.

As you can see, the “fund of funds” strategy may be different, but it has become very popular for a reason. Though the structure may inherently protect investors more than a normal private equity firm, remember, your success depends SOLELY on the fund manager (“General Partner”).  If you do choose to invest with a fund of funds, make sure they are diversified amongst several investment strategies, markets, geographies, and histories.  The fact is, if a fund of funds isn’t accomplishing proper diversification, it is no better than a regular private equity firm!

We hope you enjoyed this great article on the “fund of funds” strategy, and it’s place in the private equity market. To learn more on private equity investing, visit our “Related Articles Section” below.  As we all know, education is EVERYTHING, especially in the alternative investment world…

InsideTrade LLC Staff
(412) 235-2855

Hello Everyone,

This video outlines the private equity industry, and gives you an idea of where it fits within the economy. As the analyst explains, this alternative investment market has become so popular over recent years, that many are now choosing private equity funds over large cap stocks.  Though some claim that private equity leveraged buy-outs are bad for the economy, these firms also offer unique investment opportunities, and significant liquidity to the markets.

We hope you enjoy the video!

InsideTrade LLC Staff
(412) 235-2855