INTRODUCTION TO PRIVATE EQUITY. 1 Meaning and definition DEFINITION: Private e!it" i# e!it" $a%ita& t'at i# not !oted on a %!(&i$ e)$'ange. Private e!it" $on#i#t# of inve#tor# and f!nd# t'at *a+e inve#t*ent# dire$t&" into %rivate $o*%anie# or $ond!$t (!"o!t# of %!(&i$ $o*%anie# t'at re#!&t in a de&i#ting of %!(&i$ e!it". Mo#t of t'e ti*e, ti *e, %rivate e!it" inve#tor# are in#tit!tiona& inve#tor# and 'ig' netort' individ!a&# 'o 'ave a &arge a*o!nt of $a%ita& to $o**it to t'e#e inve#t*ent#. Private e!it" inve#t*ent# often de*and &ong 'o&ding %eriod# to a&&o for a t!rnaro!nd of a di#tre##ed $o*%an" or a &i!idit" event #!$' a# an IPO or #a&e to a %!(&i$ $o*%an". Private e!it" i# a e&&-+non ind!#tr" in t'e finan$ia& or&d and it i# (e$o*ing a *ore fa*i&iar ter* for t'e genera& %!(&i$ a# 'ig'-%rofi&e 'ig'-%rofi&e $o*%anie# are %!r$'a#ed and ta+en %rivate (" (!"o!t fir*#. Private e!it" fir*: A %rivate %rivate e!it" fir* i# an inve#t*ent *anager t'at *a+e# inve#t*ent# in t'e %rivate e!it" of o%erating $o*%anie# t'ro!g' a variet" of &oo#e&" affi&iated inve#t*ent #trategie# in$&!ding &everaged (!"o!t, vent!re $a%ita&, and grot' $a%ita&. Often de#$ri(ed a# a finan$ia& #%on#or, ea$' fir* i&& rai#e f!nd# t'at i&& (e inve#ted in a$$ordan$e it' one or *ore #%e$ifi$ inve#t*ent #trategie#. T"%i$a&&", a %rivate e!it" fir* i&& rai#e %oo&# of $a%ita&, or %rivate e!it" f!nd# t'at #!%%&" t'e e!it" $ontri(!tion# for t'e#e tran#a$tion#. Private e!it" fir*# i&& re$eive a %eriodi$ *anage*ent fee a# e&& a# a #'are in t'e %rofit# earned /$arried intere#t0 fro* ea$' %rivate e!it" f!nd *anaged. Private e!it" fir*#, it' t'eir inve#tor#, i&& a$!ire a $ontro&&ing or #!(#tantia& *inorit" %o#ition in a $o*%an" and t'en &oo+ to *a)i*ie t'e va&!e of t'at inve#t*ent.
2I3TORY T'e ear&" 'i#tor" of %rivate e!it" re&ate# to one of t'e *a4or %eriod# in t'e 'i#tor" of %rivate e!it". 5it'in t'e (roader %rivate e!it" ind!#tr", to di#tin$t #!(-
ind!#trie#, &everaged (!"o!t# and vent!re $a%ita& e)%erien$ed grot' a&ong %ara&&e& a&t'o!g' a&t'o!g' interre&ated tra$+#. tra$+#. T'e origin# of t'e *odern %rivate e!it" ind!#tr" tra$e (a$+ to 1678 it' t'e for*ation of t'e fir#t vent!re $a%ita& fir*#. T'e t'irt"-five-"ear %eriod fro* 1678 t'ro!g' t'e end of t'e 169# a# $'ara$teried (" re&ative&" #*a&& vo&!*e# of %rivate e!it" inve#t*ent, inve#t*ent, r!di*entar" r!di*entar" fir* organiation# organiation# and and &i*ited aarene## aarene## of and fa*i&iarit" it' t'e %rivate e!it" ind!#tr". ORI;IN3 OF MODERN MODE RN PRIVATE PRIVATE EQUITY It a# not !nti& after 5or&d 5ar II t'at 'at i# $on#idered toda" to (e tr!e %rivate e!it" inve#t*ent# (egan to e*erge *ar+ed (" t'e fo!nding of t'e fir#t to vent!re $a%ita& fir*# in 1678: A*eri$an A*eri$an Re#ear$' and Deve&o%*ent Cor%oration. /ARDC0 and <.2. 5'itne" = Co*%an". ARDC a# fo!nded (" ;eorge# Doriot, t'e >fat'er of vent!re $a%ita&i#*> /for*er dean of 2arvard ?!#ine## 3$'oo&0, it' Ra&%' F&ander# and @ar& Co*%ton /for*er %re#ident of MIT0, MIT0, to en$o!rage %rivate %rivate #e$tor inve#t*ent# inve#t*ent# in (!#ine##e# r!n (" #o&dier# 'o ere ret!rning fro* 5or&d 5ar II. ARDC# #ignifi$an$e a# %ri*ari&" t'at t'at it a# t'e fir#t in#tit!tiona& in#tit!tiona& %rivate %rivate e!it" inve#t*ent inve#t*ent fir* t'at rai#ed rai#ed $a%ita& fro* #o!r$e# ot'er t'an ea&t'" fa*i&ie# a&t'o!g' it 'ad #evera& nota(&e inve#t*ent #!$$e##e# a# e&&. ARDC i# $redited it' t'e fir#t *a4or vent!re $a%ita& #!$$e## #tor" 'en it# 16B9 inve#t*ent of 9, in Digita& E!i%*ent Cor%oration /DEC0 o!&d (e va&!ed at over BB *i&&ion after t'e $o*%an"# initia& %!(&i$ offering in 168 /re%re#enting a ret!rn of over B ti*e# on it# inve#t*ent and an ann!a&ied rate of ret!rn of 110. For*er e*%&o"ee# of ARDC ent on to fo!nd #evera& %ro*inent vent!re $a%ita& fir*# in$&!ding ;re"&o$+ Partner# /fo!nded in 168B (" C'ar&ie 5aite and ?i&& E&fer#0 and Morgan, 2o&&and Vent!re#, t'e %rede$e##or of F&ag#'i% Vent!re# /fo!nded in 16G ("
ind!#trie#, &everaged (!"o!t# and vent!re $a%ita& e)%erien$ed grot' a&ong %ara&&e& a&t'o!g' a&t'o!g' interre&ated tra$+#. tra$+#. T'e origin# of t'e *odern %rivate e!it" ind!#tr" tra$e (a$+ to 1678 it' t'e for*ation of t'e fir#t vent!re $a%ita& fir*#. T'e t'irt"-five-"ear %eriod fro* 1678 t'ro!g' t'e end of t'e 169# a# $'ara$teried (" re&ative&" #*a&& vo&!*e# of %rivate e!it" inve#t*ent, inve#t*ent, r!di*entar" r!di*entar" fir* organiation# organiation# and and &i*ited aarene## aarene## of and fa*i&iarit" it' t'e %rivate e!it" ind!#tr". ORI;IN3 OF MODERN MODE RN PRIVATE PRIVATE EQUITY It a# not !nti& after 5or&d 5ar II t'at 'at i# $on#idered toda" to (e tr!e %rivate e!it" inve#t*ent# (egan to e*erge *ar+ed (" t'e fo!nding of t'e fir#t to vent!re $a%ita& fir*# in 1678: A*eri$an A*eri$an Re#ear$' and Deve&o%*ent Cor%oration. /ARDC0 and <.2. 5'itne" = Co*%an". ARDC a# fo!nded (" ;eorge# Doriot, t'e >fat'er of vent!re $a%ita&i#*> /for*er dean of 2arvard ?!#ine## 3$'oo&0, it' Ra&%' F&ander# and @ar& Co*%ton /for*er %re#ident of MIT0, MIT0, to en$o!rage %rivate %rivate #e$tor inve#t*ent# inve#t*ent# in (!#ine##e# r!n (" #o&dier# 'o ere ret!rning fro* 5or&d 5ar II. ARDC# #ignifi$an$e a# %ri*ari&" t'at t'at it a# t'e fir#t in#tit!tiona& in#tit!tiona& %rivate %rivate e!it" inve#t*ent inve#t*ent fir* t'at rai#ed rai#ed $a%ita& fro* #o!r$e# ot'er t'an ea&t'" fa*i&ie# a&t'o!g' it 'ad #evera& nota(&e inve#t*ent #!$$e##e# a# e&&. ARDC i# $redited it' t'e fir#t *a4or vent!re $a%ita& #!$$e## #tor" 'en it# 16B9 inve#t*ent of 9, in Digita& E!i%*ent Cor%oration /DEC0 o!&d (e va&!ed at over BB *i&&ion after t'e $o*%an"# initia& %!(&i$ offering in 168 /re%re#enting a ret!rn of over B ti*e# on it# inve#t*ent and an ann!a&ied rate of ret!rn of 110. For*er e*%&o"ee# of ARDC ent on to fo!nd #evera& %ro*inent vent!re $a%ita& fir*# in$&!ding ;re"&o$+ Partner# /fo!nded in 168B (" C'ar&ie 5aite and ?i&& E&fer#0 and Morgan, 2o&&and Vent!re#, t'e %rede$e##or of F&ag#'i% Vent!re# /fo!nded in 16G ("
<.2. 5'itne" = Co*%an" a# fo!nded ("
In
*ont'# after t'e origina& dea&, ;i(#on $o*%&eted a G6 *i&&ion IPO and 3i*on *ade a%%ro)i*ate&" 88 *i&&ion.J1K 3i*on and 5e#ra" o!&d &ater $o*%&ete t'e 91.8 *i&&ion a$!i#ition of At&a# Van ine#. T'e #!$$e## of t'e ;i(#on ;reeting# inve#t*ent attra$ted t'e attention of t'e ider *edia to t'e na#$ent (oo* in &everaged (!"o!t#. ?O ?U3T /166-166G0 ?" t'e end of t'e 16# t'e e)$e##e# of t'e (!"o!t *ar+et ere (eginning to #'o, it' t'e (an+r!%t$" of #evera& &arge (!"o!t# in$&!ding Ro(ert Ca*%ea!# 16 (!"o!t of Federated De%art*ent 3tore#, t'e 168 (!"o!t of t'e Rev$o dr!g #tore#, 5a&ter Ind!#trie#, FE? Tr!$+ing and Eaton eonard. Additiona&&", t'e R
re*ained &i*ited t'ro!g' t'e 16# and t'e fir#t 'a&f of t'e 166# in$rea#ing to 4!#t over 7 (i&&ion *ore t'an a de$ade &ater in 1667.
After a #'a+eo!t of vent!re $a%ita& *anager#, t'e *ore #!$$e##f!& fir*# retren$'ed, fo$!#ing in$rea#ing&" on i*%roving o%eration# at t'eir %ortfo&io $o*%anie# rat'er t'an $ontin!o!#&" *a+ing ne inve#t*ent#. Re#!&t# o!&d (egin to t!rn ver" attra$tive, #!$$e##f!& and o!&d !&ti*ate&" generate t'e vent!re $a%ita& (oo* of t'e 166#. For*er 5'arton Profe##or Andre Metri$+ refer# to t'e#e fir#t 1B "ear# of t'e *odern vent!re $a%ita& ind!#tr" (eginning in 16 a# t'e >%re-(oo* %eriod> in anti$i%ation of t'e (oo* t'at o!&d (egin in 166B and &a#t t'ro!g' t'e (!r#ting of t'e Internet (!((&e in G.JK T2E ?UR3TIN; OF T2E INTERNET ?U??E AND T2E PRIVATE EQUITY CRA32 /G-G0 T'e Na#da $ra#' and te$'no&og" #&!*% t'at #tarted in Mar$' G #'oo+ virt!a&&" t'e entire vent!re $a%ita& ind!#tr" a# va&!ation# for #tart!% te$'no&og" $o*%anie# $o&&a%#ed. Over t'e ne)t to "ear#, *an" vent!re fir*# 'ad (een for$ed to riteoff t'eir &arge %ro%ortion# of t'eir inve#t*ent# and *an" f!nd# ere #ignifi$ant&" >!nder ater> /t'e va&!e# of t'e f!nd# inve#t*ent# ere (e&o t'e a*o!nt of $a%ita& inve#ted0. Vent!re $a%ita& inve#tor# #o!g't to red!$e #ie of $o**it*ent# t'e" 'ad *ade to vent!re $a%ita& f!nd# and in n!*ero!# in#tan$e#, inve#tor# #o!g't to !n&oad e)i#ting $o**it*ent# for $ent# on t'e do&&ar in t'e #e$ondar" *ar+et. ?" *id-G, t'e vent!re $a%ita& ind!#tr" 'ad #'rive&ed to a(o!t 'a&f it# G1 $a%a$it". Nevert'e&e##, Pri$eater'o!#eCoo%er# Mone"Tree 3!rve" #'o# t'at tota& vent!re $a%ita& inve#t*ent# 'e&d #tead" at G &eve&# t'ro!g' t'e #e$ond !arter of GB.
A&t'o!g' t'e %o#t-(oo* "ear# re%re#ent 4!#t a #*a&& fra$tion of t'e %ea+ &eve&# of vent!re inve#t*ent rea$'ed in G, t'e" #ti&& re%re#ent an in$rea#e over t'e &eve&# of inve#t*ent fro* 16 t'ro!g' 166B. A# a %er$entage of ;DP, vent!re inve#t*ent a# .B %er$ent in 1667, %ea+ed at 1.9 /near&" 16 ti*e# t'e 1667 &eve&0 in G and ranged fro* .187 to .1G in G and G7. T'e
reviva& of an Internet-driven environ*ent /t'an+# to dea&# #!$' a# e?a"# %!r$'a#e of 3+"%e, t'e Ne# Cor%oration# %!r$'a#e of M"3%a$e.$o*, and t'e ver" #!$$e##f!& ;oog&e.$o* and 3a&e#for$e.$o* IPO#0 'ave 'e&%ed to revive t'e vent!re $a%ita& environ*ent. 2oever, a# a %er$entage of t'e overa&& %rivate e!it" *ar+et, vent!re $a%ita& 'a# #ti&& not rea$'ed it# *id-166# &eve&, &et a&one it# %ea+ in G. C2ARACTERI3TIC3 OF PRIVATE EQUITY FUNDIN; Mo#t of t'e %rivate e!it" fir*# are for*ed (" &i*ited %artner#'i%. T'e $o*%an" 'a# #o*e *ain %artner# 'o r!n t'e $o*%an" and %rovide t'e initia& inve#t*ent it' a *ini*!* %eriod $o**it*ent. ;enera& Partner# /;P0 : Re#%on#i(&e to rai#e $a%ita& fro* t'e 'ig' net ort' inve#tor# &i+e %en#ion f!nd#, endo*ent f!nd#, in#!ran$e f!nd#, $or%orate f!nd#, different tr!#t#, 'ig' net ort' individ!a&# et$. t'e" 'o&d t'e &ega& %o#ition a# %artner# in t'e fir*. i*ited Partner# /P0: T'e" are re#%on#i(&e for t'e re#%e$tive de(t or *one" rai#ed (" t'e*. T'e" 'ave t'e &i*ited &ia(i&it" and t'e e)tent &ie# on&" on t'e inve#t*ent rai#ed (" t'e*. T'e" 'ave no *anage*ent a!t'orit" and t'e" re$eive a ret!rn on t'eir inve#ted $a%ita&. 2ig' Ri#+-Ret!rn: Private e!it" f!nd# inve#t*ent fo&&o# 'ig' ri#+ and 'ig' ret!rn o(4e$tive. Inve#ting in %rivate&" 'e&d #tart!% $o*%anie# are ver" *!$' ri#+" and at t'e #a*e ti*e offer ver" 'ig' ret!rn %otentia&. Carried intere#t#: T'i# i# t'e #'are of %rofit# t'e f!nd *anage*ent tea* re$eive# a# a %erfor*an$e reard for r!nning t'e f!nd. T'e re#t of t'e %rofit i# #'ared a*ong a&& t'e inve#tor# (a#ed on t'eir inve#ted a*o!nt. 2!rd&e rate: A '!rd&e rate i# t'e *ini*!* rate of ret!rn on a %ro4e$t or inve#t*ent re!ired (" a *anager or inve#tor. In order to $o*%en#ate for ri#+, t'e ri#+ier t'e %ro4e$t, t'e 'ig'er t'e '!rd&e rate. If t'e ret!rn fa&&# (e&o t'e '!rd&e rate, t'en t'e *anage*ent i&& get on&" t'e (a#e %a"*ent it'o!t an" $arried intere#t. T'i# i# to %rote$t t'e inve#tor# and %rovide t'e* a *ini*!* ret!rn on t'eir inve#t*ent. Initia& inve#t*ent: A# t'e %rivate e!it" f!nd intend to inve#t a #ignifi$ant %art of a %rivate&" 'e&d $o*%an" to $ontro& t'eir (!#ine## o%eration and drive t'eir grot', it re!ire# a '!ge initia& inve#t*ent (" t'e %artner# of t'e %rivate e!it" fir*.
i*ited &i!idit" and inve#t*ent ter*: Private e!it" inve#t*ent# 'ave ver" &o &i!idit" a# t'e#e inve#t*ent# are *ade it' t'e &ong ter* intention to gain %rofit. T'e inve#t*ent ter* for %rivate e!it" i# t"%i$a&&" to 9 "ear#. 2O5 PRIVATE EQUITY FUND3 5OR@L Private e!it" f!nd# are #et !% a# a &i*ited %artner#'i% (" a %rivate e!it" fir*. T'e fir* t'en rea$'e# o!t to &arge inve#tor# &i+e !niver#it" endo*ent#, !nion %en#ion %&an#, $'aritie#, in#!ran$e $o*%anie#, and e)tre*e&" ea&t'" individ!a&# to rai#e $a%ita&. On$e inve#ted, t'e &i*ited %artner#H $a%ita& i# &o$+ed !% for a %redeter*ined n!*(er of "ear# (efore t'e f!nd i# &i!idated and t'e %rin$i%&e /and 'o%ef!&&" %rofit#0 are ret!rned to #'are'o&der#. T'e inve#tor# are &i*ited %artner# in t'e ne&" e#ta(&i#'ed f!nd. T'e %rivate e!it" fir* *anaging t'e f!nd i# t'e genera& %artner ena(&ed to *a+e a&& inve#t*ent de$i#ion# after rai#ing $a%ita&. T'e na*e %rivate e!it" e)%&ain# *!$' of 'at t'e#e f!nd# do. Private e!it" fir*# !#e t'eir rai#ed f!nd# to ta+e $o*%anie# %rivate fro* %!(&i$ #to$+ *ar+et#, or to inve#t in $o*%anie# t'at are a&read" %rivate. Inve#ting in a %rivate e!it" f!nd i# different fro* inve#ting in a *!t!a& f!nd or e)$'ange-traded f!nd. PE f!nd# are t"%i$a&&" $&o#ed-end f!nd# t'at o%erate for a &i*ited ter*, t"%i$a&&" &a#ting ten "ear#. T'e" #tart (" rai#ing *one" fro* inve#tor# and genera&&" #%end an"'ere fro* 1-1 "ear# inve#ting in a %ortfo&io of $o*%anie#, 'i$' i# +non a# t'e inve#t*ent %eriod. T'e ne)t $'a%ter i# +non a# t'e 'arve#ting %eriod, 'i$' i# 'en f!nd# rea% t'e reard# of t'eir inve#t*ent#. U&ti*ate&", 'arve#ting *ean# #e&&ing t'e f!nd# #ta+e# in $o*%anie# and &i!idating t'e f!nd, (!t t'e#e tran#a$tion# $an 'a%%en grad!a&&", one %ortfo&io $o*%an" at a ti*e. Yo! $an e)%e$t to re$eive $a#' %ro$eed# a# t'e#e event# o$$!r a# e&& a# #*a&&er interi* $a#' f&o# if and 'en #%e$ia& dividend# are de$&ared. A##!*ing t'e f!nd 'a# *et it# o(4e$tive#, over t'e $o!r#e of t'e 'arve#ting %eriod "o! re$eive "o!r *one" (a$+, %&!# %rofit#. T'e a" "o!r inve#t*ent i# initiated i# a&#o ver" different fro* 'at "o! *a" (e !#ed to it' o%en-ended f!nd# &i+e *!t!a& f!nd#. In#tead of %a"ing *one" dire$t&" into t'e f!nd, "o! *a+e a $o**it*ent of a $ertain a*o!nt of $a%ita&, and t'e f!nd
grad!a&&" dra# on t'at *one" (" i##!ing $a%ita& $a&&# ea$' ti*e it find# a #!ita(&e $o*%an" to inve#t in. If t'e f!nd $anHt find eno!g' good o%%ort!nitie#, "o! *a" end !% inve#ting &e## *one" t'an "o! 'ad $o**itted. A&#o, itH# genera&&" not %o##i(&e to redee* "o!r *one" !nti& t'e end of t'e f!ndH# #%e$ified ter*. Inve#ting in a %rivate e!it" f!nd i# a &ong-ter* $o**it*ent, and a&t'o!g' it i# %o##i(&e to #e&& "o!r #ta+e on t'e #e$ondar" *ar+et, itH# *ore $o*%&i$ated t'an #e&&ing %!(&i$&"-&i#ted #e$!ritie#, and "o! *a" 'ave to #e&& at a di#$o!nt.
ADVANTA;E3 OF PRIVATE EQUITY Private e!it" f!nd# a&a"# inve#t it' t'e intention of ver" 'ig' ret!rn# over a &ong ter*. T'e" are a&a"# $on#idered a# &ong ter* *one" en'an$er. T'e" 'ave a ver" &o and %o#itive $orre&ation it' #to$+ *ar+et 'i$' ena(&e# t'e* to %rovide #o*e diver#ifi$ation (enefit. Over t'e &ong ter*, t'e %rivate e!it" f!nd give# (etter ret!rn# t'an ot'er *ar+et inde)e#. T'e 'i#tori$a& data a&#o #!%%ort# t'e #a*e. Fro* t'e inve#ted $o*%an"H# %oint of vie, %rivate e!it" f!nd# 'e&% t'e* to rai#e t'e $a#' and *eet t'e #'ort ter* o(&igation#. A&#o t'e e)%erien$ed %rivate e!it" f!nd *anager# and %rofe##iona&# 'e&% t'e $o*%an" to ta+e good (!#ine## de$i#ion# and gro %ro%er&". Private e!it" $an %rovide t'e &arge#t a*o!nt# of *one". T'e dea&# are *ea#!red in '!ndred# of *i&&ion# of do&&ar#. Private e!it" f!nding %rovide# finan$e to ne %ro4e$t 'i$' 'ave 'ig' grot' %otentia& a$$o*%anied it' 'ig' ri#+. T'!# %rivate e!it" f!nd# 'e&% in %ro*oting entre%rene!r#'i% a*ong t'e "o!ng and ta&ented entre%rene!r#. DI3ADVANTA;E3 OF PRIVATE EQUITY Private e!it" f!nd inve#t*ent# 'ave ver" &o &i!idit" and 'en$e t'e f!nd inve#tor# $anHt #e&& t'eir inve#t*ent# 'enever t'e" ant. It re!ire# a ver" 'ig' a*o!nt of initia& inve#t*ent 'i$' on&" t'e ver" 'ig' net ort' inve#tor# $an afford.
It re!ire# a ver" 'ig' &ong ter* $o**it*ent (" t'e inve#tor#. Inve#tor# 'o $an inve#t 'ig' a*o!nt of $a%ita& for &ong ter* $an on&" inve#t in %rivate e!it" f!nd#. It a$t!a&&" r!&e# o!t a&& t'e #*a&& inve#tor# fro* t'e &i#t. T'e %rivate e!it" fir*# inve#t in on&" #tart!% $o*%anie# and %rivate&" 'e&d #*a&& $o*%anie#, t'e ri#+ of &o#ing *one" i# ver" 'ig'. Private e!it" f!nd# often de*and a *a4or #ta+e, t'i# re#!&t# in &o## of oner#'i%, a&#o t'e %rivate e!it" f!nd *anager# interfere in t'e nor*a& (!#ine## o%eration#. T'e *anage*ent $o#t and t'e tran#a$tion $o#t are ver" 'ig' (e$a!#e of t'e $o*%&e)it" invo&ved in ana&"ing t'e $o*%an" and *anaging t'e $o*%an" a# e&& a# t'e f!nd. Private e!it" fir*# are &oo+ing for %arti$!&ar $o*%anie# to inve#t in, t'e" 'ave to offer %otentia& for &arge %rofit# in a re&ative&" #'ort ti*e fra*e. A (!#ine## t'at $ant offer t'e inve#tor# a &!$rative e)it it'in a(o!t five "ear# i&& #tr!gg&e to attra$t an" intere#t fro* %rivate e!it" fir*#.
DIFFERENCE ?ET5EEN PRIVATE EQUITY AND 2ED;E FUND3 MEANIN;: 2edge f!nd# are a&ternative inve#t*ent# !#ing %oo&ed f!nd# t'at *a" !#e a n!*(er of different #trategie# in order to earn a$tive ret!rn, or a&%'a, for t'eir inve#tor#. 2edge f!nd# *a" (e aggre##ive&" *anaged or *a+e !#e of derivative# and &everage in (ot' do*e#ti$ and internationa& *ar+et# it' t'e goa& of generating 'ig' ret!rn#. A %rivate e!it" f!nd i# a $o&&e$tive inve#t*ent #$'e*e !#ed for *a+ing inve#t*ent# in vario!# e!it" /and to a &e##er e)tent de(t0 #e$!ritie# a$$ording to one of t'e inve#t*ent #trategie# a##o$iated it' %rivate e!it". Private e!it" f!nd# are t"%i$a&&" &i*ited %artner#'i%# it' a fi)ed ter* of 1 "ear# /often it' ann!a& e)ten#ion#0 INVE3TMENT 3TRATE;Y: Mo#t 'edge f!nd# inve#t in #e$!ritie# &i+e #to$+#, (ond#, derivative# and $o**oditie# t'at are tradea(&e on t'e o%en *ar+et and $an (e (o!g't or #o&d on #'ort noti$e. Po#ition# in t'e %ortfo&io# of t'e#e f!nd# $'ange often, #o*eti*e# even on an intrada" (a#i#. Private e!it" f!nd#, in $ontra#t, inve#t in $o*%anie# or %ro%ertie# it' t'e intent to o%erationa&&" *anage, gro and event!a&&" #e&& t'e#e a##et#. T'e#e inve#t*ent# genera&&" ta+e B-9 "ear#, and #o*eti*e# *!$' &onger, to (e$o*e f!&&" rea&ied.
IQUIDITY 2edge f!nd# 'ave 'ig'er &i!idit" a# $o*%ared to %rivate e!it". Private e!it" i# &e## &i!id a# t'e f!nd# 'ave to (e $o**itted for a #%e$ifi$ %eriod t'at i# !#!a&&" *ore t'an "ear# and aro!nd B-9 "ear#.
RI3@ MANA;EMENT 2edge f!nd# *ini*ie ri#+ (" 'edging 'ig' ri#+ inve#t*ent# it' #afe one#.
Private e!it" f!nd# *ean'i&e *a" $ontro& ri#+ (" !ti&iing #e$ondar" inve#t*ent#.
DIFFERENCE ?ET5EEN PRIVATE EQUITY AND VENTURE CAPITA.
Private e!it" i# #o*eti*e# $onf!#ed it' vent!re $a%ita& (e$a!#e t'e" (ot' refer to fir*# t'at inve#t in $o*%anie# and e)it t'ro!g' #e&&ing t'eir inve#t*ent# in e!it" finan$ing, #!$' a# initia& %!(&i$ offering# /IPO#0. 2oever, t'ere are *a4or differen$e# in t'e a" fir*# invo&ved in t'e to t"%e# of f!nding do t'ing#. T'e" (!" different t"%e# and #ie# of $o*%anie#, t'e" inve#t different a*o!nt# of *one" and t'e" $&ai* different %er$entage# of e!it" in t'e $o*%anie# in 'i$' t'e" inve#t. MEANIN;: Te$'ni$a&&", t'e ter* %rivate e!it" refer# to *one" inve#ted in %rivate $o*%anie#, or $o*%anie# t'at (e$o*e %rivate t'ro!g' t'e inve#t*ent. 3tart!% $o*%anie# it' a 'ig' grot' %otentia& need a $ertain a*o!nt of inve#t*ent. 5ea&t'" inve#tor# &i+e to inve#t t'eir $a%ita& in #!$' (!#ine##e# it' a &ong ter* grot' %er#%e$tive. T'i# $a%ita& i# +non a# vent!re $a%ita&.
COMPANY TYPE: Private e!it" fir*# *o#t&" (!" *at!re $o*%anie# t'at are a&read" e#ta(&i#'ed. T'e $o*%anie# *a" (e deteriorating or not *a+ing t'e %rofit# t'e" #'o!&d (e d!e to ineffi$ien$". Private e!it" fir*# (!" t'e#e $o*%anie# and #trea*&ine o%eration# to in$rea#e reven!e#. Vent!re $a%ita& fir*#, on t'e ot'er 'and, *o#t&" inve#t in #tart-!%# it' 'ig' grot' %otentia&.
ACQUIRED:
Private e!it" fir*# *o#t&" (!" 1 oner#'i% of t'e $o*%anie# in 'i$' t'e" inve#t. A# a re#!&t, t'e $o*%anie# are in tota& $ontro& of t'e fir* after t'e (!"o!t. Vent!re $a%ita& fir*# inve#t in B or &e## of t'e e!it" of t'e $o*%anie#. Mo#t vent!re $a%ita& fir*# %refer to #%read o!t t'eir ri#+ and inve#t in *an" different $o*%anie#. If one #tart-!% fai&#, t'e entire f!nd in t'e vent!re $a%ita& fir* i# not affe$ted #!(#tantia&&".
INVE3TMENT 3IE: Private e!it" fir*# inve#t 1 *i&&ion and !% in a #ing&e $o*%an". T'e#e fir*# %refer to $on$entrate a&& t'eir effort in a #ing&e $o*%an", #in$e t'e" inve#t in a&read" e#ta(&i#'ed and *at!re $o*%anie#. T'e $'an$e# of a(#o&!te &o##e# fro* #!$' an inve#t*ent are *ini*a&. Vent!re $a%ita&i#t# #%end 1 *i&&ion or &e## in ea$' $o*%an", #in$e t'e" *o#t&" dea& it' #tart-!%# it' !n%redi$ta(&e $'an$e# of fai&!re or #!$$e##.
3TRUCTURE: PE fir*# !#e a $o*(ination of e!it" and de(t. VC fir*# !#e on&" e!it".
3TA;E: PE fir*# (!" *at!re $o*%anie# VC# inve#t in ear&" #tage $o*%anie#.
PRIVATE EQUITY 3TRATE;IE3 Private e!it" f!nd# t"%i$a&&" e*%&o" a tran#for*ationa&, va&!e-added, a$tive inve#t*ent #trateg". 2oever, diver#e inve#t*ent #trategie# $an (e !#ed de%ending
on 'ere t'e $o*%an" i# in it# &ife $"$&e. Ea$' #tage of a $o*%an"H# &ife $"$&e e)'i(it# a $ertain ri#+ %rofi&e and re!ire# a #%e$ifi$ #et of #+i&&# fro* t'e genera& %artner
everaged ?!"o!t# /?O0 everaged (!"o!t# are $ond!$ted 'en a $o*%an" (orro# a #ignifi$ant a*o!nt of $a%ita& /fro* &oan# and (ond#0 to a$!ire anot'er $o*%an". Private e!it" fir*# *a+e (!"o!t inve#t*ent# 'en t'e" (e&ieve t'at t'e" $an e)tra$t va&!e (" 'o&ding and *anaging a $o*%an" for a %eriod of ti*e and e)iting t'e $o*%an" after #ignifi$ant va&!e 'a# (een $reated. everaged (!"o!t# t"%i$a&&" !ti&ie de(t to finan$e t'e (!"o!t, and t'e fir* %erfor*ing t'e ?O 'a# to %rovide a #*a&& a*o!nt of t'e finan$ing /t"%i$a&&" aro!nd 6 of t'e $o#t i# finan$ed t'ro!g' de(t0. T'e goa& of a &everaged (!"o!t i# to generate ret!rn# on t'e a$!i#ition t'at i&& o!teig' t'e intere#t %aid on t'e de(t. For t'e fir* t'atH# %erfor*ing t'e ?O, t'i# i# a a" to generate 'ig' ret!rn# 'i&e on&" ri#+ing a #*a&& a*o!nt of $a%ita&. Oftenti*e# a finan$ia& #%on#or i# invo&ved and t'e a##et# of t'e $o*%an" (eing a$!ired are !#ed a# $o&&atera& for t'e de(t. Private e!it" fir*# i&& t'en eit'er /10 #e&& off %art# of t'e a$!ired $o*%an" or /G0 !#e t'e a$!ired $o*%an"H# f!t!re $a#' f&o# to %a" off t'e de(t and t'en e)it at a %rofit.
;rot' $a%ita& ;rot' Ca%ita& refer# to e!it" inve#t*ent#, *o#t often *inorit" inve#t*ent#, in re&ative&" *at!re $o*%anie# t'at are &oo+ing for $a%ita& to e)%and or re#tr!$t!re o%eration#, enter ne *ar+et# or finan$e a *a4or a$!i#ition it'o!t a $'ange of $ontro& of t'e (!#ine##.
Co*%anie# t'at #ee+ grot' $a%ita& i&& often do #o in order to finan$e a tran#for*ationa& event in t'eir &ife $"$&e. T'e#e $o*%anie# are &i+e&" to (e *ore
*at!re t'an vent!re $a%ita& f!nded $o*%anie#, a(&e to generate reven!e and o%erating %rofit# (!t !na(&e to generate #!ffi$ient $a#' to f!nd *a4or e)%an#ion#, a$!i#ition# or ot'er inve#t*ent#. ?e$a!#e of t'i# &a$+ of #$a&e t'e#e $o*%anie# genera&&" $an find fe a&ternative $ond!it# to #e$!re $a%ita& for grot', #o a$$e## to grot' e!it" $an (e $riti$a& to %!r#!e ne$e##ar" fa$i&it" e)%an#ion, #a&e# and *ar+eting initiative#, e!i%*ent %!r$'a#e#, and ne %rod!$t deve&o%*ent. T'e %ri*ar" oner of t'e $o*%an" *a" not (e i&&ing to ta+e t'e finan$ia& ri#+ a&one. ?" #e&&ing %art of t'e $o*%an" to %rivate e!it", t'e oner $an ta+e o!t #o*e va&!e and #'are t'e ri#+ of grot' it' %artner#. Ca%ita& $an a&#o (e !#ed to effe$t a re#tr!$t!ring of a $o*%an"# (a&an$e #'eet, %arti$!&ar&" to red!$e t'e a*o!nt of &everage /or de(t0 t'e $o*%an" 'a# on it# (a&an$e #'eet.
Meanine Finan$ing
5'i&e #o*e $o*%anie# *ig't ta+e on grot' $a%ita& to finan$e t'eir e)%an#ion#, *eanine finan$ing i# an a&ternate a". Meanine finan$ing $on#i#t# of (ot' de(t and e!it" finan$ing !#ed to finan$e a $o*%an"H# e)%an#ion. 5it' *eanine finan$ing, $o*%anie# ta+e on de(t $a%ita& t'at give# t'e &ender t'e rig't to $onvert to an oner#'i% or e!it" intere#t in t'e $o*%an" if t'e &oan i#nHt re%aid in a ti*e&" *anner and in f!&&. Co*%anie# t'at ta+e on *eanine finan$ing *!#t 'ave an e#ta(&i#'ed %rod!$t and re%!tation in t'e ind!#tr", a 'i#tor" of %rofita(i&it", and a via(&e e)%an#ion %&an. A +e" rea#on '" a $o*%an" *a" %refer *eanine finan$ing i# t'at it a&&o# it to re$eive t'e $a%ita& in4e$tion needed for (!#ine## it'o!t 'aving to give !% a &ot of e!it" oner#'i% /a# &ong a# itH# a(&e to %a" (a$+ it# de(t on ti*e and in f!&&0. Anot'er advantage of ta+ing on *eanine finan$ing i# t'at it *a" (e ea#ier to re$eive traditiona& (an+ finan$ing #in$e itH# treated &i+e e!it" on a $o*%an"H# (a&an$e #'eet. On t'e f&i% #ide, t'ere are #o*e di#advantage# to $o*%anie# t'at ta+e on *eanine finan$ing. 3in$e *eanine finan$ing i# not $o&&atera&ied, t'e &ender ta+e# on greater ri#+. T'erefore, *eanine finan$ing i# t"%i$a&&" $ond!$ted ("
!n$onventiona& &ending in#tit!tion# ver#!# #tandard &ending in#tit!tion#. A# a re#!&t, intere#t rate# and ter*# $an (e *!$' 'ig'er t'an traditiona& de(t finan$ing.
Vent!re $a%ita& Vent!re $a%ita& i# a (road #!($ategor" of %rivate e!it" t'at refer# to e!it" inve#t*ent# *ade, t"%i$a&&" in &e## *at!re $o*%anie#, for t'e &a!n$' of a #eed or #tart-!% $o*%an", ear&" #tage deve&o%*ent, or e)%an#ion of a (!#ine##. Vent!re inve#t*ent i# *o#t often fo!nd in t'e a%%&i$ation of ne te$'no&og", ne *ar+eting $on$e%t# and ne %rod!$t# t'at do not 'ave a %roven tra$+ re$ord or #ta(&e reven!e #trea*#. Vent!re $a%ita& i# often #!(-divided (" t'e #tage of deve&o%*ent of t'e $o*%an" ranging fro* ear&" #tage $a%ita& !#ed for t'e &a!n$' of #tart-!% $o*%anie# to &ate #tage and grot' $a%ita& t'at i# often !#ed to f!nd e)%an#ion of e)i#ting (!#ine## t'at are generating reven!e (!t *a" not "et (e %rofita(&e or generating $a#' f&o to f!nd f!t!re grot'. Entre%rene!r# often deve&o% %rod!$t# and idea# t'at re!ire #!(#tantia& $a%ita& d!ring t'e for*ative #tage# of t'eir $o*%anie# &ife $"$&e#. Man" entre%rene!r# do not 'ave #!ffi$ient f!nd# to finan$e %ro4e$t# t'e*#e&ve#, and t'e" *!#t t'erefore #ee+ o!t#ide finan$ing. T'e vent!re $a%ita&i#t# need to de&iver 'ig' ret!rn# to $o*%en#ate for t'e ri#+ of t'e#e inve#t*ent# *a+e# vent!re f!nding an e)%en#ive $a%ita& #o!r$e for $o*%anie#. ?eing a(&e to #e$!re finan$ing i# $riti$a& to an" (!#ine##, 'et'er it i# a #tart-!% #ee+ing vent!re $a%ita& or a *id-#ied fir* t'at need# *ore $a#' to gro. Vent!re $a%ita& i# *o#t #!ita(&e for (!#ine##e# it' &arge !%-front $a%ita& re!ire*ent# 'i$' $annot (e finan$ed (" $'ea%er a&ternative# #!$' a# de(t. A&t'o!g' vent!re $a%ita& i# often *o#t $&o#e&" a##o$iated it' fa#t-groing te$'no&og", 'ea&t'$are and (iote$'no&og" fie&d#, vent!re f!nding 'a# (een !#ed for ot'er *ore traditiona& (!#ine##e#. Inve#tor# genera&&" $o**it to vent!re $a%ita& f!nd# a# %art of a ider diver#ied %rivate e!it" %ortfo&io, (!t a&#o to %!r#!e t'e &arger ret!rn# t'e #trateg" 'a# t'e %otentia& to offer. 2oever, vent!re $a%ita& f!nd# 'ave %rod!$ed &oer ret!rn# for inve#tor# over re$ent "ear# $o*%ared to ot'er %rivate e!it" f!nd t"%e#, %arti$!&ar&" (!"o!t.
3%e$ia& #it!ation# or di#tre##ed PE 3%e$ia& #it!ation# f!nd# #%e$ifi$a&&" target $o*%anie# t'at need re#tr!$t!ring, t!rnaro!nd, or are in an" ot'er !n!#!a& $ir$!*#tan$e#. Inve#t*ent# t"%i$a&&" %rofit fro* a $'ange in t'e $o*%an"H# va&!ation a# a re#!&t of t'e #%e$ia& #it!ation. E)a*%&e# of #%e$ia& #it!ation# in$&!de: a &arge %!(&i$ $o*%an" #%inning off one of it# #*a&&er (!#ine## !nit# into it# on %!(&i$ $o*%an", tender offer#, *erger# and a$!i#ition#, and (an+r!%t$" %ro$eeding#. ?e#ide# %rivate e!it" f!nd#, 'edge f!nd# a&#o i*%&e*ent t'i# t"%e of inve#t*ent. 3e$ondarie# 3e$ondar" inve#t*ent# refer to inve#t*ent# *ade in e)i#ting %rivate e!it" a##et#. T'e#e tran#a$tion# $an invo&ve t'e #a&e of %rivate e!it" f!nd intere#t# or %ortfo&io# of dire$t inve#t*ent# in %rivate&" 'e&d $o*%anie# t'ro!g' t'e %!r$'a#e of t'e#e inve#t*ent# fro* e)i#ting in#tit!tiona& inve#tor#. ?" it# nat!re, t'e %rivate e!it" a##et $&a## i# i&&i!id, intended to (e a &ong-ter* inve#t*ent for (!" and 'o&d inve#tor#. 3e$ondar" inve#t*ent# %rovide in#tit!tiona& inve#tor# it' t'e a(i&it" to i*%rove vintage diver#ifi$ation, %arti$!&ar&" for inve#tor# t'at are ne to t'e a##et $&a##. 3e$ondarie# a&#o t"%i$a&&" e)%erien$e a different $a#' f&o %rofi&e, di*ini#'ing t'e 4-$!rve effe$t of inve#ting in ne %rivate e!it" f!nd#. Often inve#t*ent# in #e$ondarie# are *ade t'ro!g' t'ird %art" f!nd ve'i$&e, #tr!$t!red #i*i&ar to a f!nd of f!nd# a&t'o!g' *an" &arge in#tit!tiona& inve#tor# 'ave %!r$'a#ed %rivate e!it" f!nd intere#t# t'ro!g' #e$ondar" tran#a$tion#. 3e&&er# of %rivate e!it" f!nd inve#t*ent# #e&& not on&" t'e inve#t*ent# in t'e f!nd (!t a&#o t'eir re*aining !nf!nded $o**it*ent# to t'e f!nd#. Rea& E#tate
Private e!it" rea& e#tate invo&ve# %oo&ing toget'er inve#tor $a%ita& to inve#t in oner#'i% of vario!# rea& e#tate %ro%ertie#. Fo!r $o**on #trategie# !#ed (" %rivate e!it" rea& e#tate f!nd# are:
Core: Inve#t*ent# are *ade in &o-ri#+ &o-ret!rn #trategie# it' %redi$ta(&e $a#' f&o#. Core P&!#: Moderate-ri#+ *oderate-ret!rn inve#t*ent# in $ore %ro%ertie# t'at re!ire #o*e for* of va&!e added e&e*ent. Va&!e Added: A *edi!*-to-'ig'-ri#+ *edi!*-to-'ig'-ret!rn #trateg" 'i$' invo&ve# t'e %!r$'a#ing of %ro%ert" to i*%rove and #e&& at a gain. Va&!e added #trategie# t"%i$a&&" a%%&" to %ro%ertie# t'at 'ave o%erationa& or *anage*ent i##!e#, re!ire %'"#i$a& i*%rove*ent#, or #!ffer fro* $a%ita& $on#traint#. O%%ort!ni#ti$: A 'ig'-ri#+ 'ig'-ret!rn #trateg", o%%ort!ni#ti$ inve#t*ent# in %ro%ertie# re!ire *a##ive a*o!nt# of en'an$e*ent#. E)a*%&e# in$&!de inve#t*ent# in deve&o%*ent, ra &and, and *ortgage note#.
52AT DO PRIVATE EQUITY INVE3TOR3 ACTUAY DOL
T'ere are fo!r (a#i$ t'ing# %rivate e!it" inve#tor# do to earn *one". Rai#e *one" fro* i*ited Partner# /P#0 &i+e %en#ion and retire*ent f!nd#, endo*ent#, in#!ran$e $o*%anie#, and ea&t'" individ!a&# 3o!r$e, di&igen$e, and $&o#e dea&# to a$!ire $o*%anie# I*%rove o%eration#, $!t $o#t#, and tig'ten *anage*ent in t'eir %ortfo&io $o*%anie# 3e&& %ortfo&io $o*%anie# /i.e., e)it t'e*0 at a %rofit Rai#ing Mone" Private e!it" fir*# rai#e f!nd# (" getting $a%ita& $o**it*ent# fro* e)terna& finan$ia& in#tit!tion# /P#0. T'e" a&#o %!t !% #o*e of t'e t'eir on $a%ita& to $ontri(!te into t'e f!nd /$o**on&" 1-B (!t it $an (e 'ig'er0. T'e %artner# of t'e fir* /t'e ;P0 *ig't go on a road#'o t'e*#e&ve# to rai#e t'e *one" /a# did t'e %artner# at t'e fir* I or+ed at0 or t'e" *ig't !#e a %&a$e*ent agent /an o!t#ide f!ndrai#ing tea*0 to 'e&% t'e* do a &ot of t'e &egor+. P# are !#!a&&" re!ired to $o**it a #ignifi$ant a*o!nt of $a%ita& in order to (e a&&oed to %arti$i%ate in t'e f!nd, #in$e t'e &a#t t'ing t'e %artner# ant i# to (e fie&ding #!%%ort $a&&# and $o**!ni$ation# to a &ong tai& of *an" &itt&e inve#tor# 'o on&" $o**it a #*a&& a*o!nt (!t re!ire a &ot of 'and-'o&ding to #ervi$e. T'e idea& f!nd to a PE fir* o!&d (e $o*%ri#ed of a 'andf!& of P# t'at ea$' $o**it ten# or '!ndred# of *i&&ion# of do&&ar#, or even (i&&ion# of do&&ar#, ea$'. 2!nt#*an ;a", t'e ?ain Ca%ita& #%ino!t t'at I or+ed at, 'ad &e## t'an 1 P# t'at ea$' $o**itted *ore t'an 1M. If "o!Hre a 'ig' net ort' individ!a&, t'e $o**it*ent t're#'o&d# *ig't (e a &itt&e &oer t'an a nor*a& P, (!t t'e" i&& &i+e&" #ti&& (e in t'e *i&&ion# in order to $o*%&" it' federa& #e$!ritie# &a# t'at (a#i$a&&" #a" "o! $an on&" #e&& PE inve#t*ent# to ri$' %eo%&e (e$a!#e t'e" are t'e one# 'o a$t!a&&" %ro(a(&" +no 'at t'e" are doing.
?!t even t'o!g' P# *a+e a $a%ita& $o**it*ent, t'e" donHt give a&& t'e *one" to t'e ;P a&& !%front. In#tead, t'e ;P (egin# to #o!r$e and $&o#e dea&#, and a# t'o#e dea&# need to (e f!nded, t'e" $a&& $a%ita& fro* t'e P#. P# t'en 'ave a ver" &i*ited indo /e.g., G ee+#0 to rite a $'e$+ to t'e ;P #o t'at t'e ;P $an f!nd and $&o#e t'e dea&. 3o $o**itted f!nd# are $a&&ed $o**itted $a%ita& 'i&e di#(!r#ed f!nd# are $a&&ed $ontri(!ted $a%ita&. Man" PE f!nd# 'ave #o*et'ing $a&&ed fir#t $&o#e v#. fina& $&o#e. Fir#t $&o#e (a#i$a&&" *ean# t'at 'en a $ertain t're#'o&d of *one" 'a# (een rai#ed, t'e PE fir* $an (egin *a+ing inve#t*ent# and a$t!a&&" $&o#ing dea&# and ne P# $an #ti&& 4oin in (" $o**itting $a%ita& for a &i*ited ti*e /e.g., 1 "ear fro* fir#t $&o#e0. Fina& $&o#e *ean# t'at 'en a #e$ond t're#'o&d 'a# (een rea$', ne P# $an no &onger 4oin in on t'at %arti$!&ar f!nd.
3o!r$ing, di&igen$ing, and $&o#ing dea&# 5'en PE fir*# ana&"e $o*%anie# for %otentia& a$!i#ition, t'e" i&& $on#ider t'ing# &i+e 'at t'e $o*%an" doe# /t'eir %rod!$t or #ervi$e and t'eir #trateg" for it0, t'e #enior *anage*ent tea* of t'e $o*%an", t'e ind!#tr" t'e $o*%an" i# in, t'e $o*%an"H# finan$ia& %erfor*an$e in re$ent "ear#, and t'e va&!ation and &i+e&" e)it #$enario# of t'e $o*%an". Pro#%e$tive dea&# $o*e in to t'e fir* t'ro!g' a $o*(ination of t'e %artner#H re%!tation /in 'i$' $a#e $o*%anie# t'e*#e&ve# *a" rea$' o!t to t'e fir*0, inve#t*ent %rofe##iona&# 'o %roa$tive&" rea$' o!t to %otentia& inve#t*ent target# t'ro!g' t'eir on netor+# or t'ro!g' $o&d $a&&#, or t'ro!g' inve#t*ent (an+# t'at *a" (e re%re#enting a $o*%an" and %it$'ing it to inve#tor# t'ro!g' t'e i##!an$e of (an+ (oo+# or $onfidentia& inve#t*ent *e*orand!*#. 5'en inve#t*ent (an+# r!n a %ro$e##, t'e" often do it t'ro!g' an a!$tion 'ere #evera& %rivate e!it" fir*# (id for t'e $o*%an", and fir*# dro% o!t a&ong t'e a" a# t'eir (id# are eit'er re4e$ted or a$$e%ted to ea$' #!$$e##ive ro!nd of (idding. T'e (e#t a" to get dea&# i# t'ro!g' %ro%rietar" *ean# (e$a!#e t'at *ean# t'e PE fir* 'a# an edge again#t ot'er fir*# in a$!iring t'e $o*%an", eit'er t'ro!g' %er#ona& re&ation#'i%# or #%e$ia& +no&edge or #i*%&" a 'ead #tart. At 2!nt#*an
;a", t'ere ere a fe %ro%rietar" dea&# e &oo+ed at and $&o#ed, and t'o#e ere definite&" t'e one# e tried to *ove *ore !i$+&" on, t'at didnHt tend to get dragged o!t in a %ro$e##, and t'at ere *ore %&ea#ant to $&o#e. To get good %ro%rietar" dea& f&o, t'e %artner# of t'e f!nd 'ave to (!i&d and *aintain #trong re&ation#'i%# it' +e" %eo%&e in ind!#tr", advi#er#, and even (an+er#. On$e a %otentia& dea& 'a# (een #o!r$ed, t'en t'e inve#t*ent tea* i&& $ond!$t 'eav" d!e di&igen$e to a##e## t'e $o*%an"H# #trateg", (!#ine## *ode&, *anage*ent tea*, t'e ind!#tr" and *ar+et, t'e finan$ia&#, t'e ri#+ fa$tor#, and t'e e)it %otentia&. Di&igen$e i# t"%i$a&&" $ond!$ted in #tage# t'at $orre#%ond to %'a#e# of t'e (idding %ro$e##, 'ere finan$ia& and o%erationa& infor*ation i# %rogre##ive&" revea&ed to PE fir*# (a#ed on (idder# t'at are #ti&& in t'e r!nning at ea$' %'a#e. If t'e dea& &oo+# %ro*i#ing and no dea&(rea+er red f&ag# are fo!nd, t'en t'e inve#t*ent %rofe##iona&# i&& %re#ent to t'e inve#t*ent $o**ittee /$o*%ri#ed of %artner#0 for f!nding a%%rova&. Fina& ter*# of t'e dea& it' (e negotiated it' &a"er# on (ot' #ide#, and t'e dea& i&& tran#a$t, it' f!nd# (eing re&ea#ed and e!it" (eing traded.
I*%roving o%eration#, $!tting $o#t#, and tig'tening *anage*ent One t'ing to (e ver" $&ear on i# t'at t'e ;P doe# NOT r!n t'e %ortfo&io $o*%anie# on a da" to da" (a#i#. T'e" are not in#ta&&ing t'e*#e&ve# a# CEO# and COO#. In#tead, t'e" ta+e (oard #eat#, t'e" *a" or *a" not re#'!ff&e #enior *anage*ent of t'e $o*%an", and t'e" %rovide advi$e, #!%%ort, introd!$tion#, et$, re&ating to o%eration#, #trateg", and finan$ia& *anage*ent. 2o invo&ved t'e ;P i# rea&&" de%end# on 'o (ig t'eir #ta+e in t'e $o*%an" i#. If t'e" on&" on a #*a&& *inorit" #ta+e, t'en t'e" onHt (e ver" invo&ved rat'er, t'e &ead inve#tor oning t'e (igge#t #ta+e i&& (e *o#t invo&ved. 2oever, if t'e" on eit'er a #iea(&e %er$entage of t'e e!it" or a #ignifi$ant %ortion of t'e entire f!nd i# inve#ted in t'e $o*%an", t'en t'e" i&& (e *!$' *ore 'ig'&" engaged in #trea*&ining and i*%roving t'e $o*%an" for a %rofita(&e e)it don t'e &ine. T'e ;P *!#t a&#o %rod!$e offi$ia& re%ort# for P#, genera&&" ea$' !arter, on t'e %rogre## and va&!e of t'eir %ortfo&io $o*%anie#, a&ong it' genera& finan$ia&
!%date#, and P# *a" !#e t'at infor*ation to *ar+ t'eir on %ortfo&io# to *ar+et 'en t'e" re%ort t'eir re#!&t# to t'eir on inve#tor#.
E)iting %ortfo&io $o*%anie# T'e end goa& for PE fir*# i# to e)it t'eir %ortfo&io $o*%anie# at a #!(#tantia& %rofit. T"%i$a&&", t'e e)it o$$!r# (eteen -9 "ear# after t'e origina& inve#t*ent, (!t it $o!&d (e #'orter or ta+e &onger de%ending on t'e #trategi$ $ir$!*#tan$e#. T'e *ain #o!r$e# of va&!e $a%t!re at e)it in$&!de: groing reven!e /and t'erefore E?ITDA0 #!(#tantia&&" d!ring t'e 'o&ding %eriod, $!tting $o#t# and o%ti*iing or+ing $a%ita& /and t'erefore in$rea#ing E?ITDA0, #e&&ing t'e $o*%an" at a 'ig'er *!&ti%&e t'an t'e origina& a$!i#ition *!&ti%&e, and %a"ing don de(t t'at a# initia&&" !#ed to f!nd t'e tran#a$tion. Mo#t e)it# 'a%%en a# t'e re#!&t of an IPO or a$!i#ition (" anot'er fir*, it' a$!i#ition# (eing t'e *ore $o**on *et'od. Ret!rn# are t'en *ea#!red (" t'e interna& rate of ret!rn /IRR0 /'i$' i# t'e di#$o!nt rate t'at *a+e# t'e net %re#ent va&!e fro* t'e entr" date of a&& $a#' f&o# (eteen entr" and e)it e!a& ero0, or it# !i$+er %ro)" t'e *!&ti%&e of *one" /MoM0 'i$' i# #i*%&" t'e a*o!nt of *one" ret!rned divided (" t'e a*o!nt inve#ted for t'at %arti$!&ar inve#t*ent. Note t'at t'e IRR de%end# on t'e d!ration of t'e 'o&ding %eriod 'i&e t'e MoM te$'ni$a&&" doe# not /a&t'o!g' "o! i&& (e 4!dged (" "o!r inve#tor# 'o &ong it too+ to generate t'at MoM0. 3o, for in#tan$e, if a 1M inve#t*ent i# #o&d for GM 4!#t one "ear &ater, t'e MoM i# G) (!t t'e IRR i# 1 if itH# #o&d after "ear#, t'e MoM i# #ti&& G) (!t t'e IRR 'a# fa&&en to G8 and itH# #o&d B "ear# &ater, t'e MoM i# #ti&& G), (!t t'e IRR i# 1B. 5'i&e %artner# do a &ot of t'e $oordination to #e&& t'e fir*H# %ortfo&io $o*%anie#, t'e" *a" a&#o retain inve#t*ent (an+# to 'and&e t'e e)e$!tion, e#%e$ia&&" 'en t'e tran#a$tion# are &arge or $o*%&e). T'atH# 'o inve#t*ent (an+# earn t'eir fee# S on #e&&ing t'e %ortfo&io $o*%anie# into PE fir*# and t'en again on #e&&ing t'e* o!t to don#trea* a$!irer#.
T2E PRIVATE EQUITY PROCE33
T'e Private E!it" Pro$e## in 9 3te%#: Dea& Origination /Dea& 3o!r$ing0 D!e Di&igen$e Dea& Negotiation Dea& C&o#ing /A$!i#ition0 Po#t A$!i#ition Monitoring E)it /IPO, Trade 3a&e or ?!" (a$+0 Re%eat.
Dea& Origination: Dea& Origination or a# #o*e $a&& it Dea& 3o!r$ingH i# 'o t'e" get t'eir dea&#, a %otentia& dea& $an eit'er $o*e t'ro!g' a $o*%an" oner a%%roa$'ing t'e* or fro* an inter*ediar" 'o i&& tr" to (ring (ot' %artie# /Co*%an" and Dea& Ma+er0 to $&o#e t'e dea&. In #o*e $a#e#, t'e" *a" 4!#t a%%roa$' $o*%anie# 'o are e)%anding fa#t and i#' to gro f!rt'er. In a "ear, t'e %rivate e!it" fir* $o*e# a$ro## '!ndred# of %otentia& dea&# (!t on&" a fe are #e&e$ted. D!e Di&igen$e: D!e Di&igen$e i# 'at "o! $o!&d $a&& doing "o!r 'o*eor+H. ?efore #tarting detai&ed negotiation#, t'e PE Fir* trie# to *a+e #!re ever"t'ing i# fair and #!are. A&t'o!g' A!ditor# and Con#!&tant# are a%%ointed to $ond!$t t'e Finan$ia&, Ta), ega& and Te$'ni$a& D!e Di&igen$e T'e" a&#o or+ #ide (" #ide to !nder#tand t'e target $o*%an" and it# ind!#tr" (etter. A&& t'e infor*ation $o&&e$ted at t'i# ti*e, i# t'en !#ed d!ring negotiation. Dea& Negotiation: At t'e Dea& Negotiation %'a#e, t'e" #et o!t t'e ter*# and $ondition# /$ovenant#, re%re#entation# and arrantie#0 and ot'er dea& ter*# t'at define or *a+e t'e dea&. Contra$t# #!$' a# Inve#t*ent Agree*ent, 3'are P!r$'a#e Agree*ent, Manage*ent Agree*ent, Advi#or" Agree*ent et$ are drafted to in$&!de a&& ite*# t'at %!t t'e dea& toget'er. Dea& C&o#ing: Dea& C&o#ing i# %ro(a(&" t'e ea#ie#t %art (!t a&#o $ontain# an e&e*ent of ri#+. ItH# t'e $on$&!#ion of t'e dea&, t'e #igning of a&& Agree*ent# and tran#ferring f!nd# fro* t'e (!"er to #e&&er, $ond!$ting ot'er
ad*ini#trative f!n$tion# /!#!a&&" done (" a #e%arate entit"0 &i+e !%dating an" arti$&e# of a##o$iation et$. Po#t A$!i#ition Monitoring: Po#t A$!i#ition Monitoring re!ire# t'e Dea& Tea* /t'o#e 'o 'ave or+ed on %!tting t'e dea& toget'er0 to $&o#e&" *onitor t'e $o*%an", (ot' fro* an o%erationa& and finan$ia& %oint of vie again#t t'e e)%an#ion %&an and (!dget# t'at ere #et!% ear&ier (" t'e $o*%an". I*%rove*ent# to (!#ine##, fro* Cor%orate ;overnan$e, Finan$ia& Re%orting, Infor*ation F&o to 3trateg" are *ade at ea$' &eve& t'ro!g' eit'er t'e $o*%an"H# *anage*ent or it# (oard. E)it: A# t'e $o*%an" *at!re# /!#!a&&" after G 7 "ear#0 it' t'e %re#en$e of t'e Dea& Tea*, t'e" %re%are it for an E)it - eit'er an IPO or a Trade 3a&e /#a&e to a &arger %art", *!&ti-nationa& or $ong&o*erate0 or in rare $a#e# a ?!" ?a$+ (" t'e oner#. ?" t'i# ti*e, t'e $o*%an" i&& 'ave gron !ite a (it it' #ti&& %&ent" of roo* to gro f!rt'er. Re%eat: And on$e t'e" 'ave e)ited t'e $o*%an", t'e" ret!rn t'eir inve#tor# *one" it' t'e %rofit t'e" gained for t'e* after ta+ing t'e fee# for a&& t'e effort %!t in t'e a(ove %ro$e##. T'en, t'e" 4!#t re%eat t'e %ro$e##, a&(eit it' a greater a%%etite for inve#t*ent#. A&t'o!g' t'i# *a" #ee* &i+e a &inear %ro$e## - it i#nHt e)a$t&" #o, %ri*ari&" (e$a!#e t'e %rivate e!it" fir* dea&# it' a n!*(er of $o*%anie# and ea$' one i# at a different #tage in t'e %rivate e!it" %ro$e##.
EWIT ROUTE3 IN PRIVATE EQUITY It i# t'e !&ti*ate o(4e$tive of a&& %rivate e!it" inve#tor# to rea&ie t'e ret!rn on t'eir inve#t*ent after a $ertain a*o!nt of ti*e, t"%i$a&&" (eteen t'ree to #even "ear# after t'e origina& tran#a$tion too+ %&a$e. Perfor*ing an e)it i# t'e %ro$e## (" 'i$' %rivate e!it" fir*# a$'ieve #!$' goa&, 'i$' i# t'erefore a nat!ra& %art of t'e &ife-$"$&e of ever" %rivate e!it" tran#a$tion. A&#o, t'e n!*(er of #!$$e##f!& e)it# a$'ieved (" a $ertain %rivate e!it" 'o!#e 'a# a #trong inf&!en$e on it# a(i&it" to attra$t inve#tor# and rai#e f!nd#. A$$ording&", t'e %otentia& e)it o%%ort!nitie# fro* an inve#t*ent %&a" a 'ig'&" i*%ortant ro&e in an inve#torH# de$i#ion a(o!t 'et'er or not to inve#t in a $o*%an". T'i# i# t'e rea#on '" e)it# re$eive #!$' #%e$ia& attention fro* t'e ear&ie#t #tage# of t'e dea&. T'ere are *an" e)it #trategie# t'at %rivate e!it" inve#tor# $an !#e to off&oad t'eir inve#t*ent. T'e *ain o%tion# are di#$!##ed (e&o: Initia& %!(&i$ offering: Initia& %!(&i$ offering /IPO0 or a# #o*eti*e# referred to f&otation or &i#ting i# t'e *et'od 'ere(" t'e $o*%an"H# #'are# get &i#ted on t'e #to$+ *ar+et for t'e fir#t ti*e, #o t'e inve#tor i&& (e a(&e to #e&& it# #'are# to t'e %!(&i$. T'i# i# one of t'e *o#t %o%!&ar e)it #trategie# !#ed (" %rivate e!it" %rovider#, d!e to t'e fa$t t'at 'en t'e %ro%er *ar+et $ondition# are avai&a(&e, t'i# *et'od i# &i+e&" to ena(&e t'e inve#tor to rea&ie t'e 'ig'e#t ret!rn on it# inve#t*ent. Notit'#tanding t'e 'ig'er o!t$o*e t'at $an (e o(tained, IPO# a&#o 'ave #erio!# di#advantage# $o*%ared to ot'er e)it *et'od# t'at need to (e ta+en into $on#ideration. Fir#t of a&&, t'e %!(&i$ offering of #'are# in it#e&f doe# not *ean an e)it. T'e %rivate e!it" %rovider i&& on&" (e a(&e to e)it it# inve#t*ent 'en it# #'are# are a$t!a&&" #o&d on t'e #to$+ *ar+et, 'i$' i# ver" !n&i+e&" to 'a%%en #i*!&taneo!#&" it' t'e IPO. T'erefore, t'e inve#tor #ee+ing to %erfor* an e)it i&& (e e)%o#ed to f&!$t!ation# and ot'er *ar+et ri#+# for a $ertain a*o!nt of ti*e after t'e IPO i# $arried o!t. A&#o, t'e &i#ting of t'e #'are# of a $o*%an" i# t"%i$a&&" #!(4e$t to #tri$t reg!&ator" re!ire*ent# and re#tri$tion#, 'i$' *a+e t'e IPO a &engt'" and e)%en#ive %ro$e##.
Trade #a&e: Anot'er $o**on&" !#ed e)it ro!te i# t'e trade #a&e in 'i$' t'e %rivate e!it" inve#tor #e&&# a&& of it# #'are# 'e&d in a $o*%an" to a trade (!"er, i.e. a t'ird %art" often o%erating in t'e #a*e ind!#tr" a# t'e $o*%an" it#e&f. T'i# *et'od i# %referred (" %rivate e!it" %rovider# *ain&" (e$a!#e it %rovide# a $o*%&ete and i**ediate e)it fro* t'e inve#t*ent. Anot'er advantage of t'e trade #a&e i# t'at in t'i# $a#e, t'e negotiation# ta+e %&a$e it' a #ing&e (!"er 'i$' a&&o# for a !i$+er and *ore effi$ient %ro$e## 'i$' i# not #!(4e$t to t'e reg!&ator" re#tri$tion# a%%&i$a(&e to IPO tran#a$tion#. In a trade #a&e tran#a$tion, t'e inve#tor $an a&#o e)er$i#e *ore $ontro& over t'e 'o&e %ro$e##, and in $ertain $a#e# *ig't even end !% o(taining a 'ig'er va&!e for t'e $o*%an" $o*%ared to ot'er e)it *et'od#. On t'e ot'er 'and, trade #a&e i# not free fro* %otentia& %ro(&e*# and ri#+# eit'er. T'e *anage*ent of t'e $o*%an" *a" (e re#i#tant #!$' a tran#a$tion a# t'e $'ange of $ontro& often re#!&t# in t'e re%&a$e*ent of t'e $o*%an"H# *anage*ent a# e&&. A trade #a&e *ig't a&#o entai& #erio!# (!#ine## ri#+# a# t'e (!"er i# oftenti*e# a $o*%etitor of t'e $o*%an", 'i$' i&& inevita(&" o(tain $onfidentia& (!#ine## infor*ation d!ring t'e negotiation %ro$e##. 3e$ondar" (!"o!t: In t'e $a#e of a #e$ondar" (!"o!t, t'e $o*%an" i# #o&d (" a %rivate e!it" inve#tor to anot'er %rivate e!it" fir*. In ot'er ord#, t'e %arti$!&ar nat!re of a #e$ondar" (!"o!t &ie# in t'at %rivate e!it" 'o!#e# a%%ear on (ot' #ide# of t'e dea&, 'i&e in t'e average tran#a$tion %rivate e!it" inve#tor# o!&d on&" (e invo&ved eit'er a# #e&&er or %!r$'a#er. T'ere are a n!*(er of %o##i(&e rea#on# '" an inve#tor *a" $'oo#e t'i# *et'od a# t'e e)it ro!te. It $an (e a *ean# of #'ortening t'e &ife-ti*e of a tran#a$tion 'i$' 'a# (e$o*e a %riorit" for %rivate e!it" 'o!#e# in t'e re$ent e$ono*i$ $&i*ate, and t'erefore #e$ondar" (!"o!t# 'ave (e$o*e in$rea#ing&" %o%!&ar. 3o*eti*e#, t'e inve#tor 'i$' $arried o!t t'e origina& a$!i#ition i# not i&&ing to /or $annot0 finan$e a (!#ine## an"*ore, even t'o!g' t'e $o*%an" *ig't not "et (e read" for a trade #a&e or IPO. In t'at $a#e, #e&&ing t'e $o*%an" to anot'er %rivate e!it" fir* 'i$' #ee# %otentia& in f!rt'er deve&o%ing t'e $o*%an"
*ig't (e a rea#ona(&e #o&!tion. T'i# *et'od $an a&#o (e !#ed (" t'e *anage*ent 'en t'e" i#' to re%&a$e t'e %rivate e!it" inve#tor (a$+ing t'e $o*%an". A #e$ondar" (!"o!t offer# t'e advantage# of an i**ediate and $o*%&ete e)it and it $an (e $arried o!t even fa#ter t'an a trade #a&e or an IPO. T'i# %&a"# a #ignifi$ant ro&e in it# in$rea#ing %o%!&arit". everage re$a%ita&iation: everaged re$a%ita&iation i# a %artia& e)it *et'od, 'ere(" t'e %rivate e!it" inve#tor i# a(&e to e)tra$t $a#' fro* a (!#ine## it'o!t a$t!a&&" #e&&ing t'e $o*%an". T'i# i# a$'ieved (" re-&everaging t'e $o*%an" i.e. #!(#tit!ting #o*e of t'e $o*%an"H# e!it" it' additiona& de(t. It i# !#!a&&" done (" t'e $o*%an" rai#ing *one" (" (orroing fro* a (an+ or i##!ing (ond#, 'i$' a*o!nt i# t'en !#ed to re%!r$'a#e t'e $o*%an"H# on #'are# fro* t'e inve#tor. T'e *o#t i*%ortant advantage# genera&&" a##o$iated it' &everaged re$a%ita&iation# are t'at inve#tor# $an re*ain in $ontro& 'i&#t #ti&& re$eiving %a"*ent and t'e %o##i(&e ta) (enefit# $o*%ared to ot'er t"%e# of e)it#. On t'e ot'er 'and t'ere are #ignifi$ant di#advantage# to t'i# *et'od too. A &everaged re$a%ita&iation *a" re#!&t in over-&everage t'at $an event!a&&" &ead to finan$ia& diffi$!&tie# and even (an+r!%t$". A&#o, in$rea#ed &everage &i*it# t'e f&e)i(i&it" of t'e $o*%an"H# o%eration#.
i!idation: T'i# i# t'e &ea#t favora(&e o%tion (!t #o*eti*e# i&& 'ave to (e !#ed if t'e %ro*oter# of t'e $o*%an" and t'e inve#tor# 'ave not (een a(&e to #!$$e##f!&&" r!n t'e (!#ine##.
TYPE3 OF RI3@ AND RI3@ MANA;EMENT IN PRIVATE EQUITY
Fir#t, %rivate e!it" i# an e!it" inve#t*ent into non-!oted $o*%anie#. A# t'e $o*%anie# are not traded on a #e$ondar" *ar+et &i+e t'e #'are# of %!(&i$&" &i#ted $o*%anie#, t'ere i# no *ar+et %ri$e avai&a(&e on a reg!&ar (a#i#. On&" if t'e $o*%an" i# #o&d to anot'er inve#tor $an tr!e *ar+et va&!e# (e o(#erved, (!t t'i# t"%i$a&&" on&" 'a%%en# after a n!*(er of "ear#. D!e to t'e &a$+ of reg!&ar *ar+et %ri$e#, t'e t"%i$a& and e&&-+non ri#+ *ea#!re# of %!(&i$ *ar+et#, #!$' a# vo&ati&it", va&!e-at-ri#+ or #'ortfa&&-ri#+, $annot (e !#ed in %rivate e!it". ?e$a!#e of t'i# &a$+ of avai&a(i&it" of *ar+et %ri$e#, f!nd *anager# derive a va&!e for ea$' $o*%an" !#ing one of t'e ind!#tr"H# #tandard va&!ation *et'od# e.g. *ar+et $o*%ara(&e#, di#$o!nted $a#' f&o *et'od# or ot'er#. T'e#e net a##et va&!e# /NAV0 are not *ar+et %ri$e#. Rat'er, t'e" are #i*i&ar to a$$o!nting va&!e# and are re%orted to inve#tor# on a !arter&" (a#i# to %rovide t'e* it' an indi$ative %ri$e for t'eir inve#t*ent (a#ed on va&!ation# of t'e !nrea&ied inve#t*ent# 'e&d. Even if t'e#e NAV# are #o*eti*e# !#ed to $a&$!&ate a ri#+ *ea#!re, it i# i*%ortant to !nder#tand t'at t'e" are not (a#ed on a$t!a& *ar+et tran#a$tion#. Con#e!ent&", t'e" $an differ fro* tr!e fair *ar+et va&!e#. 3e$ond, a t"%i$a& %en#ion f!nd, in#!ran$e $o*%an", (an+ or fa*i&" offi$e doe# not inve#t dire$t&" into a $o*%an". In t'e &arge *a4orit" of $a#e#, a f!nd i# !#ed a# t'e inve#t*ent ve'i$&e (e$a!#e t'e %rofe##iona& f!nd *anager 'a# (ot' t'e e)%erien$e and +no&edge to #o!r$e and #e&e$t t'e inve#t*ent#, *anage t'e* a$tive&", ad4!#t t'e #trateg" of t'e $o*%an" in order to $reate *ore va&!e, *onitor t'e $o*%an", and #e&& it after an average 'o&ding %eriod of five "ear#. T'e t"%i$a& inve#t*ent i# done t'ro!g' a $&o#ed end i*ited Partner#'i% #tr!$t!re. 2ere, inve#tor# are t'e i*ited Partner# /P0 'o $o**it an a*o!nt of $a%ita& at t'e (eginning of t'e &ife of t'e %artner#'i% it' t'e &ega& o(&igation to %a" t'i# $a%ita& into t'e f!nd 'enever t'e f!nd *anager /;enera& Partner ;P0 $a&&# for it. 5'en t'e f!nd *anager 'a# identified an attra$tive inve#t*ent o%%ort!nit" in a $o*%an", t'e" i&& dra don t'e $a%ita& fro* t'e inve#tor !#!a&&" t'i# i&& (e done d!ring an inve#t*ent %eriod of five "ear#. T'ereafter t'e inve#t*ent i&& (e 'e&d and e)ited. In tota&, P #tr!$t!re# tend to (e #et-!% for a &ong-ter* 'orion of 1 "ear# it' no rede*%tion rig't# for inve#tor#. T'e" $an on&" tr" to &i!idate t'eir #ta+e at t'e #e$ondar" *ar+et for de%ending on t'e *ar+et #it!ation and e)terna& fa$tor# a %otentia&&" &arge di#$o!nt, d!e to t'e i&&i!idit" and ineffi$ien$" of t'i# *ar+et. In addition, #a&e# negotiation# $an t"%i$a&&" ta+e #evera& ee+# to $o*%&ete. A# #!$',
an inve#tor in %rivate e!it" $an r!n a &i!idit" ri#+. a#t&", an inve#tor doe# not %a" in a&& of t'eir $a%ita& on t'e fir#t da" rat'er, t'e *one" i# dran fro* t'e f!nd over ti*e. T'i# re%re#ent# a #%e$ifi$ ri#+ for inve#tor#, 'i$' i# of $o!r#e a re#!&t of t'e t"%i$a& f!nd #tr!$t!re di#$!##ed in t'e %revio!# %aragra%' i.e. f!nding ri#+. If t'e inve#tor i# not a(&e to %a" t'e $a%ita& $a&& in a$$ordan$e it' t'e ter*# of t'e %artner#'i% agree*ent, t'e" defa!&t on t'eir %a"*ent. In #!$' a $a#e, t'e inve#tor *ig't &o#e t'e entire inve#t*ent and a&& t'e $a%ita& 'i$' t'e" a&read" %aid into t'e f!nd. Man" f!nd *anager# 'ave #tri$t r!&e# in t'eir i*ited Partner#'i% Agree*ent# in t'e $a#e of a defa!&ting inve#tor. T"%i$a&&", t'e inve#tor i&& &o#e t'eir entire inve#t*ent in #o*e $a#e# t'e" #ti&& 'o&d t'e &ia(i&itie#. T'i# #tri$t *e$'ani#* i# i*%ortant for t'e f!nd *anager a# t'e" need to 'ave t'e 'ig'e#t %o##i(&e #e$!rit" to f!nd t'e inve#t*ent# t'e" o!&d &i+e to a$!ire. In addition to t'e ri#+ of not (eing a(&e to f!&fi&& t'eir on !ndran $o**it*ent ea$' inve#tor $an (e adver#e&" i*%a$ted a# a re#!&t of ot'er inve#tor# defa!&ting. 2en$e, &i!idit" and f!nding ri#+# ari#ing t'ro!g' !nf!nded $o**it*ent# are an i*%ortant e&e*ent and need to (e ref&e$ted in #o%'i#ti$ated ri#+ *anage*ent #"#te*#. Fo&&oing ri#+# $an (e identified in %rivate e!it":
1. F!nding ri#+: T'e !n%redi$ta(&e ti*ing of $a#' f&o# %o#e# f!nding ri#+# to inve#tor#. Co**it*ent# are $ontra$t!a&&" (inding and defa!&ting on %a"*ent# re#!&t# in t'e &o## of %rivate e!it" %artner#'i% intere#t#. T'i# ri#+ i# a&#o $o**on&" referred to a# defa!&t ri#+. If t'i# ri#+ *ateria&i#e#, an inve#tor $an &o#e t'eir f!&& inve#t*ent in$&!ding a&& %aid-in $a%ita&, 'i$' i# '" it i# of %ara*o!nt i*%ortan$e for inve#tor# to *anage t'eir $a#' f&o# to *eet t'eir f!nding o(&igation# effe$tive&". T'e finan$ia& $ri#i# in G 'ig'&ig'ted t'e i*%ortan$e of *anaging f!nding ri#+. 3in$e t'en, reg!&ator# 'ave fo$!#ed *ore on f!nding ri#+ and 'ave i##!ed %rin$i%&e# for #o!nd f!nding = &i!idit" ri#+ *anage*ent. ?!t 'o doe# f!nding ri#+ o$$!r 'en *anaging a %rivate e!it" %ortfo&ioL In genera&, t'ere are to rea#on#: /i0 over-$o**it*ent and /ii0 *ar+et di#tortion in $a%ita& $a&&# and di#tri(!tion#. 2o $an f!nding ri#+ (e *ea#!red and 'i$' #o&!tion# are %o##i(&eL •
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F!nding ri#+ $an (e *ea#!red t'ro!g' a f!nding te#t or t'ro!g' $a#' f&o *ode&# 'i$' ta+e e)tre*e $a#e# into a$$o!nt. T'e f!nding te#t %&a$e# t'e !ndran $o**it*ent# in re&ation to t'e re#o!r$e# avai&a(&e for $o**it*ent#. A&ternative&", a $a#' f&o *ode& %rovide# t'e inve#tor it' a #i*!&ation of t'e e)%e$ted $a%ita& $a&&# and di#tri(!tion# in t'e f!t!re. It i# ver" i*%ortant t'at e)tre*e #$enario# are a&#o $on#idered in 'i$' $a%ita& $a&&# are *!$' 'ig'er t'an di#tri(!tion# and, 'en$e, &arge a*o!nt# of o!t#ide $a%ita& are ne$e##ar". 2o $an f!nding ri#+ (e red!$edL Inve#tor# $an red!$e t'e ri#+ (" a##e##ing t'eir f!t!re $o**it*ent %&an it' $a#' f&o #i*!&ation# and $a!tio!# %&anning. Inve#tor# 'o 'ave &i*ited e)terna& $a%ita& avai&a(&e or &arge a&&o$ation# to i&&i!id a##et# #'o!&d (e *ore $a!tio!# on t'e over-$o**it*ent and #e&ff!nding #trateg". 2oever, 'en de$iding on #!$' a #trateg", inve#tor# #'o!&d (e aare of %o##i(&e e)tre*e #$enario# and 'o *!$' $a#' o!&d (e ne$e##ar" and 'o t'i# $o!&d (e o(tained fro* ot'er #o!r$e#. A #trategi$ %&an for t'e#e e)tre*e $a#e# a# e&& a# t'e %ortfo&io $on#tr!$tion %&an i# t'e +e" e&e*ent.
G. i!idit" ri#+: i!idit" Ri#+ i# t'e ri#+ t'at an inve#tor i# !na(&e to redee* t'eir inve#t*ent at t'e ti*e of t'eir $'oo#ing. 5e 'ave a&read" noted t'at %rivate e!it" f!nd #tr!$t!re# are de#igned #o t'at t'e inve#tor re*ain# in t'e f!nd for it# f!&& ter* it'o!t an o%%ort!nit" to redee* t'eir $o**it*ent. A# a re#!&t of t'e#e #tr!$t!re#, 'oever, a #e$ondar" *ar+et for P $o**it*ent# /%arti$i%ation#0 'a# evo&ved. Con#e!ent&", &i!idit" ri#+ *a" a&#o (e regarded a# t'e ri#+ t'at an inve#tor ant# to #e&& t'eir %rivate e!it" inve#t*ent /in t'e for* of a f!nd $o**it*ent0 on t'e #e$ondar" *ar+et, (!t t'e *ar+et doe# not offer eno!g' vo&!*e or effi$ien$" for a fair trade. •
2o $an &i!idit" ri#+ (e *ea#!red and 'i$' #o&!tion# are %o##i(&eL i!idit" ri#+ in %rivate e!it" i# diffi$!&t to *ea#!re. 5'i&e t'e #e$ondar" *ar+et $an (e ver" a$tive in a nor*a& *ar+et environ*ent and d!ring (oo* %'a#e#, t'i# &eve& of a$tivit" i# far fro* 'at one
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o!&d #ee in even t'e *o#t i&&i!id of &i#ted *ar+et#. Moreover, t'e #e$ondar" *ar+et a# #'!t don d!ring t'e finan$ia& $ri#i# in G6 it' ver" &o trading vo&!*e#. A# #!$', t'e &i!idit" ri#+ for inve#tor# in %rivate e!it" #ee*# to (e 'ig' d!e to ineffi$ient #e$ondar" *ar+et#. 2o $an &i!idit" ri#+ (e red!$edL i!idit" ri#+ in %rivate e!it" i# diffi$!&t to red!$e, a&t'o!g' it i# #i*%&er to 'and&e for inve#tor# in an overa&& a##et a&&o$ation *ode&. If an inve#tor i# #o&e&" fo$!#ed on %rivate e!it" a##et# and t'e" need to #e&& in diffi$!&t *ar+et ti*e#, t'e" $annot $ir$!*vent t'e &i!idit" ri#+. 2oever, if %rivate e!it" i# on&" a #*a&& %art of a e&&diver#ified a##et a&&o$ation, a# i# t'e $a#e for *an" in#!ran$e $o*%anie#, %en#ion f!nd# and (an+#, *an" ot'er a##et# are *ore &i!id and $an (e traded. In rea&it", t'e e)%erien$e i# t'at (an+# or in#!ran$e $o*%anie# !#e t'e #e$ondar" *ar+et in "ear# of 'ig' %ri$e# to #e&& t'eir a##et# and do not !#e it fre!ent&" in di#tre##ed *ar+et#.
. Mar+et ri#+: T'e f&!$t!ation of t'e *ar+et 'a# an i*%a$t on t'e va&!e of t'e inve#t*ent# 'e&d in t'e %ortfo&io. •
2o $an *ar+et ri#+ (e *ea#!red and 'i$' #o&!tion# are %o##i(&eL A# t'e NAV# are avai&a(&e on a !arter&" (a#i#, #tati#ti$# t'at are a%%&ied to $ontin!o!#&" traded #e$!ritie# $an a&#o (e !#ed for %rivate e!it" inve#t*ent#, #!$' a# t'e vo&ati&it" of t'e NAV-(a#ed ret!rn ti*e #erie# on a !arter&" (a#i#. 2oever, a# *entioned a(ove, #!$' !nad4!#ted ti*e #erie# o!&d !nfair&" favo!r %rivate e!it" inve#t*ent# over t'e #to$+ *ar+et and t'erefore #'o!&d not (e !#ed. To #ti&& a&&o for a #i*%&e $o*%ari#on it' ot'er a##et $&a##e#, t'ere are a%%roa$'e# to de-#*oot' t'o#e NAV# (efore r!nning ri#+ ana&"#e#. Ot'er ana&"#e# fo$!# on t'e ti*e-&ag of re%orting.1 2oever, it i# de(ata(&e 'o e&& #!$' ad4!#t*ent# or+ for %rivate e!it" ret!rn#. F!rt'er*ore, re#!&t# (a#ed on #!$' *ar+et ri#+ *ea#!re# are $entered on t'e i*%&i$it a##!*%tion t'at t'e !arter&" NAV# are a$t!a& *ar+et va&!e# 'i$' an inve#tor $o!&d (!" and #e&&.
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T'i# i# not tr!e for %rivate e!it" inve#t*ent# and a# #!$' t'e re#!&t# $an give an inve#tor a *i#&eading vie on t'eir inve#t*ent. Rat'er, t'e" #'o!&d fo$!# on t'e &ong-ter* %ro%ertie# of %rivate e!it" a# it i# in'erent&" a &ong-ter* a##et $&a##. 2o $an *ar+et ri#+ (e red!$edL Mar+et ri#+ a# t'e !arter&" $'ange of t'e net a##et va&!e i# a #'ortter* ri#+ *ea#!re and, t'erefore, a&#o de%end# on t'e #'ort-ter* *ove*ent of %!(&i$ and FW ri#+#. A# #!$', if t'e %ortfo&io i# &arge&" diver#ified over vario!# geogra%'ie#, *ar+et# and ind!#trie#, t'i# vo&ati&it" $an (e *ini*i#ed.
7. Ca%ita& ri#+: C&o#e&" re&ated to *ar+et ri#+ i# $a%ita& ri#+ for t'e inve#tor. Ca%ita& ri#+ for t'e inve#tor i# defined a# t'e %ro(a(i&it" of &o#ing $a%ita& it' a %rivate e!it" %ortfo&io over it# entire &ifeti*e.16 A# a $on#e!en$e, t'e inve#tor o!&d 'ave a rea&i#ed &o## in t'eir %ortfo&io, 'i&e *ar+et ri#+ i# (a#ed on !nrea&i#ed va&!e#. 3i*i&ar&" to *ar+et ri#+, $a%ita& ri#+ i# driven (ot' (" interna& and e)terna& fa$tor#. In t'e &ong-ter*, t'e deve&o%*ent of t'e !nder&"ing $o*%anie# in a f!nd %ortfo&io affe$t# t'e %erfor*an$e and t'e $a%ita& ri#+ of t'e inve#t*ent#. T'e %o#itive o%erationa& deve&o%*ent of t'e $o*%anie# and t'eir finan$ia& #it!ation i# a #!(#tantia& #o!r$e of va&!e $reation for inve#tor#. A# #!$', t'e f!nd *anager #%end# a #ignifi$ant a*o!nt of ti*e or+ing it' t'e *anage*ent ana&"#ing and i*%roving t'e $o*%anie#H #trategie# d!ring t'eir 'o&ding %eriod# in order to e)it t'e $o*%an" to a va&!e a(ove t'e inve#t*ent $o#t. T'e $ondition# of t'e e)it *ar+et, *et'od and ti*ing of t'e e)it $an a&#o (e a ro!te t'ro!g' 'i$' t'e f!nd *anager $an $reate va&!e for inve#tor#. 2o $an $a%ita& ri#+ (e *ea#!red and 'i$' #o&!tion# are %o##i(&eL •
For &i!idated or *at!re f!nd#, t'e ratio (eteen di#tri(!tion# and %aid-in $a%ita& $an (e !#ed a# a *ea#!re for $a%ita& ri#+ /DPI0. If t'i# ratio i# (e&o one for a #%e$ifi$ inve#t*ent, an inve#tor 'a# &o#t *one". T'i# *ea#!re $an (e $a&$!&ated on t'e %ortfo&io &eve& of t'e inve#tor, on t'e f!nd &eve& and on t'e %ortfo&io $o*%an" &eve&. For f!nd# t'at are #ti&& a$tive, t'e re#id!a& NAV #'o!&d (e added to t'e
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n!*erator to *ea#!re tota& va&!e to %aid-in $a%ita& /TVPI0. T'i# *ea#!re i# t'en de%endent on t'e !a&it" of t'e re%orted NAV. 2o $an $a%ita& ri#+ (e red!$edL 3t!die# 'ave #'on t'at, over t'e &ong-ter*, interna& fa$tor# are $riti$a& 'en (!i&ding a #!$$e##f!& %rivate e!it" %ortfo&io. Inve#tor# are a(&e to *ini*i#e t'eir $a%ita& ri#+ #ignifi$ant&" 'en diver#if"ing over a &arge n!*(er of f!nd# in *an" geogra%'ie#, ind!#trie#, and over *an" "ear# and it' different f!nd *anager#. In genera&, t'e (e#t re#!&t# 'ave (een a$'ieved 'en f!nd# 'ave e!a& eig'ting it' t'e #a*e inve#t*ent #trateg". A%art fro* inve#ting in dire$t f!nd#, doing #o in $o-inve#t*ent# and #e$ondar" f!nd# f!rt'er in$rea#e# diver#ifi$ation.
