Private equity firms use the money raised from institutional investors to acquire several (usually 10 – 15) private businesses. They aim to own and grow them for 3 – 5 years, and sell them for a profit, generating return for their investors.
Where does private equity money come from?
The money managed by most private equity funds comes from institutional investors e.g. large corporate and local authority pension funds, insurance companies or sovereign wealth funds. These are much the same institutions that are also heavily invested in public markets, bonds, real estate and infrastructure. Today, most institutional investors see investing in private equity funds as a key part of their overall investment portfolio.
Why do institutions invest in private equity funds?
Over the last 40 years in the UK, the private equity market on average has generated better returns for investors than other forms of equity or debt investment. Large investors are under pressure to generate higher returns for their stakeholders (e.g. pensioners) as we are living longer, healthier lives so they have allocated more capital to private equity to achieve this. As a result, the private equity market has grown considerably and continues to do so.
How many private equity funds are there and what sort of organisations are they?
Private equity is an increasingly global industry with over 3,800 private equity firms in Europe, over 7,000 in the US and over 700 in Asia. The 1,200 firms based in the UK form a significant and growing element of the corporate landscape, with 2017 revenues generated by the thousands of private-equity-owned companies in the UK totalling £71.3bn*. Since the UK is also an attractive market for foreign investors; US, Continental European and Asian investors have also increased their activity in the UK. Recent growth in the private equity market has resulted in numerous successful individuals and teams leaving established firms to set up and raise their own funds. Private equity firms that invest in SMEs are usually small organisations of less than 30 people often with a similar strong, entrepreneurial culture to the SMEs they invest in.
What do private equity firms promise their investors?
Private equity firms set out to generate ‘above-market’ returns through a specific investment strategy. This means targeting a certain part of the market, usually defined by the size and location of the companies they are investing in (e.g. UK SMEs) and the company’s situation (e.g. profitable). Further examples could be: turning around un-profitable companies; taking minority stakes; focusing on a particular industry; backing management succession; backing ‘buy and build’ strategies; and backing international expansion.
An attractive strategy to an investor is one that has been consistently and successfully applied, so each private equity firm develops its own focus and searches for deals that fit those criteria. Our interactive PDF illustrates many of the private equity firms we work with at RSM in the UK; the differences in criteria, activity levels and funding sources between them. The below table explains the types of funds available.
|Types of funds|
|Pooled fund||Usually a 10-year fund comprising of capital raised from a variety of sources including pension, sovereign wealth, insurance, family office and university endowments.|
|Family office||Wealth management firm that serves one or more high net worth individuals or families.|
|Deal by deal||Investment raised on an ad-hoc basis for a specific transaction.|
|VCT||Venture capital trust – usually an early stage investment for small expanding companies. VCTs are very tax efficient closed-ended investment schemes.|
|Balance sheet||Funded from an organisation’s balance sheet.|
|Run off||A fund, with a portfolio, that is no longer raising new capital for future investments.|
To further explore private equity as an option for your business, please get in touch with our team today.
*Sources: Pitchbook and Preqin