Private Equity Demystified

Continuing with the build up of the events leading to the Big Bang, i.e. the PE Symposium 2008 on the 20th of september, we have this post which answers everyting about PE that you ever wanted to know.

Private Equity....what is it??

Equity capital that is not quoted on a public exchange. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet.

Private equity first emerged in the early 1980s, with Kohlberg, Kravis and Roberts (KKR) opening the first, and still among the largest LBO (Leveraged Buy Out) firms. The logic for LBO firms, at least initially, was this: Publicly traded companies are forced to focus on extremely short-term (often quarterly or monthly) results, thus making decisions which may not be in line with their long-term goals. Going 'private' or delisting from the exchanges allows them to focus on these goals. Leveraging, that is, taking debt to buyback these shares as well as spending on longer-term expansion, etc allowed managers to run their companies the way they wanted to. Moreover, the LBO firms were often run by investment bankers and consultants who contributed significant financial and industry expertise. Over time, however, the deals also began to be 'hostile', that is, the LBO managers perceived value in firms which they felt were mismanaged, so they would buy them out, restructure them, and then sell them off once more.

The other side of private equity investment comes from the world of venture capital, where small companies that need to grow but are cash-strapped and too small to list on exchanges approach (or are approached by) VC firms to take a stake in the company, as well as hand-hold them onto a growth path.

India and PE

In India, private equity is reasonably young, dating back to the mid-1990s. The environment heated up in the end of the ‘90s with the IT boom, with companies investing (and getting their fingers burnt) with their investments. In recent years, there has been a resurgence of these firms, with India’s stock markets booming and sectors like the life sciences, infrastructure and most recently, real estate being growth stories for the future. Global firms such as Warburg Pincus, Blackstone and the Carlyle Group have a presence in India while Indian players like ICICI Venture and ChrysCapital also have a large presence.

India’s private equity sector is moving to the big league. Fund sizes have increased dramatically from US $0 to US $25 million just a few years ago, to between US $400 million and US $ billion today. The minimum deals now start at around US $25 million, eclipsing the average deal size of US $8 million in 2002. With the strong global interest in the Indian market continuing, the challenge is no longer about raising private equity funds, but how to extract value from
the portfolio investments, turning the focus from financial capital to human capital.

Where does the Moolah come from??

Essentially, PE funds raise money from high net worth individuals, financial institutions, etc. for a period of seven-ten years and then invest in opportunities as and when they arise, either in early-stage, maturing or even public companies. The work involves of course, valuing the companies that approach you and deciding how much of the company your stake is actually worth, what the company’s growth prospects are, etc. Structuring the transactions for tax-efficiency and industry-specific reasons is also part of the job. Post-stake taking, day-to-day monitoring and growth plans are monitored by the fund, with a senior director taking a seat on the company’s board. Since the target is also to exit the investment in a few years and return money to investors, the deal teams also constantly monitor the capital markets for suitable times to do an Initial Public Offering or find a strategic investor to sell to.

Whats in it for You..

Outside of entrepreneurship, private equity arguably offers the best shot you’ll get at ‘being the boss’ yourself, and not just being just an employee. Since the money is, in some sense, your own, the attachment you would have with your investments is much greater than in most jobs. Additionally, the nature of work offers an unparalleled opportunity to understand a variety of industries and also get to know many of the movers and shakers in the corporate world, investment banking, etc.

Monetarily, private equity is possibly the most highly-paid post-MBA job you can hope to get. The biggest incentive in this industry is the concept of carried interest, which means that the firm keeps a portion (typically 20 pc) of the profits made for its investor, which is then distributed to employees.

What they want ??

The skill set necessary for a PE job includes significant financial expertise, an intuitive understanding of capital markets, but most importantly, an eye to capture the right businesses and entrepreneurs at the right time.

Some good websites on this are:

www.vccircle.com
www.indiape.com

I am Still Bullish.......