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Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. Categories of private equity investment include Leveraged buyout, venture capital, growth capital, angel investing, mezzanine capital and others.
Private equity firms
Generally, private equity funds are organized as limited partnerships which are controlled by the private equity firm that acts as the general partner. The fund obtains commitments from certain qualified investors such as pension funds, financial institutions and wealthy individuals to invest a specified amount. These investors become passive limited partners in the fund partnership and at such time as the general partner identifies an appropriate investment opportunity, it is entitled to "call" the required equity capital at which time each limited partner funds a pro rata portion of its commitment. All investment decisions are made by the General Partner which also manages the fund's investments (commonly referred to as the "portfolio"). Over the life of a fund which often extends up to ten years, the fund will typically make between 15 and 25 separate investments with usually no single investment exceeding 10% of the total commitments.
General partners are typically compensated with a management fee, defined as a percentage of the fund's total equity capital, as well as a carried interest, defined as a percentage of profits generated by the fund (so long as some minimum return for the investors called the hurdle rate is achieved). Typically, general partners of funds will receive a management fee of 2% and carried interest of 20%. (Although typically, the carry is reduced by the amount of the management fees received). Gross private equity returns may be in excess of 20% per year, which in the case of leveraged buyout firms is primarily due to leverage, and in the case of venture capital firms, due to the high level of risk associated with early stage investments. Although there is a limited market for limited partnership interests, such interests are not freely tradeable like mutual fund interests.
Size of industry
Nearly $180bn of private equity was invested globally in 2004, up over a half on the previous year as market confidence and trading conditions improved. Funds raised globally increased 40% in 2004 to $112bn. Prior to this, investments and funds raised increased markedly during the 1990s to reach record levels in 2000. The subsequent falls in 2001 and 2002 were due to the slowdown in the global economy and declines in equity markets, particularly in the technology sector. The decline in fund raising between 2000 and 2003 was also due to a large overhang created by the end of 2000 between funds raised and funds invested.
The regional breakdown of private equity activity shows that in 2004, 66% of global private equity investments (up from 58% in 1998) and 62% of funds raised (down from 72%) were managed in North America. Between 1998 and 2004, Europe increased its share of investments (from 24% to 26%) and funds raised (from 18% to 31%). Asia-Pacific region’s share of investments and of funds raised during this period was virtually unchanged at around 6% while share of the rest of the world fell. The country breakdown for private equity activity shows that private equity firms in the US managed 64% of global investments and 59% of funds raised in 2004. The UK was the second largest private equity centre with 13% of investments and 11% of funds raised.
See also
External links
- Economist.com - Survey - The new kings of capitalism
- The rise of the new conglomerates
- Directory of private equity firms
References
"Private equity"