Private Equity

Private equity is a type of private markets investment that involves investing in private companies that are not publicly traded on a stock exchange. Private equity firms raise money from institutional investors, such as pension funds, and high net worth individuals, and then use that money to buy stakes in private companies.

Private equity allows companies that are not able to get funding from traditional sources, such as banks or public markets, to obtain funding to help them grow and become more profitable and allows investors to shape how a company is run and make a profit when it's sold.

Private equity firms typically take an active role in managing the companies they invest in, with the goal of improving their performance and increasing their value. Once a private equity firm has invested in a company, it will typically hold the investment for several years before selling it. This could involve selling the company to another private equity firm, taking the company public, or selling the company back to the management team.

Private Equity: a brief history

Private equity can trace its roots back to the early 1900s when investors would purchase shares in companies that were not listed on a public stock exchange. Private equity firms began to gain popularity in the 1970s when many firms were founded to invest in leveraged buyouts (LBOs), to take companies private and sell them off over time. This type of transaction became popular due to high interest rates, as banks were less willing to lend money to small businesses.

The private equity industry grew significantly in the 1990s, thanks in part to the passage of the Private Equity Firm Disclosure Act of 1995. This act required private equity firms to disclose certain information about their activities, including how much money they had raised and how many companies they had invested in.

The 2000s were a challenging time for the private equity industry, as the dot-com bubble burst in 2001, while the financial crisis of 2008 caused many firms to go bankrupt or sell their assets at a loss. The global private equity industry has rebounded in recent years and is now worth more than $3 trillion.

There are several different types of private equity, each with its own unique set of goals and strategies. The most common types of private equity are listed below.

Leveraged Buyouts (LBOs)

A leveraged buyout (LBO) is a type of transaction in which a company is purchased using debt funding from private equity investors. The goal of an LBO is to take a company private, make it more efficient and profitable, and then sell it off over time. This type of transaction became popular in the 1980s when interest rates were high and banks were unwilling to lend money to small businesses.

Venture Capital

Venture Capital entails investing in young, high-growth companies that have the potential to become major players in their industry. The goal is to help these companies grow and achieve profitability.

Real Estate Private Equity

Real Estate Private Equity entails investing in commercial and residential properties to generate income and capital appreciation.

Management Buyouts (MBOs)

An MBO, or management buyout, is a type of buyout private equity. In an MBO, the management of a company purchases a controlling stake in the company from the previous owners. The goal is to make the company more efficient and profitable, and then sell it off over time.

Fund of Funds

A fund of funds is a type of investment fund that invests in other investment funds. This type of fund allows investors to pool their money and invest in a variety of different private equity funds. This can be a more efficient way to invest in private equity, as it allows investors to access a range of different funds with one investment.

Distressed and Special Situations

Distressed and special situations focus on companies/assets that are in financial trouble or undergoing major change. Distressed private equity investments focus on companies that are in financial trouble, with the goal being to help these companies restructure their debt and become more profitable. Special situations private equity investments focus on companies that are undergoing a major change or event, with the goal being to help these companies take advantage of the situation and maximize their value.

Secondaries

Secondary private equity is a type of investment that focuses on buying stakes in existing private equity funds. The goal is to allow investors to exit their investments in existing funds and to provide capital to new and upcoming private equity funds. Secondary private equity can be a more efficient way to invest in private equity, as it allows investors to access a range of different funds with one investment.

Mezzanine Capital

Mezzanine capital is a type of private equity that is used to finance the growth of a company. It is typically provided by a mezzanine lender, which is a company that specializes in providing mezzanine capital. The goal of mezzanine capital is to help companies grow and become more profitable.

Growth Capital

Growth capital is used to finance the growth of a company, and to help them become profitable. It is typically provided by a growth capital lender, which is a company that specializes in providing growth capital.

Private Equity vs Hedge Funds

Private equity and hedge funds are both types of investment vehicles, but they are different in a few key ways. Firstly, private equity is focused on investing in companies, while hedge funds can invest in a variety of assets, including companies, bonds, and commodities. Private equity investors typically invest in companies that are not publicly traded, while hedge funds can invest in both public and private companies.

Private Equity vs Growth Equity

Private equity and growth equity are both types of investments, but they are different in a few ways. Private equity is focused on investing in companies in general, while growth equity is focused specifically on investing in high-growth companies. Other key differences include:

• Private equity investors typically have more patience than growth equity investors and are willing to wait for a greater return on their investment. Growth equity investors are typically looking for shorter-term profits.
• Private equity investors are also more likely to be able to provide financing and expertise that can help a company grow. Private equity investors may be able to provide a company with access to new markets.
• Growth equity investors are also more likely to invest in companies that are already profitable.
• Private equity investors typically invest in companies that are not publicly traded, while growth equity investors can invest in both public and private companies.

Private Equity vs Private Credit

Private equity and private credit are both types of investments, but they are different in a few ways. Private equity is focused on investing in companies, while private credit is focused on lending to companies.

Private Equity vs Public Equity

Private equity and public equity are both types of investments, but they are different in a few key ways. Private equity is focused on investing in private companies, while public equity is focused on investing in stocks that are traded on public exchanges, e.g. the New York Stock Exchange (NYSE).

What are private equity firms and what do they do?

A private equity firm is a company that invests in high potential or undervalued companies, intending to improve their performance and take them private when they are ready, by buying out all other shareholders and taking the company off of the public markets. This can be done through an initial public offering (IPO) or by selling the company to another organization. Private equity firms typically hold onto their investments for several years, so they can see significant value growth. By selling their shares at a later date, private equity firms can generate a substantial profit for their investors.

Private equity firms typically raise money from investors, such as pension funds, endowments, and high-net-worth individuals, and then use that money to invest in private companies, often companies that need a turnaround or have high growth potential and might not have yet achieved profitability.

Companies that PE firms invest in may be young and have yet to achieve profitability, or they may need additional capital to grow. Private equity firms can provide this capital, which can help these companies expand and become more successful.

Once a private equity firm has invested in a company, it will often work closely with management to help grow the business. In addition to providing capital, private equity firms can also offer their expertise and guidance to the companies they invest in. This can be helpful for companies that are still in the early stages of development and need help growing their business. Private equity firms often have a great deal of experience with running businesses, and they can share this knowledge with the companies they invest in.

How are private equity firms organized?

Private Equity firms can be organized in various ways, but they all have one common goal: to make money for their investors. They typically have a team of professionals who analyze potential investments and make decisions about where to invest the firm's capital. This team includes investment bankers, analysts, and lawyers. Private Equity firms typically specialize in a particular industry, such as healthcare or technology, and have extensive knowledge about that industry.

Private equity investing is the process of investing in private companies. Private equity firms use this money to invest in companies, intending to generate a return for their investors. Private equity investors typically seek a return on their investment that is higher than what they could earn from investing in public equity. However, the returns can vary widely depending on the type of private equity investment, the stage of the company's life cycle in which it is invested, and the overall economic conditions.

Private equity firms typically target high-net-worth individuals or pension funds as investors, as they have the capital to invest and are typically willing to take on the risks associated with private equity.

Private equity investments are often riskier than other types of investments, so it's important to understand the risks, as well as the benefits, before investing.

How are private equity investments funded?

There are a variety of ways to raise money for private equity investments, including through private equity funds, which are investment vehicles that allow investors to pool their money and invest it in private equity deals. Private equity firms use this money to invest in companies, intending to generate a return for their investors.

Private Equity Funds can be raised in several ways, including through a public offering or by invitation only. They can also be raised by targeting certain types of investors, such as pension funds or high-net-worth individuals. Private Equity Funds typically have a minimum investment requirement, so not everyone will be able to invest in them.

But for those who meet the minimum investment threshold, this can be a convenient way for investors to access the private equity market, as this can be difficult to do on their own. They can simply invest in the fund and let the fund manager do all the work of finding and investing in companies. Private equity funds also offer liquidity, which means you can sell your shares in the fund at any time. This can be helpful if you need to access your money quickly.

However, private equity funds also come with risks. The most important risk is that you may not get back as much money as you put in. Private equity investments are often riskier than other types of investments, so it's important to understand the risks before you invest.

How are private equity funds structured?

Private equity funds are usually structured as limited partnerships or limited liability companies. In a limited partnership, the general partner is responsible for the management of the fund and assumes most of the risk. The limited partners are investors in the fund and have no responsibility for its management. In a limited liability company, all members are treated as equivalent to general partners.

The size of the global Private Equity market reached $X.X trillion in 2022 and is expected to reach $X.X trillion by the end of 2023.

Private Equity Market Size by AUM

The North American private equity market is the largest in the world, with total assets under management of $X.X trillion.

The Asia-Pacific region is the second-largest market, with AUM of $X.X trillion.

Private Equity AUM in Europe totalled $X.X trillion in 2021.

Rest of world AUM

There has been a shift in the private equity landscape in recent years. Some of the trends shaping the private equity market include:

• A slowdown in exits between 2021 and 2023: PE exits were 20% lower in Q3 2023 than Q3 2021, with longer holding periods testing PE firms’ ability to create value. Exits are on the rise, however.
• The rise of AI: fund managers are exploring the use of AI in private equity to add value by boosting productivity.
• Increased regulation: the SEC has implemented new rules for US private fund advisers, designed to increase transparency and accountability.
• A push towards retail investors: PE funds see individual capital as an area of opportunity and are accelerating outreach to retail investors as the flow of capital from institutional investors slows.
• PE-backed M&A slumps: Private equity-backed M&A activity is expected to continue slowing into 2023, with smaller-sized transactions and carve-outs most likely.

Private equity exits below 2021 levels, but rising: entries slump

Private equity exits were 20% lower in Q3 2023 than the same period in 2021, with fund managers avoiding pulling the trigger on sales or IPOs due to macroeconomic conditions and the current high interest rate environment. This is causing longer private equity holding periods and testing PE firms’ value creation strategies. Exits were, however, 21.6% higher in Q3 2023 versus the same period in 2022, and are on track to be higher in 2023 overall compared to 2022. Strong stock market performance and the availability of debt financing is providing more favorable conditions for private equity exits.

Entries, however, have slumped. The value of private equity and venture capital entries globally fell 22.3% year over year to $28.55 billion in September 2023. This decrease in entries was due to the rising cost of capital due to high interest rates, and private equity firms are concerned about the uncertain economic outlook.

The rise of AI in private equity

The more widespread adoption of AI is shaping broader investment themes for private equity firms. Firms are attempting to position their portfolios to catch AI tailwinds and avoid the sectors and subsectors poised for disruption by the evolving technology. For example, companies in the call center space, translation, and transcription businesses are facing a "red alert," while companies building and supporting AI systems are increasingly investment targets.

Private equity fund managers are exploring the use of AI in private equity to add value by boosting productivity. The speed at which companies adopt AI could prove to be a critical competitive factor. Some specific examples of how companies are using AI to boost productivity include:

• Tracking customer interactions and prompting salespeople to make timely follow-up calls
• Quickly drafting and sending personalized communications to clients
• Automating tasks that are performed manually
• Providing financial advisers with immediate access to information and analysis

Private equity firms are also using AI for internal purposes, such as automating routine tasks and producing unique insights from proprietary data. Limited partners are aware of AI's productivity improvements as a potential competitive advantage.

SEC regulatory action on US private equity

The SEC has adopted a set of new rules for private fund advisers, designed to increase transparency and accountability, including enhanced reporting requirements and investor protections. The new rules have sparked industry concern over the cost of compliance, but the SEC has made some concessions to fund managers in the final rules.

Despite the concessions, some industry experts believe that the new rules could still increase expenses for funds and could disproportionately impact small and emerging funds. Other industry experts believe that the benefits of the new rules outweigh the costs. They argue that the rules will help to protect investors and ensure that private markets are fair and efficient.

The SEC's emphasis on private markets regulation is likely to continue, having proposed a number of other rules in recent months that could have implications for private market participants.

Private equity fund managers push to grow retail investor base

Private equity funds are accelerating their outreach about private equity for retail investors, as the flow of capital from institutional investors slows. Fund managers see individual capital as an area of opportunity, as high net worth individuals hold a significant portion of global private wealth, yet a relatively small portion of such wealth is currently invested in private equity.

Fund managers are offering tokenized funds (in which shares or units are digitally represented and can be traded and recorded on a distributed ledger), as well as a variety of semi-liquid investment products such as tender offer funds, interval funds, business development companies, and nontraded real estate investment trusts in order to attract retail investors. These products offer some liquidity, but they still have longer investment horizons than traditional private equity investments.

Private equity-backed M&A activity decreasing

The slowdown in private equity-backed M&A activity is expected to continue into 2023, with smaller-sized transactions and carve-outs being the most likely types of deals to be completed. This is due to several factors, including macroeconomic headwinds, buyer and seller disconnect (buyers are being more conservative in their valuations, while sellers may still be expecting to get peak multiples for their businesses) and limited availability of debt (investment banks and other lenders are hesitant to provide financing for large deals.)

S&P Global is well-positioned to support across the entire private equity lifecycle with a wealth of experience and solutions. We bring transparency to the private market universe with data on 52+ million private companies and private markets, credit analytics and risk assessments for over 50 million companies, and rate the creditworthiness of several types of Alternative Investment Fund (AIF).