A private equity fund is a collective investment scheme used to make investments in various equity and debt securities. These investment strategies are limited only by the imagination of the management of the Private Equity Firm charged with making the investments. All private equity firms with more than $150 million in assets must register with the SEC as an investment adviser under the Investment Company Act of 1940. Firms of this type are often associated with making leveraged buyout (LBO) or management buyout (MBO) purchases of target companies. The loans of which are secured against the cash flows of the target firm.
Due to the risks involved when using such levels of leverage these investments are usually made by institutional investors. When the fund is created, these investors make a commitment to the limited partnership to supply funds which is then drawn down over the term of the fund. The life of the Private equity funds is often a fixed term of 10 years although this is frequently extended on an annual basis especially is performance is strong.
Private Equity Firm Operations
A private equity fund typically operates a portfolio of investments to help spread risk often specializing in a particular event driven strategy such as distressed debt, or an industry segment such as infrastructure or commercial retail spaces. These investments, made on behalf of investors or the fund itself, are financed with capital raised from investors or debt, generally secured against the assets of the investment. This leverage is therefore dependent on the private equity firm and can be a unique characteristic. Cash flows from the investments provide the ability to service such large borrowings.
Once the business is ready to be sold, there are two options available to the fund. A total exit or partial exit. A total exit can be made via a trade sale to another buyer within the industry or a Leveraged Buyout by another private equity firm. Alternatively, using an Initial Public Offering (IPO) can initially begin as a partial exit by selling a small percentage of the firm and obtaining a listing on a public stock exchange. This can eventually become a total exit and can de dependent on market conditions. For a partial exit, the private equity fund could pursue a private placement, where another investor purchases a stake in the business or a corporate restructuring involving external investors to invest new additional capital. Management may also be able to take part in this action if they have not already done so.
