Private Equity: what is it and why is it important?

Private equity is a type of investment that helps add value to assets and redefine the future of businesses. Beyond traditional investments in stocks and bonds, private equity plays a key role in the financing and growth of businesses around the world, with the potential to generate significant returns. Find out what private equity is, its benefits and challenges, and how to invest in it.

What is Private Equity?

As the name suggests, private equity is a form of private investment. It refers to capital investment in companies whose shares are not traded on the stock exchange, and is an alternative to traditional financing (such as bank loans or bond issues).

In this sector, investors acquire stakes in existing businesses, giving them influence and control over their management and operations. This influence can be used to implement strategic changes, improve operational efficiency and promote sustainable growth. Investors can also provide capital to early-stage companies, often with significant potential for growth. In both cases, the objective is to increase the value of the companies in which they invest over time, using various strategies, including restructuring, international expansion, mergers and acquisitions, among others.

After a period of time, usually between five and ten years, private equity investors "exit", i.e. they stop investing and receive a financial return. This exit can take the form of a sale to another company, to other institutional investors, or through an Initial Public Offering (IPO).

The figures illustrate the growth of the private equity sector. According to a recent report by Bain & Company, the sector is set to reach a record $3.7 billion (€3.48 billion) in available capital by 2022.

Total Private Equity Investment (USD billion)

Source: Bain & Company

These numbers are all the more significant given the uncertainty caused by rising inflation and interest rates. It is therefore a sector that should be considered by high network investors, institutional investors, or even Family Offices.

Why invest in Private Equity?

Investing in private equity can offer investors a number of benefits. The main ones are:

1. Potentially high returns

The objective of investing in private equity is to generate significant returns. By investing in companies with growth potential and implementing effective strategies, investors can achieve attractive returns over time.

2. Access to exclusive investment opportunities

Private equity gives investors access to companies that are not open to public investment. This means they have the opportunity to invest before companies go public, which can be a significant advantage.

3. Control and influence

Private equity investors typically acquire a majority stake in the companies in which they invest, giving them control and influence over management and strategic decisions. This allows investors to actively work to improve the performance and growth of the businesses, increasing the likelihood of success.

4. Flexibility and a longer time horizon

Private equity investments tend to have a longer time horizon, allowing investors to take a long-term approach. This is particularly beneficial in sectors or companies that need time to develop and implement sustainable growth strategies.

5. Portfolio diversification

Investing in private equity is a way of diversifying an investment portfolio. Returns have a low correlation with those of other assets, such as equities and bonds, which can help reduce the overall risk of a portfolio.

What types of private equity are available?

There are a number of different types of private equity, each with their own characteristics and investment strategies. However, they are not mutually exclusive and can often overlap. The main types of private equity include:

• Growth Equity

This type of private equity involves investing in companies with significant growth potential. Investors provide capital to drive business expansion, launch new products or services, enter new markets or make strategic acquisitions. The aim is to accelerate growth and increase the value of the company to generate substantial returns in the future

• Buyout

In this case, investors acquire a majority stake in established companies. Buyouts can be divided into two main types: Leveraged Buyout (LBO) or Management Buyout (MBO). In the first case, the acquisition is mainly financed by debt, and the target company is used as collateral for the loan. The aim is to restructure the company, improve its operational efficiency and increase its value with a view to selling or listing at a later date. In a Management Buyout (MBO), the acquisition is made internally by the managers of the company itself. Often this is done in partnership with an external investor and the team formed takes control of the business to improve performance and then sell the stake.

• Distressed Private Equity

This type of private equity involves investing in companies in financial difficulty or crisis. Investors provide capital to restructure and revitalize companies, usually by acquiring significant stakes, with the aim of making substantial returns when the situation stabilizes.

• Venture Capital

Venture capital is a form of private equity that focuses on early-stage companies with high growth potential. Venture capital investors provide capital and resources to promising companies, such as start-ups and other high-growth businesses. In addition to funding, investors provide strategic advice and expertise to help these companies develop and reach their full potential.

• Mezzanine Capital

This form of private equity occupies an intermediate position in a company's capital structure, combining debt and equity characteristics. Mezzanine investors provide capital with a longer term and higher expected return. It is often used to finance expansions, acquisitions or recapitalizations of mature companies.

How do you invest in Private Equity?

Investing in private equity is a complex process and requires a careful approach. The most common forms include:

• Investing in specialist private equity funds

This is the most common way to invest in private equity. Specialist funds are managed by teams of professional investors and pool the capital of several investors. To choose this route, you must meet the fund's eligibility criteria and make a usually substantial minimum investment.

• Investing directly in companies

This type of private equity investment is suitable for investors with in-depth knowledge and experience of the market. It involves researching and identifying investment opportunities, carrying out a detailed analysis of the companies to be invested in, negotiating the terms of the investment and committing the capital. It therefore requires a high degree of ability to actively manage the investment.

• Equity co-investment

In some cases, investors may have the opportunity to co-invest with a private equity fund in a particular company. This route can provide greater control over the investment and the ability to take advantage of specific opportunities, but can also require in-depth analysis and particularly careful due diligence.

What precautions do you need to take when investing in private equity?

When investing in private equity, it is important to take certain precautions to make informed decisions and mitigate risk. Key points to consider include:

Careful assessment of opportunities

Carry out a thorough analysis of private equity investment opportunities. Evaluate the company's track record, growth potential, sector, proposed investment strategies, management team and other relevant factors. Be aware of the risks involved and have a clear view of the potential return.

Sector knowledge and experience

Invest in sectors that you understand well. Having experience or access to industry experts can be valuable in making informed decisions and tracking company performance over time.

Portfolio diversification

Diversifying your private equity portfolio is a good way to reduce the specific risk of any one investment. By investing in several private equity companies or funds, you can reduce the impact of potential losses on a single investment and increase the likelihood of consistent returns.

Assessment of the private equity manager

When investing in private equity funds, it is important to assess the reputation and experience of the fund manager, as well as the type of companies in which the fund invests. Research the manager's track record, investment strategy, performance of previous funds and investor relations. Also consider the management team and the resources available to support the companies.

Liquidity and investment period

It is important to bear in mind that private equity investments generally have longer terms and are less liquid than other investments. Before investing in private equity, consider your liquidity needs and your ability to hold the investment for an extended period of time.

Risks and volatility

Investing in private equity involves risk. The companies in which you invest may face challenges and uncertainties and there is no guarantee of a return on your investment. Be prepared for the possibility of losses and be aware that returns may be volatile over time.

Professional advice

Consider seeking professional advice from financial advisors specializing in private equity. The Banco Carregosa team can provide personalized advice based on your specific circumstances and help you assess the risks and opportunities associated with investing in private equity.

Investing in private equity with Banco Carregosa

If you are considering investing in private equity, you can count on the Banco Carregosa team to help you understand the risks and opportunities involved and develop a sound investment strategy. You will be better equipped to make informed decisions and maximize your chances of succeeding in the complex and challenging world of Private Equity. Contact us.