Market Outlook for 09 September 2024
What is the Private Equity Market?
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Last Updated: 15th May 2024 - 06:42 pm
Stock market or share market is well known that stocks of publicly listed companies are traded on the exchange. However, not all companies are publicly listed. In fact, a startup company goes through multiple stages of growth before it is publicly listed. These privately known companies need capital funding and look for investors who believe in their growth story. Investing in companies that are not publicly listed is called private equity investment, where investors offer money for equity ownership of the company. The private equity market offers a unique set of challenges and opportunities for investors.
This blog will explore private equity market meaning, its types, and its popularity in India.
Private Equity Market in India
The private equity market in India has grown rapidly in the last five years. Over 86% of the total $11.79 billion in private equity-backed investments in 2023 were from outside sources. It is driven by a mature corporate ecosystem that increases the availability of managerial talent. The fast-growing private companies operate in sectors like technology, healthcare, and consumer, aligning with the country's growth trajectory.
Retail inventors often wonder what is private equity market because it is not publicly listed. You must find platforms that associate with private equity investors and allow you to pool in to invest in growing companies.
Types of Private Equity Investors
The PE market is a crucial funding source for promising businesses. These empower budding entrepreneurs to innovate at scale and become potential market leaders. Recent reports are concerning as the PE fundraising in the Asia Pacific region is expected to decline by 6.5% until 2028. However, demographic advantages, a thriving entrepreneurial ecosystem, and digital adoption provide compelling opportunities for private equity investment. Many major players contribute to this dynamic landscape.
Venture Capitalists
Venture capitalists fund startups and early-stage companies with high growth potential. They take a minority equity stake in the company and offer funding. The entrepreneurs can also get strategic guidance and operational support from their venture capitalists. However, company management has control of the business. It is a riskier investment strategy because these early-stage companies generally have no track record of growth.
Growth Capital Investors
After a company is launched, it needs growth capital funds to scale and grow. Growth capital investors invest in early-growth companies in exchange for equity or convertible debt. The companies use these funds for financial expansion. Some funds are allocated to R&D, and sometimes, they are also used for working capital needs. This type of investment is slightly less speculative because investments are made in profitable companies with higher valuations and little debt.
Pension Funds
Many public pension funds have started investing in alternative investments like private equity to make up for the shortage of investment choices. Pension fund managers carefully invest in the private equity market to benefit from the higher return potential. The returns are used to fund pension obligations and benefit pension beneficiaries.
Sovereign Wealth Funds (SWFs)
SWFs are state-owned investment funds that invest in the private equity market to diversify their holdings and support national economic development. Funds come from the country's surplus reserves, such as natural resources revenue, excess budgeting, and trade surpluses. In 2023, Norway SWF disclosed its assets, showing $24 billion in investments in India by the end of December. SWFs from other countries like Abu Dhabi, Ireland, Malaysia, etc, are also showing interest in investing in India's growing sectors.
Buyout funds
Buyout funds are an investment type that acquires controlling stakes in established companies. The primary objective is actively managing and enhancing the company's value to generate returns. Buyout funds use a leveraged buyout (LBO) strategy to combine equity and debt financing to increase returns using financial engineering and operational improvements. The investment horizon is finite, ranging from 3 to 7 years, and buyout funds exit at a profit through IPOs, secondary buyouts, or strategic sales.
Specialised Funds
Specialised funds are a group of PE funds focusing primarily on specific industry sectors with high growth potential. Generally, sectors like healthcare, technology, infrastructure, and consumer goods attract these types of investors. Some types of funds focus on geographic or stage-specific funds. Turnaround or distressed funds invest in underperforming companies to generate returns by improving the company.
How Does Private Equity Work?
Step No. | Stage Name | Description |
1 | Fundraising | Private equity firms raise capital from investors, such as institutional investors, pension funds, and high-net-worth individuals. |
2 | Deal Sourcing | Private equity firms identify potential investment opportunities through various channels, including networking, industry research, and proprietary deal pipelines. |
3 | Due Diligence | Conduct thorough due diligence on potential target companies to assess their financial health, growth prospects, market position, and potential risks. |
4 | Valuation | Determine the fair market value of the target company based on its financial performance, growth potential, comparable transactions, and market conditions. |
5 | Negotiation | Negotiate terms of the investment, including purchase price, ownership stake, governance rights, and potential management changes. |
6 | Investment | Close the investment deal and provide capital to the target company in exchange for an ownership stake. |
7 | Operational Improvement | Work closely with the portfolio company's management team to implement operational enhancements, strategic initiatives, and cost-saving measures. |
8 | Value Creation | Execute value-creation strategies to enhance the profitability, growth, and market position of the portfolio company, aiming to increase its overall enterprise value. |
9 | Exit Strategy | Determine the optimal exit strategy for the investment, including an initial public offering (IPO), strategic sale, or secondary buyout. |
10 | Exit Execution | Execute the chosen exit strategy to sell the ownership stake in the portfolio company and realise investment returns for the private equity firm and its investors. |
How to Analyse Private Equity?
Detailed analysis and due diligence play a crucial role in evaluating PE investment opportunities. The primary factors that measure private equity performance are:
● Internal Rate of Return (IRR) – implied annual rate of return on the investment.
● Multiple of Invested Capital (MOIC) – net total return from the investment (final amount divided by initial investment) regardless of the investment horizon
● Public Market Equivalent (PME) – comparison of PE performance to the same investment in a public stock market during the same period.
How to Invest in Private Equity?
As per private equity market definition, it requires a substantial amount of money invested directly in private companies through direct investments, private equity funds, or funds of funds. It is reserved for institutional investors and high-net-worth individuals. However, the Indian private equity market is slowly becoming inclusive with newage platforms that can pool retail investors together to invest in private equity assets. You can find mutual fund schemes with PE exposure and specialised FOF mutual funds. Many Alternative Investment Funds (AIFs) have higher minimum requirements for retail investors. Angel investment platforms also connect startups with angel investors.
Conclusion
The private equity market offers diverse investment opportunities for investors to be a part of private companies at various stages of their lifecycle. While such investments offer attractive returns, there are numerous risks involved. Due diligence is crucial to evaluate companies worthy of investing. Retail investors should be cautious while diversifying their portfolios with private equity participation.
Frequently Asked Questions
How is the private equity market different from the public equity market?
Who participates in the private equity market?
What types of companies are targeted in the private equity market?
How does regulation impact the private equity market?
What are the exit options available to private equity investors?
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