Private Equity Funds have different characteristics and they are specified below with the importantly used terms.
A private equity fund maintained by some experienced and capable investment professionals of a private equity firm.
Most of the private equity firms are formed by limited partnership. The company has some main partners who run the company and provide the initial investment with a minimum period commitment.
General Partners (GP): Responsible to raise capital from the high net worth investors like pension funds, endowment funds, insurance funds, corporate funds, different trusts, high net worth individuals etc. They hold the legal position as partners in the firm.
Limited Partners (LP): They are responsible for the respective debt or money raised by them. They have the limited liability and the extent lies only on the investment raised by them. They have no management authority and they receive a return on their invested capital.
Carried Interests: This is the share of profits the fund management team receives as a performance reward for running the fund. The rest of the profit is shared among all the investors based on their invested amount.
Hurdle Rate: This is the minimum rate of return the fund must generate to make the fund managers eligible for the carried interest payment. If the return falls below the hurdle rate, then the management will get only the base payment without any carried interest. This is to protect the investors and provide them a minimum return on their investment.
As the private equity funds intend to invest a significant part of a privately held company to control their business operation and drive their growth, it requires a huge initial investment by the partners of the private equity firm.
Private equity investments have very limited liquidity as these invests are made with the long term intention to gain profit from the private company’s long term growth story. It is considered to be almost illiquid investment because of minimum period constraint involved in the investment.
All the investment decisions are taken by the managers who analyze a private company properly before taking any investment decision. They look for companies with very high growth potentials which is expected to provide very high return after some long duration.
High Risk-Return: Private equity funds investment follows high risk and high return objective. Investing in privately held startup companies are very much risky and at the same time offer very high return potential.
The most important type of private equity investments are leveraged buyouts (LBO), distressed investments and mezzanine capital etc.
After the minimum investment period, the private equity fund sells the stake of the company to realize the gain. The sell amount can be raised through Initial Public Offering or external debt or from some other company who want to buy that part.
Normally private equity funds seek for return in the range of 25% to 35%.