How does private equity work?

Private equity firms raise money from institutional investors (e.g. pension funds, insurance companies, sovereign wealth funds and family offices) for the purpose of investing in private businesses, growing them and selling them years later, generating better returns for investors than they can reliably get from public market investments. 

Private equity firms do not run the businesses they invest in. They back an experienced management team to carry out an ambitious but realistic growth plan usually over a period of three to five years. The key to success is making sure that the management team is able to focus fully on executing the growth plan. This means that the private equity investment must provide an exit for shareholders wishing to leave the business, a partial exit for those wishing to ‘de-risk’ or ‘step back’ and equity for new or existing team members that need incentivising. A private equity deal achieves this at its outset and the result is an aligned, executive management team, heavily motivated to take on an ambitious growth plan.

Following investment, private equity firms take an active but non-executive role in the business, contributing particularly where their skills as financers can help, such as finding and funding acquisitions, building the company’s finance and governance functions and assisting with the recruitment of senior hires.

How can private equity benefit me?

Private equity is used to fund positive change in a business. Owner-managers that have spent their careers painstakingly building a valuable business can realise some of that value (for cash) and approach their business thereafter in the knowledge they are no longer risking everything when they make a bold business decision.

Private equity funding is flexible, and every deal is tailored and negotiated to fit the situation. Each shareholder can have a different deal and full or partial exits can be accommodated in differing proportions for each shareholder, usually depending on the executive’s day-to-day role in the business and their role in its ongoing success. As importantly, significant equity incentives can be created to retain and reward ‘rising stars’ in the business to enable and manage succession in the senior team.

Because a private equity firm invests with a view to selling the business in the medium term, the company needs to be well-invested to be attractive to the eventual acquirer. On exit, a private-equity-backed business is usually resourced for the next phase of expansion so that it is attractive to a wide range of buyers. The following example illustrates how a private equity deal can work.

To further explore private equity as an option for your business, please get in touch with our team today.