Types Of Private Equity Investments

Private equity refers to investment firms that acquire stakes in private companies or public companies with the intent of generating returns through improving operations, strategy, and financial performance. Private equity is an important alternative asset class that provides investors with opportunities for higher potential returns compared to public markets, albeit with higher risks and less liquidity.

This comprehensive guide covers the main types of private equity investments, including their strategies, goals, risks, and potential returns. Each investment type has its own unique characteristics that investors should understand before allocating capital to this asset class.

Key Takeaways:

Type of Investment	Goal	Potential Returns	Risk Level
Leveraged Buyouts	Acquire undervalued companies, improve operations and finances, then exit	Moderate to High	Moderate to High
Venture Capital	Invest in startups/emerging companies with high growth potential	Very High	Very High
Growth Equity	Provide capital for established companies to fund growth initiatives	Moderate to High	Moderate
Distressed/Special Situations	Invest in troubled companies and turnaround situations	Very High	Very High
Real Estate PE	Acquire properties, develop, reposition assets for income/appreciation	Moderate to High	Moderate to High

Leveraged Buyouts (LBOs)

A leveraged buyout (LBO) refers to a private equity acquisition of a company, whether private or public, using a significant amount of borrowed money (leverage) to meet the cost of acquisition. The assets of the company being acquired are used as collateral for the borrowed capital.

The typical LBO process involves:

1. Identifying an undervalued target company to acquire
2. Creating a new company (“NewCo”) to act as the acquisition vehicle
3. Financing the purchase using a mix of equity from the PE firm’s fund and debt raised by NewCo
4. Taking the target company private and transferring its ownership to NewCo
5. Improving operations, finances, and cashflow over the next few years
6. Exiting the investment by selling or taking the company public again

LBOs typically target mature companies with stable cashflows that can service the debt used for acquisition. After taking a company private, the PE firm implements operational improvements like cutting costs, optimizing capital expenditures, strategic initiatives, and more.

For example, in one of the largest technology LBOs, Lenovo acquired IBM’s $16.7 billion PC business in 2005. Lenovo was able to leverage IBM’s global distribution but cut costs through operational improvements.

Potential returns on leveraged buyouts can be moderately high to high, but they also carry a moderate to high level of risk due to the debt involved.

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Venture Capital (VC) Investments

Venture capital refers to investments in startups and other young companies with high growth potential. VC firms provide funding in exchange for equity stakes, with the goal of supporting rapid growth before eventually exiting the investment through an acquisition or IPO.

Most VC investing occurs across these stages:

• Seed Stage: Earliest investment in a startup, often just an idea or prototype
• Early Stage: The company has a product/service but needs funds for initial marketing and manufacturing
• Late Stage: Mature startup seeking capital to scale operations, expand, etc.
• Growth Equity: Established company looking for capital to fuel growth and expansion

VC firms conduct extensive due diligence, analyzing factors like the strength of the founding team, market opportunity, proprietary technology, revenue traction, growth potential, and exit possibilities.

In addition to capital, VCs provide strategic guidance, mentorship, professional networks, and active portfolio management to nurture their investments.

The top venture capital (VC) deals in 2023 are:

Rank	Firm	Deals (Globally)	Deals (United States)	Deals (Europe)	Deals (Rest of the World)
1	HarbourVest Partners	213	192	116	34
2	Ares Management	212	156	–	32
3	Shore Capital Partners	193	–	–	24
4	EQT	190	–	153	23
5	The Carlyle Group	179	103	–	–

These rankings provide insights into the venture capital landscape, highlighting the firms that were most active in terms of deal volume during 2023. Remember that these numbers represent the activity during that year, and the industry continues to evolve! For more detailed information, you can explore the full interactive league tables on PitchBook’s website. 🚀

VC investing has a very high risk due to the high failure rate of startups but also offers tremendous upside potential for successful companies. Research by Cambridge Associates found that top-quartile VC funds generated an annualized return of 23.6% over 10 years.

Growth Equity

Growth equity investing provides capital to established, profitable companies to fund growth initiatives such as:

• Expansion into new geographic markets
• Product line extensions
• Acquisitions
• Increasing manufacturing capacity
• Sales and marketing push

Unlike venture capital, growth equity targets more mature businesses that are already commercial successes and simply need capital for their next phase of growth. The investment risk is lower than VC since the companies have proven business models and revenues.

However, growth equity investments still carry a fairly high risk/return profile compared to traditional investments. Growth funds typically target an internal rate of return of at least 20%.

Some notable growth equity deals include:

• Uber raised $3.5 billion from Saudi Arabia’s Public Investment Fund in 2016
• Alibaba invested $1.7 billion in Toutiao (Bytedance) in 2018
• KKR’s $628 million investment in WebstaurantStore in 2017

Growth equity allows large private capital infusions that would be difficult through traditional funding routes like debt or public markets.

Related: The Top Hedge Funds for 2024 And Everything You Need To Know

Distressed/Special Situations

In distressed or special situations private equity involves investments in troubled companies or unique situations like bankruptcies, restructurings, turnarounds, or corporate divestitures.

PE firms look for opportunities to acquire the assets or business operations of distressed companies at discounted prices. Their goal is to overhaul operations, fix financial issues, and then exit at a much higher valuation.

Common investment scenarios include:

• Buying a struggling company and improving/repositioning it
• Purchasing non-core divisions being divested
• Debt investments in distressed companies
• Bankruptcies and restructuring with the firm taking an equity stake

These opportunities arise due to factors like poor management, operational issues, excess leverage, industry disruption, and corporate divestitures.

Distressed investments carry very high risk due to the troubled nature of the companies involved. However, the upside potential is also extremely high if the turnaround efforts are successful.

For example, in 2009 Apollo Global Management acquired the outstanding debt of LyondellBasell when the chemical company went bankrupt. Apollo ended up owning a majority of Lyondell’s equity when it exited bankruptcy in under a year.

Real Estate Private Equity (REPE)

Real estate private equity involves raising capital funds to acquire, develop, reposition, operate, and sell real estate assets and properties. The main investment strategies include:

• Fix and Flips: Buying undervalued properties, renovating, and quickly re-selling
• Developments: Building new properties from the ground up
• Value-Add: Acquiring underperforming properties and improving operations
• Core: Buying high-quality, stable assets in prime locations
• Debt Investments: Providing debt financing for acquisitions, developments, etc.

Most REPE deals are executed through closed-end funds with a typical lifespan of 7-10 years. Funds may focus on specific property types like:

• Residential (single-family, multifamily)
• Retail (malls, shopping centers)
• Office
• Industrial/Logistics
• Hospitality

Real estate PE funds often utilize leverage through borrowing to amplify potential returns. However, prudent use of debt is key to managing risk.

Due to the tangible nature of property assets, real estate PE is seen as having moderate to high return potential with moderate to high risk. Investing in income-producing assets like multifamily or office can provide more stable returns.

Other Private Equity Types

Mezzanine Financing: A hybrid of debt and equity financing. Mezzanine funds extend capital that gets repaid after senior debt but before equity. Higher risk but can generate returns over 20%.

Secondaries: Purchasing existing investor commitments to private equity funds on the secondary market rather than direct fund investments. Allows shorter time horizons and avoids the J-curve effect.

Co-Investments: Directly investing equity capital into a deal alongside a PE fund rather than through the fund itself. Potentially lower fees but higher governance burden.

Funds of Funds: A fund that builds a diversified portfolio by investing in other underlying private equity funds across different strategies. Offers broad diversification but with additional layers of fees.

Private Equity Fund Structure

Most private equity groups are structured as limited partnerships, with the PE firm being the general partner (GP) and investors as limited partners (LPs).

Limited partners include institutional investors like:

• Pension funds
• Endowments
• Foundations
• Family offices
• Sovereign wealth funds
• High-net-worth individuals

The general partner (GP) is the private equity firm that raises capital commitments from LPs and makes the investment decisions. GPs typically invest a small percentage of their capital alongside the LPs’ committed capital.

Private equity funds have a finite life, usually 7-10 years with the possibility of extensions. The fund life consists of:

• Investment Period (first 3-6 years): Where the committed capital is deployed into investments
• Value Creation Period: The GP works on improving portfolio companies
• Harvesting Period: Exits occur by selling investments to realize returns

The GP charges annual management fees of around 1.5-2% of committed capital during the investment period, dropping to around 1% during the remaining fund life. They also receive a share of profits known as “carried interest”, typically around 20% over a hurdle rate.

This fee structure incentivizes generating high returns for investors. Top-performing funds can raise larger future funds and charge higher fees.

Common Exit Strategies

The ultimate goal of any private equity investment is to eventually make a profitable exit and return capital plus gains to the fund’s investors. The three most common exit routes are:

1. Initial Public Offering (IPO)
   • Taking the portfolio company public through an IPO on a stock exchange
   • High profile way to maximize returns but a complex process
2. Acquisition/Strategic Sale
   • Selling the entire company to another firm, commonly an industry competitor
   • Often a quicker exit than an IPO may not maximize the valuation
3. Private Sale/Restructuring
   • Selling the firm or stake to another PE group or existing investors/partners
   • Recapitalizing the business by restructuring debt and equity

Other possible exits include a leveraged recapitalization, selling off certain divisions, or passing the return of capital to limited partners.

Timing exits appropriately during market cycles is critical for PE firms to generate their targeted investment returns for a fund.

Benefits of PE for Companies

While private equity offers a high potential return for investors, it also provides several key benefits for the companies receiving the investment capital:

• Infusion of Cash: Growth capital for scaling, acquisitions, new initiatives, turnarounds, etc.
• Operational Expertise: Most PE firms are deeply involved, providing strategic guidance and sharing best practices
• Higher Potential Returns: PE firms can generate higher returns than remaining private or going public
• Competitive Advantages: Developing innovative growth strategies away from public markets
• Top Talent and Connections: PE firms leverage their networks for high-level recruiting and strategic partnerships

For young, high-growth companies, venture capital is a way to rapidly scale with smart funding and operational mentorship. More mature companies can access cheaper capital through other PE types like growth equity instead of excessive debt.

Overall, private equity allows companies to affordably access expansion capital and expertise they may not receive through conventional means.

How to Invest in Private Equity

Due to the complex nature of private equity funds, most opportunities are only open to accredited investors who meet certain income and net worth requirements.

Additionally, the minimum investment commitments in PE funds are quite high – often $25,000 to $500,000 or more at the lower end for fund of funds and feeder funds. Direct PE fund investments frequently require at least $5 million in commitments.

There are a few main routes for individual investors to gain exposure:

• PE Funds: Investing directly into a private equity fund as a limited partner
• Fund of Funds: Investing in a fund that itself invests in multiple underlying PE funds
• Co-Investments: Making direct co-investment alongside a PE fund into a specific deal
• Separately Managed Accounts: Some firms create SMA vehicles for high-net-worth investors

Including private equity can provide diversification benefits when part of a balanced portfolio. However, the high minimums, illiquidity, high fees, and complex fund structures mean PE remains an accredited investment not suitable for all individual investors.

Conclusion

Private equity encompasses a diverse range of alternative investment strategies that can generate higher potential returns compared to public markets, albeit with added risk, illiquidity, and complexity.

The main private equity investment types covered include leveraged buyouts, venture capital, growth equity, real estate, distressed, and more specialized strategies.

While access remains limited for individual investors, understanding private equity is important to make informed decisions around this asset class. Those able to invest should thoroughly research funds, and strategies, and conduct due diligence based on their specific goals and risk tolerances.

FAQs

What are the types of private equity?

The main types of private equity investments include:

1. Leveraged Buyouts (LBOs) – Acquiring companies using significant debt financing, then improving operations and exiting.
2. Venture Capital – Investing in startups and early-stage companies with high growth potential.
3. Growth Equity – Providing capital to established, profitable companies to fund growth initiatives like expansion, acquisitions, etc.
4. Distressed/Special Situations – Investing in troubled companies, turnarounds, bankruptcies, or unique situations.
5. Real Estate Private Equity – Acquiring, developing, and repositioning real estate assets and properties.
6. Mezzanine Financing – Hybrid debt and equity financing.
7. Secondaries – Purchasing existing private equity fund interests on the secondary market.
8. Co-investments – Directly investing in deals alongside private equity firms.
9. Funds of Funds – Portfolios that invest in multiple underlying private equity funds.

What are the 7 types of investment?

The 7 main types of investments are:

1. Stocks
2. Bonds
3. Cash/Cash Equivalents
4. Real Estate
5. Commodities
6. Cryptocurrencies/Digital Assets
7. Alternative Investments (Private Equity, Hedge Funds, Venture Capital, etc.)

Which one of the following is a type of private equity investment?

The options that are types of private equity investments are:

a) Leveraged Buyout b) Venture Capital c) Growth Equity d) Distressed/Special Situations e) Real Estate Private Equity

What are the types of equity in private companies?

The main types of equity in private companies are:

1. Common Stock
2. Preferred Stock
3. Partnership Interests
4. Convertible Notes/SAFEs
5. Stock Options/RSUs for employees

What is investing in private equity?

Investing in private equity refers to providing capital to private equity firms that acquire stakes in private or public companies with the goal of improving their operations and eventually selling at a profit. It involves committing capital as a limited partner to PE funds across strategies like leveraged buyouts, venture capital, growth equity, etc. in exchange for a share of the returns.

What are the 2 types of equity?

The two main types of equity are:

1. Common Stock – Represents ownership in a company with voting rights and a claim on profits/assets after debt/preferred obligations.
2. Preferred Stock – Has preferences over common stock for dividends/distributions and asset claims but typically no voting rights.