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What is Private Equity?

During the last two decades, private equity has established itself as one of the key alternatives to investing in traditional securities in the developed markets, and there it represents one of the main components of institutional investors' portfolios today.

In its essence, private equity connects the surplus of capital in the markets (investors) with needs for capital (investments - companies and/or projects with high economic potentials). The basic distinction is in the fact that, usually, such investment opportunities are not accessable to investors through stock exchange, while, on the other side, entrepreneurs are not able to secure the required equity capital in banks or from other investment or pension funds.

Private equity, as an asset class, consists of several investment tehniques, strategies and asset classes, which are all complementary to investing in traditional securities through regulated markets or stock exchanges. Some commentators use the term “private equity” to refer only to the buy-out and buy-in investment sector. Others, in Europe but not the USA, use the term “venture capital” to cover all stages, i.e. synonymous with “private equity”. In the USA “venture capital” refers only to investments in early stage and expanding companies. To avoid confusion, the term “private equity” is used by NPEP to describe the industry as a whole, encompassing both “venture capital” (the seed to expansion stages of investment) and management buy-outs and buy-ins.

Investors provide private equity capital in the hopes of achieving risk adjusted returns that exceed those possible in the public equity markets and will typically include private equity as part of a broad asset allocation that includes traditional assets (e.g., public equity and bonds). Most institutional investors, do not invest directly in privately held companies, lacking the expertise and resources necessary to structure and monitor the investment. Instead, institutional investors will invest indirectly through a private equity fund. Certain institutional investors have the scale necessary to develop a diversified portfolio of private equity funds themselves, while others will invest through fund of funds to allow a more diversified portfolio than an investor could construct.

 

Most private equity funds have a fixed life of 10 years, with the possibility of a few years of extensions to allow for private companies still seeking liquidity. The investing cycle for most funds is generally three to five years, after which the focus is managing and making follow-on investments in an existing portfolio.