Before we get to the “How to Choose the Right Private Equity Fund for Your Business in 2021” part, you need first to understand what private equity actually is and what are the different types of Private Equity Funds available out there that you need to choose from.
What is Private Equity?
Private Equity is an investment primarily made by institutional investors and accredited investors in a business that is not publicly listed or traded. Herein, investors directly invest in private companies or buyout public companies which results in the delisting of the public company.
Types of Private Equity Funds
There are numerous types of private equity funds, the names of which are based on the different types of assets investors are interested in investing in.
Investors invest their money in companies that are troubled or sick with a lot of underperforming assets. The aim is to revive them by making necessary changes in their management or operations or sell their assets in order to earn a profit (hence the name, “Distressed Funding”). It is also known as Vulture Financing.
This one involves buying out a company in order to improve its business so that it can be put up for resale at a profit, or an IPO can be conducted. A combination of Debt and Equity is used to finance these transactions. A huge sum of debt is borrowed from bank and term loans or mezzanine debt, and investors invest a little bit of their own money in equity capital. Debt financing can be done up to 90%. The target company’s assets can be used as collateral when obtaining debt. The process is summarised as much as possible to derive the name.
Venture Capital is a form of private equity funding that usually invests in start-ups, often in high-growth sectors. Venture capitalists can invest at two stages- very early stage or later stage. “Early” stage funds are commonly invested in companies that can invent and commercialise new technologies whereas “Later” stage funds are invested in companies that have already demonstrated these things and want to grow a company further by scaling up the operations.
Fund of Funds
As the name suggests, the money is invested in other funds (like hedge funds, mutual funds, or private equity funds) instead of directly investing in shares, bonds, or securities. The investment can be:
“Fettered” which means it only invests in funds managed by the same investment company or
“Unfettered” which means investment can be made in external funds run by different managers.
Although this fund is criticised for high management fees due to additional funds involved, it is also known as multi-manager investment.
Wikipedia explains, “Growth capital (also called expansion capital and growth equity) is a type of private equity investment, usually a minority investment, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a significant acquisition without a change of control of the business.”
Mezzanine Financing is a mixture of debt and equity financing in which, if there’s a case of default, the lender has the right to convert to an equity interest in the company and represents a claim on the assets after senior leaders and venture capital companies are paid.
It’s time to tell you how to recognise which Private Equity Fund is best for your business.
How to Choose the Right Private Equity Fund for your Business?
Choosing the right private equity fund for a business is one of the most crucial decisions that senior management needs to make.
It can make a huge difference in the future of your company.
Here are some factors that need to be considered to understand and make a wise choice of the Right Private Equity Fund for your Business:
1. Clarity of the Outcome you Expect from your Investment
You can take control of any process when you have clarity about what you intend to do. The same thing applies here. You need to be clear about basic but significant questions like how much amount you expect as a return on a per annum basis and from the overall tenure of investment, etc.
2. Purpose of Investment
Always be conscious of the purpose of your investment and accordingly, it will strike off alternatives that do not match with your investment goals.
3. Amount to be Invested
The amount you plan to invest and the way you can disburse it. For instance, whether you will disburse the whole amount at once or disburse as the year goes by.
4. Investment Horizon
Investment Horizon means for how long you plan to invest your money. This will play a major role in ruling out the options.
5. Risk Appetite
Risk Appetite means how much risk you can take because higher the risk, higher the returns. How much risk one can take depends on the business’s investment goals.
6. Expense Ratio
The fee that an Asset Management Company(AMC) charges the investor for managing the fund or the commission paid to the broker is included in the expense ratio. The expense ratio will differ from fund-to-fund depending on where it invests. The aim should be to always go for a fund with a lower expense ratio as for smaller sums, it is negligible, but for the huge amount of sums, it can make a sizable difference.
Once you have shortlisted the types of fund you are planning to invest in, you should go through the tax planning section of it and then select the fund that can help your business make maximum savings.
Let us know your views in the comment section below.
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