Investments made by private equity firms are unique within the investment world. Private equity firms create and manage pooled investment vehicles known as private equity funds, earning money by charging management and performance fees to those who invest in them. Rather than individual purchasing shares in a company, a private equity fund will utilize the pooled resources to purchase an entire company.
According to Mark Hauser, founder and co-managing partner of Hauser Private Equity, private equity firms take an active role in the companies they invest in. They identify businesses with strong growth potential and focus on improving operations to facilitate rapid expansion. A private equity fund will typically seek to realize an investment within three to seven years, most often by selling the business to another company but also through the initiation of an initial public offering, taking the business public.
Mark Hauser says that due to this relatively quick turnaround time, potential investments must be highly scrutinized. Private equity firms typically consider these factors when making an acquisition decision in order to gain a firm grasp of the company's investment potential.
Market volatility. A private equity fund will seek to transform a company operationally over the course of several years, meaning that any changes to a market or economy could have the potential to inhibit a planned exit. For this reason, private equity firms typically invest in non-cyclical industries that will not be impacted by an economic downturn such as consumer staple goods, utilities, and healthcare.
Disruptive potential. A business with an innovative business model will have a much better chance of gaining a high market share. Transformative companies are often those that utilize emerging technologies in a novel way, positioning them for strong growth and attracting the attention of private equity investors.
Routes to growth. The more revenue streams a business has, the more potential it has for expansion. Private equity firms look at how many ways in which they can grow a business, and the more potential markets and locations available to a company the better-positioned it is for acquisition.
Capital needs. Private equity firms will typically shy away from companies such as start-ups that anticipate multiple rounds of investments in order to achieve growth. While this strategy works well for other types of investors such as venture capitalists, in the world of private equity these are seen as high-risk and not a sound investment for the strategy.
Governance and management. While private equity firms are not passive in their investments, they also refrain from becoming deeply involved in the company, focusing mostly on overall structure and operations. This is why a target investment's current management and executive team is an important factor to consider for private equity funds. A business with a fiscally responsible and organizationally sold team in place will better allow the firm to focus on what it does best.
Mark Hauser says that these are just a few of the considerations made when deciding on whether to add a company to a private equity fund's portfolio.