About private equity

What is private equity?

Private equity is investing in private companies whose capital is not listed or traded on a regulated market. These companies are often family-owned and need additional capital to grow and improve their financial performance.

Specialized private equity funds are an important source of capital to finance the growth of these companies. Investing in private equity is attractive to an investor because it offers a source of income that is uncorrelated from traditional assets such as fixed income and public equities, thus reduces portfolio volatility. Private equity investors seek long-term returns.

How does a private equity fund work?

A private equity fund is managed by a specialized team that is responsible for the selection and monitoring of investments.

The fund usually has a life of 10-14 years and has different stages. First it raises capital from investors, which is then used to acquire majority stakes in private companies. The fund actively works with the management of these companies to improve their operational and financial performance.

Finally, the fund sells these companies, usually after 4-5 years, and distributes the proceeds to its investors.

Stages of the life of a private equity fund

Fundraising:Stage in which the fund is established and investors interested in contributing capital are approached. Each investor defines the amount of capital committed. The total amount raised will be used to make investments.

Investment period: The fund acquires stakes in private companies that it selects after a rigorous search and due diligence process to ensure the quality of the investment. It may involve the purchase of all or part of a company.

Holding or harvesting period: The manager implements strategies to improve the performance of the companies and obtain a financial return at sale, such as changes in management, operational improvements, expansion of the product portfolio, international expansion, cost optimisation, among others.

Divestment: When the manager considers that the value of the companies has been maximized and that it is the right time to sell them, the fund sells the companies, capitalising proftis for investors. These gains are distributed to investors and the fund is liquidated.

Commitment and valuation of a private equity fund

Investor commitment:
Investors commit a specific amount of capital to the fund at fundraising, but this capital is not disbursed immediately. Unlike other financial assets, investors do not have to pay out all of the committed capital at once but pay out gradually over the investment period as the fund identifies investment opportunities.

On a quarterly basis throughout the life of the fund, investment valuations are calculated to assess the fund’s performance and inform investors. The private equity funds’ valuations are not subject to market comparables, which protect their portfolios from short- and medium-term fluctuations in the public markets.

What is a fund of funds?

A fund of funds is an investment vehicle that invests in multiple private equity funds rather than investing directly in companies. Fund of funds managers select and allocate capital to different private equity funds to diversify risks and leverage the specialised expertise of multiple managers. This investment strategy provides investors with an easy way to access a variety of private companies with a single investment, thereby gaining a high degree of diversification.