There are various steps that private equity firms take throughout the lifecycle of an investment. Note that we drill into these steps in more detail later in the course.
1. Raise funds
Private equity firms – or PE firms - raise capital from investors who are looking for higher returns than those accessible via traditional investments such as publicly traded shares or bonds. This requires PE firms to demonstrate that they have the expertise and experience to invest in a way that will lead to strong financial returns for investors, at which point investors will entrust their money to the PE firm to manage on their behalf. The money raised from a variety of investors will be pooled in what is known as an “investment fund”.
2. Identify investment opportunities
PE firms will then scout for investment opportunities, generally focusing on established companies that are undervalued, are experiencing rectifiable operational or financial challenges, and/or show promise for growth or opportunities to increase efficiencies (and therefore profit and value). During this stage, PE firms will carry out due diligence into promising target companies, and build financial models to try to determine valuations.
Many PE firms focus on opportunities in specific sectors, for example technology, media and telecommunications, consumer retail, financial services, infrastructure, life sciences, healthcare, and so on (although the largest PE firms might invest across a broad range of industries, with each industry being covered by a distinct team).
3. Invest in businesses
When a suitable opportunity is identified, a PE firm will then invest its funds in the chosen company. Note that in practice, there may be multiple PE firms competing to invest in a target company – with the prospective investors participating in what is known as an “auction process” – meaning some PE firms lose out on the opportunity to invest.
In return for investing capital, a PE firm receives an ownership stake in the business. This would typically be a significant shareholding, giving the PE firm major influence over the company's management and strategic decisions.
4. Create additional value
After acquiring a stake in a target company, the PE firm works closely with its management team to enhance the company's performance and value. This could involve implementing operational improvements, growth initiatives, and corporate or financial restructuring, with the goal of maximising the company's potential and increasing its value over time.
5. Exit
Once the company has been successfully transformed and its value has increased, the PE firm would seek to monetise its investment. This is done through an exit strategy, which could involve selling the company to a trade buyer or another investor, taking it public through an IPO, or merging it with another company. Part of the proceeds from the exit are distributed to the PE firm and the investors who invested in the fund that was used to acquire the relevant business.
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