What is the Private Equity Cycle?

I recently spoke with a reporter at a major newspaper who was doing a story on a private equity fund.  He asked some rather basic questions on the cycle of a private equity fund and so I thought I would share a brief look at the private equity cycle.  (There are more detailed videos available through the Private Equity Training program we offer).

Here is a look at the main cycles of a private equity fund:

1. Raising capital from investors.  This is really preceded by planning the fund, developing what is sometimes a vague strategy for what investments the fund hopes to make (although for some funds, the management team has a very clear idea and possible buyout targets), structuring the fund and its management team and other preliminary activities.  Now the fund will begin by looking to limited partners that have interest in the fund.  This may fall to a third party marketer who will market the fund to his/her existing network of investors and then introduce the fund’s management to the investors if there is interest.  Or, especially for larger funds that have a history of success and strong investor interest, an in-house marketing team will work existing investors and look for new ones to join the fund.  Private equity funds only reach out to accredited investors that meet certain qualifications, and commonly look to fund of funds, institutional investors like endowments and pension funds, family offices, ultra-high net worth individuals, and sovereign wealth funds.
2. Investing the capital in companies.  This is, of course, the purpose of a private equity fund.  The fund’s team will identify worthy targets and invest in these companies, often taking whole companies private through leveraged buyouts.  These companies are often undervalued or mismanaged in a way that the private equity team believes that by taking it private and reorganizing or making changes it can exit for a greater return than the capital invested in the company.
3. Adding value to the company and achieving a return for the fund/investors.  This is where the private equity fund’s management team will work with existing portfolio company management (or often replace or alter the management team at the company) to improve operations, increase efficiency and otherwise create value at the company, making it more profitable.  By improving the companies, private equity firms often make the firm more attractive to other investors whether it be industry rivals who might consider a merger or acquisition, other private equity firms, or public investors through an initial public offering.
4. Exit the investment.  This is the stage in the private equity fund cycle where the fund looks to exit its investment.  For a company taken private by the private equity fund, this may mean an initial public offering where stock becomes available to the public and the market is left ultimately to decide the value of the company.  Private equity firms may also want to purchase the company, allowing the existing PE fund owners to exit the investment and realize profits on the investment.  Other industry firms or corporate investors may bid for the company as well, now that it has presumably been improved by the PE fund.
5. Realizing the profits and distribution.  At this stage, the payoff finally occurs after an investment for LP’s that may have locked up their capital for several years.  The private equity fund’s team will likely take a 20% cut of the profits (the carry) but the remaining profits are distributed to the limited partners.

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