The term Private Equity refers to the acquisition of equity shares that are traded privately, not publicly on the market. Equity holdings are traded off-exchange when, for example, a business division is to be sold or no internal successor can be found to manage a business.
At this point, we must make a clear distinction between Private Equity (PE) and venture capital (VC). Private Equity is characterized by the fact that it is invested in established small and medium-sized companies or in large corporations. Venture capital, on the other hand, is primarily invested in new and innovative companies (also commonly referred to as risk capital).
In the Private Equity industry, equity shares are purchased by funds that are administered and managed by managers and their teams. Private Equity funds normally have a term of 10 years and are only available to institutional investors. These funds acquire holdings in 10-20 companies with the above characteristics during the initial investment period of around 5 years.
The goal of each investment is, together with managing the acquired company, to develop a strategy for implementing value-generating measures and to implement these within 3-6 years. Value is created through organizational and company growth, growing operative profitability, and increasing cash flows, or through acquiring companies that provide synergistic effects (add-ons).
Private Equity companies are temporary owners. The investments are sold, with the proceeds flowing back to the investors in the fund, after the business plan has been implemented successfully. If all investments have been sold, the fund is liquidated.
Private Equity funds receive an annual management fee as fixed compensation. Additional performance-based profit shares (carried interest) are only available to the fund if the investors have achieved a minimum return in a specified amount (hurdle rate).