What is Private Equity and How Does It Work?
Private equity is when investment partnerships buy into a company and manage it before selling their stake through an exit strategy. Most private equity firms oversee investment funds for accredited and institutional investors, often specialising in investing in companies within industry niches.
Most private equity funds and firms acquire private or public companies in their entirety. Alternatively, they may invest in a consortium buyout. It’s unusual for a private equity firm to hold equity in a company that remains on the stock market.
The private equity industry is booming as an alternative investment strategy with private equity funds continuing to experience strong returns for the last two decades. Private equity firms have bounced back from the impact of the pandemic with private equity buyouts doubling from 2020 to 2021 to total a record-breaking $1.1 trillion.
Companies across every industry are turning to private equity as an alternative funding source and as part of their growth strategy. We’re seeing an increase in demand for CFOs with private equity experience to oversee the fundraising process and lead on stakeholder engagement and the exit strategy.
FD Capital specialises in connecting companies with CFOs with a proven track record of delivering on private equity investment. Start your recruitment process today by contacting our team at recruitment@fdcapital.co.o.uk or on 020 3287 9501 for a no-obligation consultation.
What is Private Equity?
Private equity is the shares that signify the interest or ownership in a company that is privately owned, so not trading on the stock market. Specialist investment firms and high-net-worth individuals utilise private equity to invest in companies throughout their growth cycle. While these investments are usually made in companies that are already privately owned, a conglomerate may strategically invest to delist a company from the stock market and take it private once more.
The private equity niche is largely controlled by major firms and investment portfolios, including pension funds. Many private equity investors decide to focus their investments within a niche industry or companies at specific stages. Some investors prefer mature companies that are already experiencing growth, while others look for a diamond in the rough that may be experiencing operational and financial difficulties but that could be turned around with the right management.
Companies will target private equity investment to support their cash flow or to fund their growth strategy, including pursuing acquisitions and investing in new equipment and technology.
Private Equity vs. Venture Capital
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Private equity and venture capital are alternatives to traditional financial institutions, becoming a preferred option for innovative companies and ones that would be considered high-risk by high street banks. Venture capital and private equity are terms often used interchangeably but there are a few crucial differences.
Private equity firms invest across a diverse range of industries, whereas venture capital funds typically prioritise technological-focused companies, however, they do invest solely in these niches. The principal difference between private equity vs. venture capital is that private equity funds its investment through cash and debt, while venture capital is a strictly equity-based investment.
Private Equity Funds vs. Mutual Funds
The most noticeable differences between private equity vs. mutual funds are the capital source, how the firms collect their fees, and the type of companies they choose to invest in. Private equity firms raise capital from accredited and institutional investors, whereas mutual funds utilise funds from everyday investors. Mutual funds focus on publicly traded companies, whereas private equity firms invest in private companies. Private equity firms collect performance and management fees, whereas mutual funds only collect a management fee.
Private Equity Funds vs. Hedge Funds
Private equity and hedge funds both focus on accredited investors with the main difference being between their investment targets and funding structures. Hedge funds focus on publicly traded companies, while private equity firms target private companies.
Private Equity and the UK Economy
Private equity is a driving force in the UK economy. Over 2 million people are employed by companies backed by private equity, including venture capital. Over 1,500 UK companies received private equity investment in 2022, accumulating in over 12,000 companies now being supported by private equity funding.
While it’s easy to think that private equity focuses on major companies, 9 in 10 private equity investments in the UK are directed towards SMEs. 2022 saw £27.5 billion invested into UK companies through private equity with £70.2 billion raised by private equity and venture capital funds managed in the UK.
Private equity and venture capital companies in the UK fall under the regulation of the Financial Conduct Authority (FCA). A self-regulatory element was added in November 2007 following calls from investors and within the industry itself to establish oversight and disclosure regulations. The Guidelines for Disclosure and Transparency in Private Equity and the Private Equity Reporting Group (PERG) were established to bring in rules and measures comparable to those enforced on FTSE 350 companies.
What is a Private Equity Firm?
A private equity firm is an investment company that provides funding for companies to increase their value before exiting the investment by selling the company. Private equity firms typically raise capital from limited partners and focus on industry niches.
Private equity firms will typically take a majority stake in the companies they invest in with most investing in multiple companies at once, creating a portfolio.
The origins of private equity firms can be traced back to 1901 when J.P. Morgan purchased Carnegie Steel Corp. for $480 million, merging it with National Tube and the Federal Steel Company to create U.S. Steel. This transaction was one of the first corporate buyouts. Other noteworthy early private equity purchases include Henry Ford buying his partners out of what would become Ford Motors in 1919. The largest leveraged buyout – when adjusted for inflation – was in 1989 when KKR bought RJR Nabisco for $25 billion.
Type of Private Equity Deals
Private equity firms make several different types of deals when buying and selling portfolio companies. The deal type will usually reflect the company’s circumstances and what the investment serves to fulfil.
Buyouts are one of the preferred types of private equity deals as they involve the firm acquiring an entire company, usually one that is privately held. They may also move to buyout a public company and make it private. A buyout is common for underperforming companies that still have potential. The private equity firm will move in to restructure its operations and identify cost-saving measures.
Another private equity deal is known as the ‘carve-out’. Investors will buy a division of the company, usually a non-core business element that is put up for sale by the parent company. A carve-out type deal has lower valuation multiples than comparable private equity acquisitions. However, this type of private equity deal is largely seen to be riskier and more complex to navigate. Francisco Partners’ acquired Litmos, a corporate training platform, from SAP SE, a German software giant, in August 2022 using a carve-out deal model.
A third type of private equity deal is a secondary buyout, when a private equity firm purchases a company from another private equity firm, instead of directly from the company itself. This type of private equity deal is becoming more common as private equity firms are increasingly specialising and choosing to sell off companies that no longer fit in their niche.
Value Creation Through Private Equity
Private equity focuses on value creation. They start by following due diligence to identify the company’s strengths and weaknesses to determine their overall investment rationale. The priority is on identifying revenue generation opportunities and implementing strategies that will boost operational effectiveness and keep costs manageable. Organic growth and cost reduction are two areas that private equity investors will explore for value creation as acquisitions are becoming more complex and costly.
Value creation provides a structure and strategy, known as a common ownership vision, between investors and the company management. Unlike venture capitalist companies, private equity firms take a more hands-on approach to management by implementing organisational change and implementing KPIs, oversight measures, and a transparent decision-making process. Considering value creation in every aspect of business development is why private equity-owned companies typically outperform publicly owned companies of comparable size.
Private Equity Investor Exit
Private equity firms will have an ideal investor exit in mind when they purchase a stake in a company. Most take a majority stake which makes them directly involved in the company’s operations. While venture capitalists typically invest in multiple companies and take a more hands-off approach, private equity firms are more involved in the day-to-day activities of their companies.
Most private equity investments currently have an average holding time of six years, slightly longer than the previous average of 3-5 years. The slight delay in investor exits is largely due to increasing competition between private equity firms and a lack of available exit opportunities. Exit strategies are usually led on by the company CFO and can include selling the company to a third party or going to the stock market via an IPO.
What is a Private Equity CFO?
Private equity CFOs are specialist financial executives who have experience dealing with the nuances that come from companies funded by private equity firms and investors. They’ll lead on value creation and strive to develop an engaging investor story that raises the company’s profile and attracts new talent.
As the CFO of a private equity-backed company, these financial executives are forward-thinking with a growth-oriented approach to financial strategies and development. They oversee stakeholder engagement and act as a bridge between the company leadership and private equity investors. Many offer an exit strategy for entrepreneurs and founders who plan to leave the company by providing a clear successor to stop up to the role of CEO.
Companies that are exploring the potential of private equity investment often choose to recruit a specialist CFO to oversee the process. Most companies will bring a CFO on board two to three years in advance to prepare the company and boost its financial credibility and valuation to attract more lucrative investors. Companies in highly regulated industries will want a CFO who is an expert with industry-specific knowledge to navigate the challenges of growing governance and regulatory requirements.
Importance of a Private Equity CFO
The role of CFO has moved beyond being a bean counter to being a business leader. Private equity firms turn to CFOs to be their eyes and ears within the company, offering an unbiased overview of its finances and future growth strategy.
These investors expect their CFOs to be data-oriented, leveraging AI and automation to utilise real-time data and forecasting for better decision making. CFOs will also ensure financial transparency is met throughout the investment agreement, including meeting the company’s environmental, social, and governance (ESG) strategy.
Private equity firms expect CFOs to keep them up to date with financial forecasting and the company’s operational movements. It’s the responsibility of a private equity CFO to boost the company’s financial resilience through continuity planning and investing in the right technology as part of the company’s risk management strategy. Cybersecurity and hybrid working support should be top priorities for a CFO’s technological investment strategy.
CFOs will also lead on the valuation process of private equity-backed companies as they are responsible for oversight at each stage of the process and the eventual exit strategy. Compliance is one of the key responsibilities of private equity CFOs who will ensure that the correct procedures are met to get the company an accurate valuation.
Recruiting a Private Equity CFO
Companies are increasingly choosing to recruit CFOs early on in the private equity investment process – often two to three years in advance to lay the groundwork for exploring private investor fundraisings. SMEs may choose to recruit a part-time or interim CFO to oversee the process, transitioning the role to a full-time position when the need arises and when it makes financial sense to do so.
Recruiting a private equity CFO will look different for every company. Some choose to hire an interim CFO to oversee the initial 100 days of the deal to establish KPIs and set systems in place, while others will recruit a full-time CFO to lead the company’s value creation strategy.
FD Capital is the UK’s leading specialist financial recruitment agency. We take a curated approach to recruitment, identifying the individual needs of our clients to find the right candidate the first time around. Our traditional recruitment and headhunting services provide 360-degree recruiting. Start recruiting your private equity CFO by contacting us at recruitment@fdcapital.co.uk or by calling us at 020 3287 9501 for a no-obligation consultation.
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