Private equity investment process
Private equity companies manage funds, which typically invest in unlisted companies. The private equity investment process starts from collecting capital for a fund and ends with returning committed capital and realised returns to fund investors.
Private equity fund managers raise capital from institutional investors to establish private equity funds. Typically, investors include both private and state pension funds, funds of funds, life insurance companies, foundations and other institutions. Often the fund manager also commits capital to the newly established fund. Private equity funds are typically organized as limited partnerships with a life cycle of approx. ten years. Capital is called from investors when investments are made into portfolio companies and returned after exits. The fund manager acts as an advisor to the fund making the investment and exit proposals and developing the investment targets during the ownership period.
The private equity fund manager maps potential investment targets for the fund. Generally, the targets need to fulfil certain criteria in terms of size, industry and life cycle phase in accordance with the fund’s strategy. In addition, the fund manager evaluates the attractiveness of each potential target based on its value creation and exit potential. Investment targets are usually sourced either through proprietary networks or by participating in auction processes. Efficient deal sourcing therefore calls for strong business networks across the fund’s target geography.
After an investment target is identified, a more detailed analysis on the business is performed. This due diligence analysis usually involves going through the company’s financial and legal documents in more detail, as well as evaluating its commercial attractiveness. Negotiations with banks to arrange financing are also initiated at this stage. Provided that bank financing is available and due diligence findings support the investment, final negotiations regarding the transaction are initiated.
Once the investment is made, the private equity fund manager starts developing the company based on a detailed value creation plan. In addition to financial capital, the manager supports the target company by providing sector knowledge, operational experience and access to a wider business/industry network. This usually involves taking a seat on the target company’s board.
Private equity investors are temporary owners. Consequently, a portfolio company is usually held between 4 to 6 years, during which the value creation plan is being implemented in co-operation with the management team. There are several alternatives available for the private equity fund to exit the investment. Most commonly exits take place via:
- Trade sale to an industrial buyer
- Secondary sale to another private equity fund
- Listing through initial public offering (IPO)
- Sale to the management group
Once the exit is finalised, the initial capital and proceeds from the investment are returned to the fund investors.
