Thursday, June 21, 2007

Private equity-excerpts from Wikipedia article

I include here some parts that I think are noteworthy:

-Private equity funds are the pools of capital invested by private equity firms. Although other structures exist, private equity funds are generally organized as either a limited partnership or limited liability company which is controlled by the private equity firm that acts as the general partner. The limited partnership is often called the "Fund", and the general partners are sometimes designated as the "Management Company" (although at times, that is a separate company affiliated with the general partner). The fund obtains capital commitments from certain qualified investors such as pension funds, financial institutions and wealthy individuals to invest a specified amount. These investors become passive limited partners in the fund partnership and at such time as the general partner identifies an appropriate investment opportunity, it is entitled to "call" the required equity capital at which time each limited partner funds a pro rata portion of its commitment. All investment decisions are made by the General Partner which also manages the fund's investments (commonly referred to as the "portfolio"). Over the life of a fund which often extends up to ten years, the fund will typically make between 15 and 25 separate investments with usually no single investment exceeding 10% of the total commitments.

-General partners are typically compensated with a combination of a management fee (defined as a percentage of the fund's total equity capital), monitoring fees (fees paid to the general partner by portfolio companies for services), as well as transaction fees (fees paid to the general partner in their M&A advisory capacity). In addition, the general partner usually is entitled to "carried interest", effectively a performance fee, based on the profits generated by the fund. Typically, the general partner will receive an annual management fee of 1% to 2% of committed capital and carried interest of 20% of profits above some target rate of return, which is typically 8% to 10% (called "hurdle rate").

-Private equity firms generally receive a return on their investment through one of three ways: an IPO, a sale or merger of the company they control, or a recapitalization. Unlisted securities may be sold directly to investors by the company (called a private offering) or to a private equity fund, which pools contributions from smaller investors to create a capital pool.

-Most private equity funds are offered only to institutional investors and individuals of substantial net worth. This is often required by the law as well, since private equity funds are generally less regulated than ordinary mutual funds. For example in the US, most funds require potential investors to qualify as accredited investors, which requires $1 million of net worth, $200,000 of individual income, or $300,000 of joint income (with spouse) for two documented years and an expectation that such income level will continue.