Private equity (PE) is defined as private investment partnerships that buy, manage and re-structure companies. Generally, these investments are held for a long time and are not made in listed companies and are regulated only by industry-specific criteria and regulations.
It is seen as an alternative form of investment. PE firms earn money by charging fees for management and performance from investors who park their money in the fund.
Key elements of Private Equity
Following are the key elements of PE that can help one understand its working:
- PE firms and investors usually invest in established companies rather than start-ups.
- Established companies give them the opportunity to maximize the worth of their portfolio before exiting the investment.
- PE funds can be used to promote new technology, make acquisitions, expand business operations and working capital, etc.
- Long holding periods are often required for private equity investments to ensure an improvement for distressed companies or to enable events such as initial public offerings (IPOs) or a sale.
- The average lifespan of a private equity fund is about 10 years.
What are Venture Capital (VC) Funds?
Venture capital funds are a pool of investments invested by those who seek private equity stakes in organizations with strong growth potential. VC investments usually work in a high risk, high investment mode. Other key elements of VC funds include:
- High risk due to investment in potential growth.
- Only available to investors who can handle losses and loss of liquidity.
- VC generally used in tech savvy or emerging industry sectors.
- Returns are earned when a portfolio company exits in the form of an IPO, merger or acquisition.
What is the difference between PE & VC?
Following are the key differences between PE and VC:
| Ground |
Private Equity |
Venture Capital |
| Investment stage |
Later stage – secure company |
Initial stage – startups and nascent companies |
| Investment stage |
Later stage – secure company |
Initial stage – startups and nascent companies |
| Number of Investments |
In a few companies |
In multiple companies |
| Industries |
No specific industries |
Usually in industries of high tech, energy, etc. that require investment push |
| Risk |
Low |
High |
| Control |
High stakes in a company upon investment |
Little to no stake in a company upon investment |
Who can invest in Private Equity – eligibility?
Private equity investment is open to accredited investors and qualified clients. Accredited investors are those who are eligible to deal in securities unavailable to the general public.
Each form of entity has different thresholds to be classified as accredited investor, as listed below:
- An individual, Hindu Undivided Family (HUF), family trust or sole proprietorship, can be an accredited investor if their annual income is at least INR 2 crore or net worth is at least INR 7.50 crore, with at least half of it in financial assets.
- Entities with a combination of at least INR 1 crore annual income and a net worth of INR 5 crore, with at least half in financial assets can also become an accredited investor.
- For trusts other than family trusts, a net worth of at least INR 50 crore would be required to qualify as accredited investors while for corporates, a net worth of INR 50 crore will be mandatory.
- In case of a partnership firm, each partner independently will have to meet the eligibility criteria for accreditation.
These include High Net Individuals (HNIs), university endowments, insurance companies, pension funds, etc. Risk and initial investment in private equity is high and, hence, the regulatory bodies ensure that only high net individuals, capable of withstanding greater liability, are eligible for investment in PEs.
Often, securities which are dealt with are unregulated, leading to greater risk and chance of loss. Therefore, high value investors are sought for investment in PEs.
Types of Private Equity
Private equity also has various types. The most common of these are discussed below:
- Venture Capital Funds: Investments made in young companies and startups that may yield high returns. VCs play an important role in developing early capital. Often such young organizations have little to no outside financing and, hence, venture capitals play a big role at their nascent stage.
- Leverage Buyout (LBO): This differs from VCs. Investments are made in a larger and more established business with more leverage to garner favorable returns; fund invested are also bigger. LBO happens when a company borrows large amounts of money as loans and bonds and then LBO takes place to help with acquisitions.
- Real Estate: Firms raising capital to develop, acquire, operate, sell land and generate returns accordingly are called private equity real estate firms. Thus, most of these funds are directed towards ownership of real estate property.
Exit Strategies for Private Equity
Following are the common exit strategies for private equities:
- Initial Public Offer (IPO): Perhaps the most common exit strategy of PE is an IPO of the company invested in. Anybody who has invested in the company may sell their share immediately or after the company is listed on the stock exchange.
- Acquisition: The other alternative is the acquisition of the company one may have invested in. After the sale or acquisition, the investor can acquire the share depending on the sale value. This way, the investor can exit the PE and acquire a stake with the buyer company.
- Repurchase by Promoters: In this case, the management or promoters of the company buy back equity stake from the private investors and, hence, it is often seen as an attractive option for both investors and management.
- Liquidation: In the case of debt financing by PE, the process will eventually self-liquidate as the amount will return in the form of interest payments over a period of time. This is the least favored option but is sometimes used in case the business invested in does not successfully take-off.
Law governing Private Equity in India
SEBI (Alternative Investment Funds) Regulations 2012
- Investment via PEs are now routed through the ‘Alternative Investment Funds’ (AIF) which are established for investment purposes in compliance with SEBI. These regulations govern ‘pool investments’ such as hedge funds and private equity.
- The regulations mandate registration of all Alternative Investment Funds and restrict any person or entity from acting as an AIF unless registration from SEBI has been procured. Each registration is bifurcated into Category I/II/III, etc. with differing eligibility criteria.
- Restrictions are imposed on the number of investors and amount of investments. All investments must be in line with the regulations.
SEBI (Foreign Venture Capital Investor) Regulations 2000
- Regulates investment by Foreign Venture Capital investors, who are investors incorporated or established outside India that propose to make investments in India.
- Regulations are not mandated by SEBI or the Central Bank. However, certain benefits have been extended to foreign venture capitals registered with SEBI.
- A domestic custodian for custody of securities is also mandated in the rules.
Companies Act
- All private equity transactions are governed by applicable provisions of the Companies Act.
- Therefore, they are governed by the Registrar of Companies (RoC) under the authority of Ministry of Corporate Affairs (MCA) which has territorial jurisdiction over the concerned companies.
- Also governed by applicable notifications, circulars, rules and regulations issued by the MCA.
RBI
- The Reserve Bank of India, as the Central Bank of the country, is empowered to make rules and regulations with respect to foreign transactions and funding.
- This also includes rules and regulations about the Foreign Venture Capital Investors.
- Under the watch of the RBI, foreign venture capital is also regulated by the authorities such as: Competition Commission of India (CCI), Insurance Regulatory & Development Authority of India (IRDAI) and Pension Fund Regulatory & Development Authority.
Conclusion
Private Equity has increased manifold and is now an extremely popular method of private investment. However, only secure investors with high net-worth and an ability to withstand losses should invest. The drawback of investing through this method is the risk it entails. Exit strategies are as important when investing in private equities. An investor must be confident about the wealth and only then invest through private equity.
