An Initiation Into Private Equity Funds

What Is a Private Equity Fund and Should You Invest?

Many are familiar with stock exchanges and the publicly traded shares of companies listed on them. However, the private equity (PE) market is less understood, likely due to its domination by well-funded institutional players such as pension funds. 

Accredited investors have the opportunity to purchase private equities (i.e., shares in unlisted companies) through private equity funds. These funds directly invest in companies, often intending to gain influence with their management. Private equity also has a fascinating history, which you can read more about here. 

Private Equity Fund Considerations

Investing in a private equity fund is a long-term commitment, often lasting nearly a decade. That means that it could take a while to see returns or even assess their potential value.

Investors have to consider several factors before taking the plunge:

Illiquidity

Investments in PE funds are not quickly sold or easily converted into cash. This illiquidity means your money is tied up for the long haul, potentially making it challenging to access funds when needed.

Fund Manager Expertise

The success of a PE investment heavily relies on the fund manager’s skill and experience. A fund manager’s ability to identify promising companies, negotiate deals, and steer companies toward growth can significantly impact the returns on your investment.

Fees

PE funds typically charge management and performance fees (carried interest). Understanding how these fees are structured is essential, as they can affect your investment returns.

Private Equity Liquidity: Risk & Reward

The concept of risk in private equity investments is often tied to concerns about liquidity at both the fund level and within the individual portfolio companies. However, financial assets should be perceived as more or less liquid rather than strictly liquid. Even publicly listed assets, perceived as liquid, can become hard to sell in market downturns.

Recognizing that assets vary in liquidity helps us understand that this factor also influences their prices and returns. It’s logical to anticipate that accepting reduced access to your capital — due to its illiquidity — might yield a lower purchase price or a higher return as compensation. 

It’s also important to note that private equity funds are less risky than hedge funds. Illiquidity and long-term commitment may seem like downsides to some investors, but these characteristics also make PE funds slightly safer. Hedge funds often employ more aggressive strategies aimed at generating quick returns, carrying higher risks.

In a nutshell, private equity is typically a safer investment option due to lower volatility, stringent oversight, and superior management compared to publicly traded assets. Some may find this a radical notion, but I stand by it.

Finding the Right PE Fund Manager

Choosing the right PE fund manager is a decision that significantly influences the potential returns on your investment.

Key considerations in this selection process include:

Track Record

Accredited investors can access the performance statistics of fund managers, some of whom have decades-long track records. Plenty of documentation exists about the persistence of individual managers’ returns in private equity, which means—unlike in most asset classes—PE managers’ past performance is a good predictor of future performance. 

Management Team and Investment Strategy

The expertise, experience, and past achievements of the management team play a pivotal role. This aspect covers both the individual capabilities of team members and their collective success in steering investments to fruition. In addition, it’s important to look at the fund’s strategic approach, including its geographical focus and sector preferences, to align with the investor’s objectives and risk appetite.

Qualitative and Quantitative Factors

Additional considerations, such as the fund’s operational model, governance structure, and market positioning, also merit attention.

Finally, it is important to understand the dynamic between General Partners (GPs or fund managers) and Limited Partners (LPs or investors). The relationship between GPs and LPs can shift based on broader economic conditions.

For example, immediately after the 2008 recession, GPs struggled to raise capital from hesitant institutional funds, giving LPs greater leverage and more favorable terms. For the most part, this relationship has balanced out once again, but economic conditions can quickly change negotiating leverage.

The State of Global Private Equity

According to a 2024 report by Commonfund, PE is expected to rebound in this coming year. In the aftermath of COVID-19, the PE sector has continued to gain momentum as the global economy recovers. Portfolio companies benefited from PE firms’ quick action and expertise during the pandemic, and the market remained resilient overall.

Key Trends and Warnings

S&P Global reports a continued optimistic outlook among PE investors, with the total value up 114.3% since last February.  PE investors continue to target mostly application and systems software. 

In 2024, The U.S. and the U.K. will produce the majority of start-ups valued over $1 billion (a.k.a. unicorns), with San Francisco outpacing New York and London, respectively, by a significant margin.

On another note, venture capital continues to break funding records, and experts warn that this bubble may soon burst due to a saturated market, higher interest rates, and fewer viable exit opportunities.

Given these dynamics, the expertise of the fund manager becomes increasingly crucial. A manager’s ability to foresee industry trends and effectively allocate investments can significantly impact the fund’s success. Therefore, selecting a fund with a seasoned management team is pivotal for investors looking to navigate the complexities of the private equity landscape effectively.

Who Are the Top-Ranking PE Firms?

Between 4,000 and 5,000 private equity fund managers (i.e. PE firms) operate worldwide. According to a 2024 Forbes list, the key participants include: 

• Blackstone
• Apollo
• KKR
• The Carlyle Group
• Thoma Bravo
• Bain Capital

In venture and growth capital, these are some of the current big names topping many lists:

• Andreessen Horowitz
• Sequoia Capital
• New Enterprise Associates
• Accel
• Tiger Global Management
• Index Ventures
• Khosla Ventures

Private Equity Funds vs Direct Private Equity Deals

Now, why would an accredited investor invest in a private equity fund rather than a “one-off” deal to acquire a company with potentially the highest yields? 

Because it is still a very tough job to invest directly in private companies. It requires a lot of know-how in finding the opportunities, assessing them, negotiating (e.g., a shareholder’s agreement), monitoring the investments, and steering them as the company evolves. Then, of course, selling companies requires a great deal of contacts and mergers and acquisitions (M&A) expertise.

Accredited investors are better off investing with professional managers through a fund. A properly managed PE fund will maximize returns through the expertise of the manager and often other business experts. These professionals are vital to handling high-risk, high-return investments, making PE funds an attractive avenue for those looking to invest in the private equity space.

We think you’ll also like:

1. The Delayed Private Equity Exit Strategy – What’s a Limited Partner to Do?
2. Crash Course: Private Equity Funds, Sponsors, and Investors
3. Key Private Equity Considerations for Would-Be Investors

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Tech Talk: Current Opportunities for Investing
2. Tricks and Traps in Leveraged Finance
3. Cannabis Investment: Successes, Failures, & Strategies for the Future

This is an updated version of an article originally published on August 7, 2021.]

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