Private Equity 101

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The private equity industry is facing difficulties in exiting aging investments amounting to over $3 trillion. Large buyouts made when debt was inexpensive are struggling to find viable exit strategies in today's market environment. Public market exits are viewed with skepticism due to concerns of underperforming stock prices. Some private equity firms are resorting to delisting large portfolio companies from public markets. Additionally, the lack of attractive exit options is leading some firms to reconsider engaging in massive deals, with a shift towards smaller deals with more diverse exit opportunities. Private equity firms are encountering obstacles in exiting investments due to market volatility, limited exit options, and the reluctance of investors to engage in public offerings. The increasing preference for companies to remain private temporarily highlights the uncertainties surrounding the current market environment.

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The key institutional features of private equity are as follows: 1. Limited Partnerships: Private equity funds are typically set up as limited partnerships, consisting of a general partner (GP) and limited partners (LPs). The GP makes investment decisions and executes the fund's value-creation strategy, while LPs provide the majority of the capital. 2. LPs: Limited partners in private equity funds are usually institutional investors such as pension funds, college endowments, foundations, insurance companies, family offices, and sovereign wealth funds, as well as high-net-worth individuals. 3. Limited Partnership Agreement (LPA): The relationship between the GP and the LPs is governed by the LPA, which outlines the fund's purpose, investment strategy, term, LPs' obligations, management fee, carried interest, distribution waterfall, conditions for sale and transfer of LP interests, and protective covenants. 4. Commitment Period: Private equity funds have a commitment period of three to five years, during which the fund looks for suitable investment opportunities and implements value-creation strategies for the portfolio companies it acquires. 5. Governance Mechanisms: Limited partnerships have limited governance mechanisms compared to public corporations. LPs can engage in limited governance through the Limited Partner Advisory Committee (LPAC), which resolves conflicts of interest or waives restrictive covenants. 6. Capital Calls: LPs do not pay their committed capital up front. Instead, they receive capital calls from the GP when the fund needs to draw down capital for investments. LPs need to manage their liquidity to meet these capital calls. 7. Leverage: Private equity deals are typically financed through a combination of equity and debt. Leverage ratios in private equity deals can be high, with debt often provided by banks and syndicated. 8. Exit Strategies: As portfolio companies mature, they are prepared for exit through sale on the stock market or to strategic or financial buyers. Exit proceeds are distributed to the fund's partners according to the distribution waterfall outlined in the LPA. 9. J-Curve: Private equity funds often exhibit a J-curve, where it takes several years for the fund to "return capital" and generate capital gains. Investing in private equity requires patience and a long investment horizon. 10. Secondary Sales: LPs cannot easily sell their fund interests, but specialized investment banking teams facilitate secondary sales by approaching potential buyers. However, there is no liquid marketplace for fund interests.

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