WHAT IS PRIVATE EQUITY?

Private equity is investment capital provided to companies that are not publicly traded on a stock exchange.

Rather than purchasing shares of a public company through an exchange, private equity investors invest directly or indirectly in privately held businesses.

The objective is generally to help a company grow, improve operations, expand into new markets, complete acquisitions or otherwise increase its value over time.

If that strategy succeeds, investors may ultimately realize a return when the investment is sold or another liquidity event occurs.

HOW DOES PRIVATE EQUITY WORK?

Private equity investments can be structured in different ways.

An investor may invest through a private equity fund that pools capital from multiple investors.

The fund manager then identifies companies, makes investments and manages the portfolio according to the fund’s strategy.

In other situations, investors may participate in a direct investment or a special-purpose vehicle created for a particular company or transaction.

The basic concept is similar:

Capital is invested into a private business with the expectation that the business can become more valuable over time.

WHAT DOES A PRIVATE EQUITY FUND DO?

A private equity fund is generally managed by a professional investment manager or sponsor.

The manager may:

Identify investment opportunities

Conduct due diligence

Negotiate investments

Provide growth capital

Work with company management

Help develop strategy

Arrange financing

Support acquisitions or expansion

Monitor the investment

Eventually pursue an exit

Unlike a passive stock investment, private equity managers may take an active role in helping portfolio companies execute their business plans.

WHAT TYPES OF COMPANIES RECEIVE PRIVATE EQUITY?

Private equity covers a broad range of businesses.

Some strategies invest in established, profitable companies.

Others focus on companies requiring growth capital.

Still others may invest in businesses undergoing operational changes, acquisitions or expansion.

Within the environmental economy, private equity could potentially finance companies involved in:

Renewable energy

Sustainable agriculture

Water technology

Recycling and resource recovery

Environmental infrastructure

Energy efficiency

Environmental data and measurement

Natural-resource management

Climate and environmental technology

The fact that a company operates in an environmental sector does not, by itself, determine whether it is an attractive private equity investment. Its business fundamentals still matter.

HOW CAN PRIVATE EQUITY GENERATE RETURNS?

Private equity returns can come from several sources.

BUSINESS GROWTH

A company may increase revenue, profitability or market share.

OPERATIONAL IMPROVEMENT

Management may improve efficiency, margins or other aspects of the business.

EXPANSION

Capital may allow a company to enter new markets, introduce products or expand operations.

ACQUISITIONS

A company may acquire other businesses as part of its growth strategy.

DEBT REDUCTION

In certain structures, improving cash flow and reducing debt can increase the value attributable to equity owners.

EXIT VALUE

Ultimately, investors generally need a liquidity event to realize the value created.

WHAT IS AN EXIT?

Private equity investments are usually made with an eventual exit strategy in mind.

Potential exits can include:

Sale to another company

Sale to another private equity investor

Management or investor buyout

Recapitalization

Initial public offering

The timing and value of an exit are not guaranteed.

A company may take longer than expected to sell, or market conditions may make an attractive exit difficult.

HOW LONG ARE PRIVATE EQUITY INVESTMENTS HELD?

Private equity is generally a long-term investment.

Individual investments may be held for several years, while private equity funds themselves can have terms extending substantially longer.

Investors should therefore understand the expected holding period before committing capital.

Unlike publicly traded shares, there may be no readily available market where an investor can simply sell a private equity interest.

IS PRIVATE EQUITY LIQUID?

Generally, private equity should be considered illiquid.

Transfers may be restricted, and there may be little or no secondary market for an investor’s interest.

A fund investor may have to wait until the manager sells portfolio investments and distributes proceeds.

This means investors should not commit capital they expect to need on short notice.

WHAT IS THE DIFFERENCE BETWEEN PRIVATE EQUITY AND VENTURE CAPITAL?

Both involve investing in privately held companies, but they often focus on different stages of development.

Private equity frequently invests in more established businesses with operating histories, revenue and existing business models.

Venture capital generally focuses more heavily on earlier-stage companies pursuing rapid growth, new technologies or emerging business models.

The distinction is not absolute, and strategies can overlap.

WHAT FEES MAY APPLY?

Private equity funds commonly charge management fees and may also receive performance-based compensation.

Depending on the structure, investors may also encounter organizational, transaction, administrative or other expenses.

The exact economics vary considerably.

Investors should understand:

What fees are charged

Who receives them

When they are charged

and

How they affect investor returns

before investing.

WHAT ARE SOME OF THE RISKS?

Private equity can involve substantial risk.

These risks may include:

BUSINESS RISK

The portfolio company may fail to perform as expected.

LIQUIDITY RISK

Investors may be unable to exit for an extended period.

LEVERAGE RISK

Some strategies use borrowing, which can magnify both gains and losses.

MANAGEMENT RISK

Results may depend heavily on the abilities of both the fund manager and portfolio-company management.

VALUATION RISK

Private companies do not have continuously quoted market prices.

CONCENTRATION RISK

A fund or investment may have significant exposure to a relatively small number of companies.

EXIT RISK

An attractive buyer or other liquidity event may not materialize when expected.

Investors can lose some or all of their invested capital.

WHAT SHOULD AN INVESTOR EVALUATE?

Before considering a private equity investment, investors should understand:

What companies or sectors does the strategy target?

Who manages the investment?

What experience does the manager have?

How does the manager expect to create value?

How much leverage may be used?

What fees and performance compensation apply?

What is the expected holding period?

How are portfolio companies valued?

What is the expected exit strategy?

What are the principal risks?

Private equity should be evaluated based on the complete investment strategy—not simply an advertised target return.

PRIVATE EQUITY AND ENVIRONMENTAL INVESTING

Private equity can play an important role in financing the environmental economy.

Many companies developing environmental solutions require significant capital before they are large enough—or choose—to access public markets.

Private equity can provide capital for businesses to:

Build facilities

Acquire equipment

Expand operations

Develop new markets

Complete acquisitions

Commercialize technologies

Scale environmental solutions

That can create opportunities for private capital to participate directly in the growth of environmental businesses.

THE BIGGER PICTURE

Private equity gives investors access to a part of the economy that exists outside public stock exchanges.

The opportunity can be significant, but so can the complexity.

Investors need to understand the company, the manager, the investment structure, the fees, the holding period, the exit strategy and the risks involved.

A private company does not become a good investment simply because it operates in a promising industry.

Ultimately, private equity is about investing capital today with the expectation that a private business can become more valuable tomorrow.