Answering Questions About Private Equity with Mark Hauser

By: Sumeet_Manhas

According to McKinsey’s Private Markets Annual Review released in March of this year, private equity is continuing to experience growth. The report found that private market assets under management (AUM) has grown 170 percent over the past ten years, increasing by $4 trillion and today has reached an all-time high of $6.3 trillion. There are twice as many private equity firms out there than there were a decade ago, and the pooled investment rate of return (IRR) of 27 percent in 2021 saw private equity continue to be the highest-performing private markets asset class.

Mark Hauser, co-managing partner of Hauser Private Equity, highlights below what you need to know about private equity. Since its inception in 2008, Hauser Private Equity’s five funds have invested over $350 million in capital in privately-owned businesses nationally. With over three decades of investing and operating company experience, Hauser has facilitated the completion of over 500 investments and successfully realized over 150 of them.

What is private equity?

Generally, private equity is the term for ownership or stake in an entity that is not listed or traded publicly. When it comes to an investment strategy, private equity is also the term for partnerships that purchase and manage private businesses before releasing them for a profit. Private equity firms will develop funds by collecting money from investors –– usually large investors rather than small ones or individuals –– and invest in businesses on their behalf. This is done by either purchasing the entire company outright or taking a controlling stake.

The businesses within a fund are called portfolio companies, and partners within a private equity firm will work with their portfolio companies’ executives to improve the business. Hauser notes that this is a mutually beneficial relationship in which the business achieves growth it otherwise would have had more trouble attaining and the private equity firm and its investors are able to later sell the company for a profit.

Private equity is considered an alternative investment – one of the strategies diverging from the traditional long-only positions in stocks, bonds and cash. It is considered comparable to venture capital and hedge funds, as those who wish to invest in this asset class must be able to invest a consequential amount of capital for an extended period of time. For this reason, those who invest in private equity funds are typically institutions and high net worth individuals.

While private equity is often grouped with venture capital, they differ in their chosen investments. Where venture capitalists typically invest in startups that they identify as having high growth potential, private equity firms target established businesses. Like venture capital they may choose a company to invest in because of its strong performance, but private equity investors may also decide to invest in a company that is deteriorating or failing because they recognize its inefficiencies are resolvable.

What do private equity firms do?

Private equity firms will create and manage private equity funds, and in doing so form a limited partnership. They then seek out investors to contribute to the fund, creating a pool of capital that can then be used to invest in private companies that meet their investment strategy criterion. Investors in the fund are limited partners with no involvement besides the capital they provide, while the private equity firm is the general partner of the fund and is responsible for managing the investments.

A private equity fund’s end game is nearly always the sale of their invested stake in a company, achieving a positive return on investment (ROI). This typically takes place over the course of five to ten years. Every private equity fund will have a different strategy to achieve this. Other private equity firms will look to make co-investments alongside other funds, such as Hauser’s Hauser Private Equity. They partner with funds between $200 million and $2.5 billion that are operationally focused, lending to the partnership their operational industry expertise.

Who makes private equity investments?

Investors in private equity funds are typically institutional, including categories such as pension funds, sovereign wealth funds, and endowments. Occasionally, singular high net worth individuals may also decide to invest in a private equity fund. A standard minimum investment for private equity funds is at least $200,000, and private equity firms will combine these contributions with borrowed money to make investments.

In addition to the minimum requirements that are expected to invest in a private equity fund, investors must also be prepared for lengthy holding periods. If a company was distressed when it was invested in, adequate time will be needed for a turnaround, and there is also the time needed to complete liquidity events when the time comes to sell the business.

What does a private equity firm look for in a potential investment?

Private equity investors representing a fund will typically perform extensive research before making an investment, a process known as due diligence. They will usually look for target companies in non-cyclical industries, avoiding market volatility that could inhibit a planned exit. The business may have multiple avenues for growth, better positioning it for acquisition. Differing again from venture capitalists, private equity firms seek companies that need no more than a single cash infusion rather than startups that would most often need multiple rounds of investments in order to achieve growth. They will review the company’s governance and management, looking for companies that already have a fiscally responsible and organizationally solid team in place, says Hauser. Alternatively, they may find a business that is underperforming and recognize its growth potential when compared to organizations within the same sector.

How do private equity firms make money?

The primary source of revenue for private equity firms is usually the fees it charges those who invest in its funds. The structures for these fees can vary, but most often entails a management and performance fee. A common compensation scheme is known as “two-and-twenty” – a yearly management fee of two percent on managed assets and 20 percent of gross profits upon the sale of the company.

Private equity firms consist of partners who have the expertise necessary to help businesses they identify as underperforming and transform them into companies with better operational efficiencies and higher earnings. Their intention is to increase a portfolio company’s valuation to a targeted number that is identified in their exit strategy, which can be a resale, an initial public offering, or other options.

How do private equity firms exit an investment?

According to Mark Hauser, private equity firms will never enter an investment without a predetermined exit strategy in place. They will take into account the potential routes to exit, investment horizon, business strategy, potential buyers or acquirers, and internal rate of return (IRR) amongst other factors. Realizing an investment will usually involve either a total or partial exit. Total exits can occur through leveraged buyouts by another private equity firm, a trade sale, or a share repurchase. Partial exits may be corporate restructuring, private placement, or corporate venturing. Finally, a private equity firm may help the company go public, floating an initial public offering in which 25 to 50 percent of the business is sold.

By Sumeet Manhas

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