The Financial Mechanics Behind Private Equity

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Reach Alternative Investments
November 7, 2023
min read
The Financial Mechanics Behind Private Equity

What is Private Equity?

At a fundamental level, private equity refers to capital investment made into private companies, not listed on a public exchange. Investors in these funds are typically institutional investors, who attempt to utilise their financial capabilities to gain substantial ownership in promising firms, eyeing potential value creation opportunities over a long-term horizon.

Who Can Invest in Private Equity?

While traditionally accessible to institutional and extremely wealthy investors, private equity investments are now increasingly within the reach of sophisticated investors. These individuals, as defined in the Corporations Act 2001, can now potentially steer their investment portfolio towards private equity through platforms like Reach Alts, with entry points as low as AU $15,000 into a fund.

How Does Private Equity Work?

Understanding the working mechanism of private equity can be simplified into three primary stages: Fundraising, Investing, and Exit.

In the Fundraising phase, private equity firms raise capital from investors to create a fund, held in a structured legal arrangement. The Investing phase involves directing the collected capital into potential private companies. Following an incubation period, wherein the firm matures and hopefully expands, comes the Exit phase. The potential for financial yield materialises as the equity firm exits its investment through a strategic sale or Initial Public Offering (IPO).

How Do Private Equity Firms Add Value?

Private equity firms seek to add value through their investments. These firms utilise their industry expertise and operational knowledge to influence business growth. Strategies for potential value creation may include streamlining operations, fostering innovation, enabling strategic acquisitions, and facilitating market expansion. They offer not just capital but also the guidance required to tackle industry challenges and accelerate growth.

What are the Potential Returns?

Investing in private equity funds, like any investment, carries the potential for returns but also has its risks and unique features. Historically, private equity investments have offered attractive returns, contributing to their appeal among sophisticated investors who are comfortable with the longer investment horizon typically required. However, past performance is not indicative of future performance and investors should be mindful of the unique attributes of private equity, including their illiquidity and capital calls.

Understanding the Risks

Investing in private equity comes with its share of risks. These investments are generally illiquid due to their longer-term nature, meaning your capital could potentially be locked in for an extended period. Additionally, the value and performance of private equity investments largely depend on the performance of the manager in selecting and managing companies within the portfolio. Therefore, it’s vital that potential investors understand the risks and seek appropriate advice before committing to this type of investment.

How Do I Identify a Suitable Private Equity Investment?

Choosing the right private equity investment requires sound understanding and dedicated research. It's recommended that investors analyse fund manager track records, understand the existing portfolio, scrutinise the firm's value-creation strategies, and become comfortable with the potential risks. The Reach Alts platform provides extensive detailed insights on each fund and its unique value proposition, facilitating informed decisions. Learn more about vetting a fund here.

Private equity could potentially offer rewarding returns for the diligent investor who understands its mechanics, patience requirements, and risks. Platforms like Reach Alternative Investments aim to facilitate Australians to explore these opportunities, responsibly navigating the exclusive world of private equity. Remember, careful consideration and appropriate advice are key to any investment decision.

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