What are the key themes within private equity for investment strategies?

Despite a challenging market over the past couple of years due to the pandemic, private equity is becoming a rapidly growing and thriving field within finance and the investment sector. As a type of alternative investment, private equity exists in the same category as hedge funds, using non-traditional and risky investment strategies.

As with any type of investment, it’s important to stay on top of the trends and understand key themes when looking into private equity.

What is Private Equity?

Private equity is a source of investment capital involving investment into private companies that are not listed on any kind of public stock exchange. Private equity firms invest in these private companies with the aim of achieving a high return on investment (ROI) within a specified time period. The investment horizon for private equity is generally between four and seven years.

Private equity funds are typically 99% owned by Limited Partners (LP), who have limited liability, and 1% owned by General Partners (GP), who are fully liable and responsible for executing the investment.

Types of Private Equity Strategies

There are many private equity investment strategies, but the three most common types are venture capital, leveraged buyouts and growth equity.

Venture Capital

Venture capital is a private equity investment in a less mature company, often in the early stages of operation. Private equity firms will invest in young companies that they consider to have significant potential. This type of investment is particularly risky, as young start-up businesses generally don’t have any proof of profit; however, ROI can be very high if the business goes on to become successful.

Growth Equity

Growth equity is a private investment in an existing and established company that is in need of extra funding in order to further grow. Growth equity can still be risky; however, the risk is lower than with venture capital as investors are able to research the company’s financial record before deciding to invest.

Leveraged Buyouts

Leveraged buyouts exist at the other end of the spectrum to venture capital; they involve the purchase of a public, mature company by a private equity firm, using borrowed money. In a leveraged buyout, the private equity firm assumes control of a company without spending too much capital. This type of investment also comes with significant risk, but can also allow for significant growth and return.

Key themes within Private Equity

Special Purpose Acquisition Companies (SPACs)

A special purpose acquisition company (SPAC) is a company that has no commercial operations and is created solely for the purpose of acquiring an existing company. Funds are raised through initial public offerings (IPOs), and the SPAC then goes on to acquire one or more businesses. They usually have between 12 and 24 months to make this acquisition, otherwise they go into liquidation and must return funds to initial investors.

SPACs have a long history, but their popularity has skyrocketed in the past few years – particularly within the private equity sphere. Private equity investors back SPACs to raise capital, with a few potential benefits.

Firstly, SPACs provide private investors with access to public markets, which offers a permanent capital solution allowing them to make more private equity investments. SPACs also allow investors to pursue larger acquisition targets, with potentially higher returns.

Following the IPO, the private equity sponsor retains 20% of the SPAC. This means they are in a position of outright ownership, increasing the reward post-acquisition.

Rise of technology

Investment in tech is one of the most prevalent trends within private equity, with tech investments increasing year-on-year recently. Since covid-19 accelerated the digitalisation of many businesses and forced more and more companies to turn to technology to function, the popularity of technology investments has only increased.

In 2022, the majority of private equity funds have some kind of investment in tech. According to a study by Bloomberg, private equity firms spent $800 billion on acquisitions within the technology sector in Q1 of 2021 – and this figure has no doubt increased further since then.

Thanks to the continued demand for software-as-a-service (SaaS), data technology and Fintech, it doesn’t seem likely that private equity investments in tech will slow down any time soon.

Environmental, social and governance (ESG) investing

Environmental, social and governance (ESG) are the three categories that are used by ‘socially conscious investors’ to screen potential investments. Also known as sustainable investing, ESG investments are becoming increasingly popular as concerns such as climate change and social issues take on more global significance.

ESG investing is a popular investing strategy among millennials, who are more likely to pursue investments that reflect their values. As the millennial generation continues to join the pool of investors, ESG concerns are growing. According to the Global Sustainable Investment Alliance, total sustainable investment assets rose from $18.3 trillion to $30.7 trillion between 2014 and 2018, and have only continued to rise since then.

Many companies now include ESG metrics in their financial reports for investors, and the likelihood is that standardised ESG disclosures will soon be a requirement for publicly-traded companies.

Fundraising

Private equity fundraising saw a huge post-pandemic rebound in 2021, with approximately $940 billion raised by the end of the year. This fundraising will likely continue throughout 2022, with major private equity firms projected to raise record levels of funds.

Growth equity in particular saw a big increase in the fundraising market, raising a record high of more than $100 billion, which accounts for almost a quarter of all capital raised.