Private equity fund investment basics.
How does private equity fund operate?
Through the last course, we have an overall understanding of private equity funds. In this course, let's continue to talk about the operating mechanism of private equity funds.
The operation of private equity fund mainly includes four important stages: establishment and raising, investment, management and exit.
1. Establishment and recruitment
The organization form of private equity fund can be divided into three types: partnership type, contract type and company type. Take the more common limited partnership private equity fund as an example, the founding subjects include general partners and limited partners, and determine the relationship of power and responsibility through the partnership agreement. Among them, the general partner (GP) is generally the fund manager, usually contributing 1%, bearing unlimited liability. Each limited partner (LP) adds up to 99% of the capital contribution and bears limited liability according to their respective amount of capital contribution.
In terms of profit-sharing agreement, a non-committed priority rate of return (such as 6%) is generally agreed upon. If the rate exceeds the priority rate, the fund manager takes 20% of the profit, while the investor shares 80% of the profit.
The fund-raising of private equity funds is aimed at qualified institutional and individual investors, in which the net worth of individual investors should not be less than 3 million or the average annual income of individuals in the past three years should not be less than 500000. At the same time, whether it is individual investment or institutional investment, the amount of investment should not be less than 1 million.
Many private equity funds adopt the commitment contribution system, that is, they do not need to pay all the investment at once, and the first deduction only needs to pay a certain proportion of the total committed capital (such as 25%), and the remaining capital is paid in batches according to the payment notice of the fund manager. It is worth noting that investors must plan their own cash flow, and if they fail to pay the capital payable in full within the time specified in the payment notice, they will be deemed to be in breach of contract and will be subject to financial penalties in accordance with the relevant provisions of the partnership agreement.
2. Investment
The investment process of private equity funds to unlisted enterprises mainly includes four steps.
The first step is the preliminary review of the project. The analyst or investment manager reviews the business plan given by the target company and makes a preliminary screening, according to the market space, development stage, industry status, investment amount, management background and other factors of the project, as well as the integration with the fund investment standards, filter out projects that are not interested.
If the project passes the preliminary examination, the investment manager will generally ask to investigate the actual production, operation and operation of the enterprise on the spot. The purpose of on-the-spot investigation is to confirm the written information provided by the enterprise and to form a perceptual understanding of the management and operation of the invested enterprise.
The second step is to sign the letter of intent. A letter of intent is a memorandum defining investment intentions and conditions of cooperation. It mainly includes capital arrangement clauses such as investment amount, investment price and equity allocation, investment protection clauses such as anti-dilution clause, exit clause, preferred stock option arrangement, management control and incentive clause such as board arrangement and voting right, as well as related cost bearing mode and exclusive clause and so on. Among them, enterprise valuation is the core part of investment, which runs through the whole negotiation process from the first examination of the project to the signing of a formal investment agreement.
The third step is due diligence. Due diligence is the on-site investigation and data analysis of all investment-related matters of the target enterprise, and it is the deepening of the preliminary review of the project. It mainly includes legal investigation, financial investigation, business investigation, personnel investigation and so on.
The fourth step is to sign a formal investment agreement. A formal investment agreement is based on a letter of intent, but a formal agreement has formal legal effect. In addition to commercial provisions, there are complex legal provisions, so lawyers are required to participate in negotiations. The investment agreement must reflect the investment strategy to be adopted by the private equity fund, including the entry strategy and the exit strategy, in which the entry strategy usually adopts the way of equity transfer or capital increase.
3. Management
Private equity fund managers are basically served by two types of people, one comes from big international investment banks such as Morgan Stanley, Merrill Lynch and Goldman Sachs Group, who are proficient in finance and have a wide range of contacts on Wall Street; the other comes from entrepreneurs who retire after starting a business, have relatively deep contacts in the business world, and have a relatively broad vision of the industry.
Post-investment management is a very important link in the whole equity investment system, which mainly includes two parts: post-investment supervision and the provision of value-added services. The post-investment department of the private equity fund should not only control the operational risk of the fund, but also control the invested enterprises at any time under the changing market trend, the operating environment is facing uncertainty. Through post-investment management, we can reduce the cost of trial and error as much as possible and avoid detours as far as possible, so as to shorten the time period to complete the initial investment target, or promote the enterprise to move towards a more appropriate goal.
4. Quit
When raising private equity funds, there are strict restrictions on the duration of the funds. generally, the first 3 to 5 years of the establishment of the fund is the investment period, and the next 5 years is the withdrawal period (only exit, no investment), and the whole life cycle is generally ten years. Sometimes there are delays. After investing in an enterprise for two to five years, the fund will find a way to exit.
There are four main exit modes for private equity funds:
The first way is to exit via IPO. This is also the most profitable way to exit, in many cases can get several times or even dozens of times the return.
The second way is to exit through mergers and acquisitions. The target company is acquired as a whole, and the shares of private equity funds are also resold to the next company.
The third way is management buyback. If the target company fails to complete the listing within the agreed time limit, the private equity fund can require management to buy back shares according to the redemption clause, but the return of this exit is low.
The fourth way is company liquidation. The development of the target enterprise is not smooth, and the private equity fund exits through the way of asset liquidation. In many cases, there will be investment losses.
OK, that's all for the operation of private equity funds. In the next section, we will continue to talk about the investment strategies of private equity funds.