What is private equity?
Private equity (PE) means investing in the ownership of companies that are not listed on the stock market. A PE fund usually picks a company that is already running and earning, but could do better. The fund often buys a controlling stake, plays an active part in management, and a few years later sells the company to someone else or on the stock market.
The main difference from venture capital is the company’s age and the method. VC puts money into new, loss-making startups, buying small stakes. PE puts money into established companies, often taking control, and borrows a large part of the purchase price. This kind of purchase is called a leveraged buyout.
Say a family factory in Gazipur, run for two generations, makes buttons and zips for garments. The founder wants to retire and the children are not interested in the business. A PE fund buys 70% of the factory, installs new machines, modernises the accounts and brings in new buyers. Five years later the fund sells its stake to a larger company, hoping for more than it paid. The story is imaginary.
Why it matters to an investor
- To understand leverage: when a purchase is made with borrowed money, a small change in the company’s value means a much bigger change in the owner’s gain or loss.
- To understand liquidity and fees: money in a PE fund is often locked up for 10 years or more, and fees are higher than in an ordinary mutual fund.
- To read the news: what it means when a known company is “sold to private equity”, and what may change for staff, customers or shareholders.
- To know what is within reach: PE is usually for institutions and wealthy investors; ordinary people mostly come into contact with it indirectly.
How a PE fund works
Like VC, a PE fund raises money from institutions (such as pension funds and insurers) and wealthy individuals, and professional managers use it to buy a few companies. The US Securities and Exchange Commission (SEC) notes that these investments take a long time to sell, often 10 years or more, and that chances to withdraw money along the way are limited.
The managers take an annual fee and a share of the profits. In Bangladesh, BSEC’s Alternative Investment Rules 2015 capped a PE fund’s annual management fee at 2% of net asset value and the profit share at 20% of net annual profit. These funds raise money only by private placement and are not listed; a 2020 amendment set the minimum investment per investor at Tk 10 lakh. The rules can change.
How value is added
- Running the business better: cutting costs, raising output, bringing in good managers, fixing the accounts and governance.
- Growing it: new markets, new products, or buying several small companies and joining them together.
- Using debt: borrowing part of the purchase price so a big company can be bought with less of your own money. This boosts gains, but if business goes badly the debt can put the company in danger.
- Exiting: finally selling to another company, another PE fund or on the stock market through an IPO. An analysis based on PitchBook data found that around half of PE-owned companies worldwide had been held for more than five years.
Worked example
- Say a fund buys a company for Tk 100 crore: Tk 40 crore of its own money and Tk 60 crore borrowed. To keep it simple, interest and fees are left out.
- Good outcome: five years later the company sells for Tk 130 crore. After repaying the Tk 60 crore loan, the fund keeps Tk 70 crore. The company’s value rose 30%, but the fund’s own money rose 75% (from 40 to 70).
- Bad outcome: the company sells for Tk 80 crore. After repaying the loan, Tk 20 crore is left. The company’s value fell 20%, but the fund’s own money fell 50% (from 40 to 20).
Result: debt magnifies gains and losses alike. In real life, interest and fees take more out of these sums. The numbers are only an example.
Common mistakes
- Seeing private equity as a “guaranteed higher return”. Debt and long lock-ups make the risk large too.
- Comparing returns without counting fees. After the management fee and profit share, investors receive much less.
- Thinking the company’s value is known regularly. Unlike listed shares, there is no daily price; the value relies heavily on the managers’ own estimates.
- Giving money to a “private equity fund” run by an individual or unregistered firm without checking BSEC registration.
Private equity looks for gains by buying, changing and selling established companies; debt magnifies both gains and losses, and the money is locked up for many years.