At a high level, the goal of private equity is to invest in businesses, manage those businesses, and then exit those investments at a profit.
Private equity is the process of investing in businesses, often with the use of debt or structure to enhance returns.
Most people can intuitively understand how the private equity machine works, but it can be difficult to understand exactly what goes into the job until you get to the workplace. The process of investing may seem intuitive, but there are a large number of parts that are esoteric and unexpected.
In this post, we’re going to go over a couple of the most common work processes in private equity and explain the very specific tasks that go into assembling a work deliverable..
Associates will spend a large amount of time in Excel to build financial models, conduct due diligence, and assemble PowerPoint presentations.
Private Equity Operations
Let’s cover the most fundamental operations in the private equity business, what the significance of each function is, and then discuss a few of the main work deliverables in each.
We'll cover the following categories:
Performing Due Diligence
Negotiating Deals / Investing in Businesses
Managing Investments / Portfolio Companies
We're also going to cover Raising Funds, which is the function that involves raising the money required to start a private equity fund.
1. Sourcing Transactions
Sourcing deals and investments is a critical part of private equity, particularly in an environment where capital is relatively cheap.
Lots of money has flown into private equity (and venture capital), so there is a greater emphasis on finding and sourcing deals. If you find a company before it comes to market (i.e., before they actively decide to sell and hire an investment bank), you can potentially acquire a business at a lower multiple.
In private equity, you need to be aware of how an industry operates, who the key players are, and which companies fit your fund’s investing mandate.
Doing expert calls to learn how an industry fits together and who the key players are
Preparing an industry landscaping deck that covers industry trends and includes company profiles
Using a CRM (customer relationship management software) to keep track of potential investment ideas
Reading industry research reports to learn about different companies
Taking meetings with investment bankers and reading their pitch decks for potential ideas
As an Associate, you might support your team by building company profiles in PowerPoint, taking notes while on calls, and attending meetings with investment bankers or management teams. Associates at more growth equity oriented firms may also be expected to cold call management teams to build relationships.
Senior private equity folks spend much of their day on sourcing and looking for investing opportunities. It is common for an MD in private equity to spend most of their week on the road to attend management meetings or industry conventions.
2. Performing Due Diligence on Potential Investments
After you find a potential investment idea, you need to do the work to determine whether if it is a good investment or not. This process is called “due diligence” and it essentially describes all forms of investment analysis that a private equity firm might do.
Private equity investors typically hold a business for 5-8 years, so you need to do a lot of work to make sure that your investment is a good decision. Many funds will hold between maybe 10-20 companies, so every investment holds significant weight in the portfolio. Most private equity funds will have a rigorous investment committee process, whereby you need to present all your diligence to the senior members of the private equity firm.
Building an LBO model in Excel to determine the return profile of an investment
Developing a work plan to determine how different diligence streams will be managed
Studying the company’s unit economics and churn to determine whether the company’s margins will increase over time
Hiring consultants to evaluate the TAM of an industry
Taking files from the data room to substantiate model assumptions
Putting together an investment committee memo for senior members to evaluate data
Diligence is typically the process that Associates will spend most of their energy on. It’s typical for a mid-level professional like a VP or Principal to organize the workstreams and coordinate other professionals (consultants, accountants), whereas the Associate is the one putting together the analysis. The Associate will be responsible for the Excel model, making PowerPoint slides for the investment committee memo, and combing through data room files, as a starter.
Most of the actual decision-making will be made by senior-level private equity people. It often takes several investment committee meetings for a deal to be made.
3. Negotiating Deals / Investing in Businesses
Determining that a company is a good investment is only half the battle (or even less). Concurrent with diligence, private equity firms will have to negotiate with the selling company on matters of price and structure. Most large companies that come to market will be represented by an investment bank, who will devise a sale process that maximizes the price that a company can sell for. Investment banks are exactly like real estate agents that work on behalf of companies to sell them.
Drafting a term sheet, which summarizes a private equity firm’s investment proposal
Evaluating recent deals in the market and valuations to determine what value to bid
Talking to investment banks and lenders to determine how much debt you can raise for a transaction
Speaking with investment bankers to determine what amount to bid
Working with lawyers to draft a Share Purchase Agreement, which defines the terms of the investment
Preparing a Funds Flow model to determine how money will be paid out in a transaction
Most of the real negotiations will be done by the senior-level people of the team. Many investment processes are handled by investment bankers, where private equity firms submit what they are willing to bid on a company. Companies often pick whichever firm is willing to pay the most.
4. Managing Investments / Portfolio Companies
After a company is purchased and the deal closes, the real work begins. Most firms will have a vision for how the company will grow and what to focus on for the investment. Some companies may focus on margin expansion and begin cutting costs, while others may begin focusing on M&A to drive inorganic revenue. Private equity firms will typically get a few board seats and be able to influence the direction of the business.
Attending quarterly board meetings and discussing company strategy
Hiring new management team or replacing current staff
Implementing cost-cutting strategies or investing in new divisions
Helping with the corporate finance or corporate development teams
Helping the company develop a financial model or long-term budget
Eventually conducting a sale process to sell the investment
There is a wide range of approaches when it comes to managing your own portfolio in private equity. Some firms are extremely hands-on and want companies to execute on a specific vision, while other firms may let the management team keep operating as they are.
At the Associate level, you will often help support a lot of the corporate finance of the business. You may be responsible for sanitizing the portfolio company’s financials, performing quarterly valuation, or helping with the company budget. The level of involvement required often depends on the sophistication of the company, with larger businesses often having their own robust finance team.
Eventually, private equity firms will have to engage in some sort of sale process to exit an investment. The private equity firm may hire an investment banker and start a formal process, akin to the acquisition process.
5. Raising Funds and Interacting with Investors
The final fundamental operation in private equity is raising money. Private equity (and much of the buyside) mostly works because it pools together large amounts of capital from other investors. Most of the money in the largest private equity firms is raised from outside sources, so a lot of work is put into managing these relationships. Pension funds and family offices are some of the largest investors into private equity firms.
Building an investor presentation that discusses the private equity fund’s investment mandate and strategy
Pitching investors on the merits of your investment ideas
Preparing quarterly valuation models and reports for investors to read
Holding an annual meeting where investors can visit and gauge fund performance
The main engine at work in private equity is to invest in businesses and then sell those investments at a profit. But there is a great deal of work deliverables that go into each step in order for a deal to get done.