Opportunities in Private Equity by Alper Daglioglu, Al Troianello, Rafique Decastro, Lane Decordova

Opportunities in Private Equity by Alper Daglioglu, Al Troianello, Rafique Decastro, Lane Decordova

The Rise in Private Equity
While private equity has been a source of investment capital for 
decades, it is still considered a boutique investment category, 
representing only 2.5% of the global invested capital market. 1 In 
the early days, the private equity universe was limited to a select 
few venture capital or buyout funds, often located primarily on the 
West Coast or the Northeast. Today, awareness of private equity 
has increased and it has become an investment class that is 
accepted and commonly used by many institutional plans.
The private equity industry is now a large, global and 
developed industry. Its popularity is evident in the growth in PE 
assets under management (AUM), which combines the amount 
invested in private equity and the amount of new funds committed 
to future private equity investments. As illustrated in Exhibit 1, in 
the last 15 years alone, private equity AUM have grown almost 
five times to a record $2.4 trillion as of December 2015. 2
Along with other alternative investments, the private equity 
industry has evolved to include a variety of strategies and as a 
result now appeals to a greater variety of investors. Investors can 
access PE directly through venture capital or buyout funds, or a 
hybrid of both, such as co-investment vehicles or secondary 
vehicles.

Types of Strategies
Some of the most common private equity strategies are outlined 
below:
Buyout. Buyouts, or leveraged buyouts (LBO), are equity 
investments to acquire a controlling interest in a company, 
typically with the use of financial leverage, and are usually 
categorized from small/mid to large/mega capital funds. Investors 
in buyout strategies are interested in more mature companies with 
demonstrated cash flow, making the four primary drivers of 
buyout returns earnings, earnings multiple, debt and time. Most 
importantly, a buyout will invariably involve the use of debt. 
Indeed, today’s financial engineering solutions for buyouts will 
often involve various layers of debt, ranging from straight senior 
debt secured by the company’s assets to pure cash flow lending 
with equity kickers, what’s known as mezzanine financing. Debt 
plays a key role in the generation of buyout returns, operating to 
enhance equity returns. Buyouts can be distinguished from our 
next strategy, venture capital, in a number of ways. Chief among 
these are that buyouts generally focus on established companies 
rather than young businesses and the fact that buyouts use debt as 
well as equity financing (and frequently combinations of the two). 
Another apparent distinction is between “control” and 
“noncontrol” investing. In control investing, the private equity 
manager either owns a majority of the shares in the company or at 
least has control over the majority of the voting rights.

Venture Capital. Venture capital generally means an 
investment in a company prior to an initial public offering, and 
often early in the company's life cycle. Venture investments are
most often found in the application of new technology, new 
marketing concepts and new products with an unproven track 
record or lack of a stable revenue stream. Venture capital is often 
subdivided by the stage of development of the company, ranging 
from early-stage capital used for the launch of start-up companies 
to late-stage and growth capital that is often used to fund 
expansion of an existing business that generates revenue but may 
not yet be profitable or generating cash flow to fund future growth. 
Venture deals, unlike buyout deals for the most part, will enjoy 
successive rounds of financing, and the point in the company’s 
development when each of these rounds occurs will determine 
whether such a round is, for example, “early” or “mid.” The basic 
drivers of a venture fund’s returns are the post-money valuation of 
the rounds and the percentage of the company’s equity which a 
fund holds. By far the most important measure of venture 
performance is the money multiple, i.e., the ratio of the total 
amount of cash generated by an investment to the total amount of 
cash invested. The internal rate of return (IRR) is also important, 
but is largely meaningless in the early to mid-stages of a fund 
given the longer average holding periods of venture funds. We 
discuss private equity performance in a later section.
Growth Capital. Growth capital is an investment in more 
mature companies to provide funding for growth and expansion. 
Growth capital is usually provided to later-stage companies with 
products and services that are already generating significant 
revenue. Companies that seek growth capital will often do so in 
order to finance transformative events in their life cycle.
Distressed and Special Situations. Distressed private equity 
strategies look at companies experiencing financial stress that 
appear to be poised for a possible turnaround. A substrategy for 
distressed investing is “distressed-for-control,” which involves 
investors acquiring debt securities in the hopes of emerging from a 
corporate restructuring in control of the company’s equity. Special 
situation strategies are seeking undercapitalized segments of niche 
markets where private equity capital can exploit opportunities. 
Special situation strategies are also referred to as “turnaround” 
strategies where an investor will provide debt and equity 
investments, often in the form of rescue financing, to companies 
undergoing operational or financial challenges. 
Secondaries and Co-Investments. Secondary fund 
opportunities involve acquiring direct interests of primary funds 
from existing limited partners, usually at a discount to the 
portfolio’s net asset value. Secondary investments provide 
institutional investors, particularly those new to private equity,
with the ability to improve vintage year, sector and geographical

diversification. Secondaries also typically experience a different 
cash-flow profile, diminishing the J-curve effect of investing in 
new private equity funds (Exhibit 4, see page 5). Often 
investments in secondaries are made through a third-party fund 
vehicle, structured similarly to a fund of funds although many 
large institutional investors have purchased private equity fund 
interests through secondary transactions. Co-investment 
opportunities involve investing alongside general partners in 
individual deals. They typically are offered to preferred existing 
limited partners in the fund on a no-fee and no-carry basis. Co-

investments are usually prevalent in a market environment where 
debt financing is difficult to obtain or prohibitively expensive, or 
where general partners are limited by portfolio constraints on 
single investments in their fund, and have to partner to meet equity 
requirements. 
Other Strategies. There are numerous other strategies that can 
be considered private equity. These strategies include real estate, 
infrastructure, energy and royalty-fund investing. Real estate in the 
context of private equity will typically refer to the riskier end of 
the investment spectrum including “value-added” or 
“opportunistic” funds where the investments often more closely 
resemble buyouts than traditional “core” real estate investments. 
Infrastructure investments are in various public projects, typically 
made as part of a privatization initiative. Energy investments are in 
a wide variety of companies engaged in the production and sale of 
energy. Additionally, royalty investments purchase a consistent 
revenue stream deriving from the payment of royalties. 
Private Equity Life Cycle and 
Performance 
Private equity fund managers have four principal roles: raise 
funds from investors, source investment opportunities, select the 
most appropriate investments, and actively manage and realize 
capital gains by monetizing these investments. Remember, these
events can vary depending on the strategy but each stage typically 
occurs in a company’s life cycle (Exhibit 2, see page 4). 
Private equity funds differ in strategy, structure, and objective 
compared to more traditional investment funds. For one, private 
equity funds are unlike any other form of investment in that they 
represent a stream of unpredictable cash flows over the life of the 
fund, both inward and outward. These cash flows are 
unpredictable not only as to their amount, but also as to their 
timing. The life cycle stage of the private equity investment is 
pivotal for deciding which strategy to put into place.
The private equity life cycle begins with investors, or the 
limited partner (LP), making a capital commitment to a fund. Once 
a fund is closed to new commitments, the general partner (GP)

Opportunities in Private Equity by Alper Daglioglu, Al Troianello, Rafique Decastro, Lane Decordova