Hedge funds and Private Equity - PES

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2. Private Equity Funds
Private equity funds are similar to hedge funds in some respects. Both are lightly regulated,
private pools of capital that invest in securities and pay their managers high fees as a share of a
fund’s profits. But there are also substantial differences. Most hedge funds invest in very liquid
assets, and permit investors to enter or leave the fund reasonably easily. Private equity funds
invest much more directly in relation to “the real economy”, i.e. directly in companies. These are
very illiquid assets such as early-stage companies and buy-outs of bigger, established companies.
Consequently, investors are “locked in” for the entire term of the fund. There are, however,
examples of hedge funds investing in private equity companies’ acquisition funds.
When private equity capital is made available to companies, they are either de-listed or not yet
quoted on a stock market.
Private equity funds are a sharply growing factor in financial markets, changing the environment
quite rapidly. Private equity impact is not limited to the companies taken over by the buy-out
funds. The funds exert a profound influence on the economy as whole, including on those companies
which remain under traditional ownership whether privately held or publicly listed. As a
consequence companies are directly competing on financial markets and this underlines a
worrying tendency: the subordination of the real economy to the logic of financial markets.
2.1 Are private equity funds a single reality?
As in all other areas there are huge differences to be found among the investment funds. For
example, venture capital funds typically invest in new and upcoming companies – often within
high-tech industries. They generate real growth and support a good idea – there is a reason for
venture capital often being called “business angels”.
Private equity activity covers the process of collecting capital mainly from sophisticated investors
– but also, in the form of specifically regulated investment funds, from retail investors – and
pooling it in investment vehicles (usually called funds) and investing this capital in companies.
The phases of private equity activity are therefore fundraising and investment (as well as disinvestment,
as the aim of private equity is to realise capital gains by leaving the invested company
once its value has increased).
Classic equity financing is a way for a business to finance itself by acquiring funds from investors
rather than self-financing, where the business builds up equity from profits which it retains.
However, nowadays private equity companies generally only use equity to finance the acquisition
of a business to a small extent, using borrowed capital to a much greater degree.
In contrast to public equity, there is no organised public market for private equity. The market is
very opaque with no disclosure – this is especially the case for the so-called leverage buy-outs
(LBOs) 19 .
19 Cf. Special supplement to the Börsen-Zeitung of 27.4.2005, B 5.
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