Private Equity

Private Equity is a catch all term that is used to describe various investment strategies. Let me begin with a caution “Private Equity is not for the normal investor who invests his hard earned money in small quantities”. Private Equity products are usually available for investment only for High-Net-Worth Individuals or HNIs as they are more commonly called. This is because, these instruments carry extremely high levels of risk when compared to the normal investment options like shares, mutual funds, bonds etc. This article is just an introduction into Private Equity.

What is Private Equity?

Private Equity refers to the equity capital invested in a private company. You may be asking me how is equity held privately?

Lets say I am planning on starting a new business which requires a capital of 10 lacs but I have only 5 lacs at my disposal. I contact two of my friends who are interested in the new business I plan on starting but are not aware of the business nuances. I convince them to invest in the project promising them private equity as returns. i.e., I will create 10000 units each worth 100 rupees and give 2500 each to my two friends and retain 5000 myself (10 lacs is the total investment and I put in 5 lacs myself so I keep 5000 units or 5 lacs worth of equity myself and give 2500 each to my two friends who invested the 2.5 lacs in my project)

Now there are 10000 private shares of my company that are jointly held by me and my friends.

Aim of Private Equity:

The Aim of Private Equity is to monetize later through trade sale or buyout or an IPO.

Ex:

Buy Out: If I sell my business 5 years later when my business is worth 50 lacs, every rupee invested in my project is worth 5 rupees now. So anyone who is buying my business will be paying 50 lacs as a whole and I will share the proceeds with my friends based on what they invested. i.e., I will give 12.5 lacs each to my two friends for the 2.5 lacs they invested in me.

Trade Sale: If my business is doing very well, potential private equity buyers will be willing to buy into my company. So if my company is worth 50 lacs at the end of 5 years and a potential buyer contacts my friend and strikes a deal, he can sell his 2500 shares of private equity he owns in my company to the buyer who will pay him 12.5 lacs which is the worth of those 2500 shares he owns.

IPO: You might already know what an IPO is. So if I plan on releasing an IPO for my company, I have to take care of my private equity holders too. So lets say I give out 10 lakh shares to the public, a ratio will be decided for private equity holders. So for ex: 2500 private equity shares might be worth 25000 normal equity shares and my friend will be allotted 25000 shares when my company gets listed. He will make a profit by selling these 25000 shares in the stock market.

Risks involved in Private Equity:

The main risk involved in private equity is the fact that, my business might go bust or not make profits as suggested in the preceding paragraphs. There is no guarantee that my business will be a success. So, if I screw up on my business strategies and my company goes bankrupt, the 2.5 lacs my friends invested is gone. I din’t guarantee them returns when they invested. I only projected that if the business goes well, they will make solid profits.

But, as in all investments, rewards from private equities usually outweigh the risks involved.

There are many different types of Private Equity investments available. They are covered in the next chapter "Types of Private Equity"

Equity Shares

If you watch any news channel or listen to any of your colleagues talking you would have invariably heard the term "Shares". The term shares used here refers to "Equity Shares". "Equity Shares" are the most common types of shares and are the most widely traded stock market instruments.

"Equity" means ownership. Anyone who holds one share of XYZ company owns a portion of the company.

How are Equity Shares formed?

Any company that satisfies the conditions laid down by SEBI (Securities and Exchange Board of India) can issue equity shares. SEBI is the governing body for all market related instruments in India.

Let us say XYZ company wants to go public. (Going public is the word used in market terminology to refer to the event of a company issuing equity shares for the first time) It would file an application with SEBI. If it is filing a request to raise a capital of say Rs. 1 crore, it would be issuing 10 Lac equity shares of face value 10 each.

The terms Face value and Market value would be used through this article. Let us first understand what they are.

Face Value - The Face Value of the share refers to the intrinsic value of a share. This is the value at which the company issues its shares to the common public.

Market Value - Once a share is issued to the public, it would be bought and sold through recognized exchanges like the NSE or BSE. The price at which a particular share is being bought /sold is termed as Market Value.

Net capital Raised by the company = 1,00,00,000/-
No. of Shares issued through the public offering = 10,00,000 (Out of these 10 lac shares, the company would be holding at least 51% that is 5,10,000 shares with itself. The remaining 4,90,000 shares would be available for the public)

When XYZ files its application, based on the profit making capability, its revenue etc the company and SEBI would decide on the market value at which the share would be available for the public to buy. Say for e.g., the share with the face value of Rs. 10/- could be available at the price of Rs. 50/- for purchase through the public offering.

Net Amount raised by the company through the public offering = 4,90,000 * 50 = Rs. 2,45,00,000/-

Every individual who wants to buy the shares of XYZ limited would be filling in forms and paying the amount corresponding to the number of shares they want to buy. Say you want to buy 100 shares of XYZ you would be paying them Rs. 5000/- to buy those 100 shares.

Once the process of issuing shares is over the shares would be allotted to the people who had placed the purchase request. Based on the credibility of the company, the no. of people who place requests to buy its shares would vary. Sometimes the issue could be oversubscribed and sometimes it could be under subscribed. If the issue of XYZ limited was oversubscribed, then you may not get the exact 100 shares that you wanted. You may get a certain
number of shares based on the number of times the issue was oversubscribed.
Say you get 60 shares, then the remaining Rs. 2000/- would be returned to you.

Whatever we have discussed about till now is termed as the "PRIMARY MARKET". The Market in which fresh share offerings given by companies are bought.

Once the public issue is over, the share would get listed in any of the two or both of the Registered stock exchanges in India. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Once the companies shares are listed in the NSE/ BSE it would be available for the public to buy/sell. Say at the end of the first trading day the share closes at a
price of Rs. 53/- then the total market capitalization of XYZ limited is = 10,00,000 * 53 = 5,30,00,000/- The Market capitalization of the company would keep varying everyday based on its share price movement.

This Trading that happens everyday on the shares of companies that are listed in registered stock exchanges is termed as "SECONDARY MARKET"


What are the benefits of holding a company's share?

1. If you hold shares of a company, you are one of the owners of that company. Every year the company would send you its annual statement, its profit & loss accounts etc. Also if they have made a good profit, they would even declare a Dividend. A Dividend is something like Interest that you receive from a bank for holding a deposit with it. The only difference is
that you may or may not get Dividends. Assuming you hold 100 shares of XYZ limited and they declare a dividend of 50% per equity share it means you would be getting Rs. 5/- per share that you hold in the company. The Dividend % that any company declares is on the Face value of its share. That is you would be getting Rs. 500/- as a dividend.

2. Whenever the company takes any major decisions like change of the CEO or Acquisition of another company etc, you would be communicated. There would be a share holders meeting and only if at least 51% of the company's share holders approve the corporate action would happen.

3. As you know, the shares of the company would be traded in the secondary market everyday. Say after 3 months the Market value of the share of XYZ limited has become Rs. 70 per share, you can sell the shares of XYZ and make Rs. 7000/- which is a profit of Rs. 2000/- in 3 months.

Note: The last point about profit is the main reason why people tend to trade in the Secondary Market. The price of a share can go either ways. It can both increase & decrease. People who buy the shares of a company whose Market price is increasing make profits and similarly people who hold shares of a company whose market price is decreasing make losses.

Hope you were able to get a basic idea of what an equity share is and how it is used in the Stock Markets.