Private Equity and Joint Ventures

Capital providers who provide equity financing are also called private equity investors. Private equity financing is usually provided to privately held companies that are not listed on the stock exchange. This type of financing enables companies to access capital without tying up extensive resources for an IPO.

What do the terms private equity and equity financing mean?

Private equity investors invest capital in companies and in return receive a share of the company. Private equity investors or sponsors are often organized in fund structures that bundle capital from institutional investors such as pension funds, foundations and wealthy private individuals, and look for private investment opportunities in companies that offer higher returns on capital than listed companies. When a private equity investor acquires a stake in a company, they do not just provide liquidity in the form of capital. Rather, they also contribute strategic and operational resources as well as valuable advice to sustainably increase a company's growth potential, the efficiency of its processes and ultimately its profitability. Companies can benefit from equity financing by investors if the latter are involved in strategic decision-making, have management expertise and access to a larger network than the company itself.

For companies considering equity financing, the valuation of the company and the amount of financing required are of crucial importance. Since an equity investor usually receives shares in the company for capital provided, the current market value of the company and the amount of capital required determine how many shares in the company the company founders or early investors must sell to the equity investor.    

In order to obtain a fair company valuation, which ensures that the current owners do not have to give up too many shares but that the investment also remains attractive for investors, it is essential that extensive analysis of the company's market position, potential, and financial and earnings situation is executed. Financial investors generally provide capital to companies with a medium to long-term investment horizon. This has to do with the structuring of capital into fund structures which must also allow for repayment of the invested capital within a defined time horizon. The most common time frame for structuring a fund, from initial investment to repayment, is between five and ten years. For this reason, private equity investors have to plan for a potential exit in their investment decisions as early as the initial investment in a company. Common exit scenarios from companies include a secondary sale to another private equity firm, an initial public offering (IPO) after the company has reached a certain size, or a sale of the company to a strategic investor as part of a trade sale. The exit strategy is an important criterion for financial investors, as it represents the main source of return or profit from the investment.

In the context of equity financing for companies, intensive due diligence is carried out on the financial and earnings position of the target company. Important criteria for investors are high growth potential and a good management team in the company.  

Investors often work closely with management after the investment is made to achieve operational improvements and strategic initiatives to realize the company's growth potential and sustainable value creation.

Relevant terms in the context of private equity investors.

Equity financing is a dynamic and strategic financing option that often goes beyond only capital injection. In addition to using capital alone to realize returns, private equity firms may also provide direct support to increase the value of their portfolio companies with operational resources and know-how.

General Partner (GP) and Limited Partner (LP): A private equity fund is a structure or partnership in which capital is collected to invest in private companies based on a predefined investment strategy. The investment decisions and management of the fund are carried out by the general partner, often the private equity firm. Investors become limited partners in the fund and are therefore generally only liable up to the amount of their capital contribution. The lifespan of a fund is referred to as the fund term, which is usually limited in time (often five to ten years).

Limited partners are typically institutional investors such as pension funds, insurance companies and high net worth individuals.

Committed Capital and Dry Powder: When an investor participates in a private equity fund, the committed capital that the investor would like to invest in the fund is specified in the partnership agreement. This amount is usually not called upon by the private equity fund until an investment in a future portfolio company is pending. The uncalled investment amount is called an unfunded commitment or dry powder.

Dry powder is the uncalled capital that private equity firms have available for future investments as per the partnership agreements with their investors.

LBO (leveraged buyout) and MBO (management buyout): A leveraged buyout (LBO) is usually the takeover of a company by a financial investor, such as a private equity fund. The acquisition price is usually financed with a high proportion of debt capital. This is usually raised by issuing corporate bonds or taking out acquisition financing. The assets and the amount of the available cash flows of the company to be acquired are used to service interest and amortization payments.

A management buyout (MBO) refers to a transaction in which a company's managers or teams of managers purchase the company from the current owner. The total financing required for an MBO usually consists of a combination of debt and equity provided by the buyers, financial investors, external lenders and sometimes also the seller in the form of shareholder loans. The MBO is a type of leveraged buyout (LBO) and is therefore often structured with a significant amount of debt capital compared to other sources of financing.

What is a joint venture?

A joint venture (JV) is a business agreement between two parties, in both a corporate and real estate context, in which resources are combined to implement a joint project. In a cooperation, each party contributes something, be it capital, entrepreneurial experience or a long-standing network or market access, which increases the chances of success of the project. However, the joint venture is a separate entity from the other business interests of the parties involved. The control relationships within a joint venture are defined by the respective resources contributed and the individual ownership structures within the partnership. The ownership structure determines the extent to which each partner company has a say in strategic and business decisions. Profits and losses are also distributed in proportion to ownership, which aligns interests and provides an incentive for all parties to optimally contribute their resources and know-how to the partnership.

Joint venture partnerships between partner companies for the realization of real estate projects

A joint venture partnership in the commercial real estate context is most often associated with larger real estate development projects, where the need for capital and resources for the project is particularly high. By forming a joint venture, two partner companies can share the resource requirements and become more resilient to market fluctuations and other operational risks.

A real estate joint venture typically consists of an operating partner company that implements the project operationally and a capital partner that provides the necessary financial resources. The joint venture partnership agreement is of central importance for a successful cooperation. It defines the roles of the partners, the expected profit sharing, the responsibilities of each partner and the arrangements for resolving disputes during the partnership or on exit.  

Entering into such a partnership for commercial real estate projects can allow the companies involved to maximize their returns while better managing the risks of the project.