What are Private Markets?

The world of private markets is quite different from the hustle and bustle of Dalal Street. This place is where the money flows through the lesser-known paths of private companies.

Picture a group of affluent investors, each with their own stash of capital coming together for a common purpose. They form what’s known as a ‘limited partnership’ – a tight-knit group of investors who share a common goal: Scout for, and invest in good businesses. These investors are called ‘limited partners’ or ‘LPs’ who entrust their wealth to a select few individuals, called ‘general partners’ or ‘GPs’.

Now, what makes this fascinating is that these LPs have a whole array of options when it comes to where they invest their money. This brings us to Private Market Funds.

Private market funds are a gigantic bracket divided into 6 categories:

Let’s look at these categories in detail.

What are the Different Types of Private Market Funds?

Private market funds can be categorised depending on their purpose and the asset class they invest in.

Private equity funds, as the name suggests, allow investors the chance to invest in privately held companies at different stages of their lifecycle. This means these companies are not listed on a stock exchange and any transactions that take place are finalised manually.

Any investments in startups are considered private equity investments. These funds play a crucial role in nurturing and growing companies, driving them towards a profitable exit.
Now, private equity funds can also be further sub-categorised depending on their strategy of investment and what stage of the company they’re investing in.

• Buyout Funds

  The objective of buyout funds is to acquire an influential stake in mature companies, aiming to enhance their operations and eventually sell them at a higher valuation. These target companies typically have established cash flows and tangible assets.
  To finance these acquisitions, buyout funds often use leverage, where up to 75% of the purchase price is borrowed, using the acquired company’s assets and anticipated cash flows as collateral. This approach is why they’re also known as ‘leveraged buyouts.’

  Buyout funds usually excel at improving companies through strategies like mergers and cost-cutting.

  Eventually, they sell these improved businesses for a profit through strategic sales or Initial Public Offerings (IPOs).

• Growth Funds

  Growth funds invest in companies that have a high growth potential. These companies are not as early-stage as the kind that venture capital funds invest in, and the investment size is not as large as buyout funds.

  However, there’s a distinction between growth-stage VC and growth buyout. Growth-stage VC deals with companies already backed by VC funding, often prioritizing growth over profitability. In contrast, growth buyout firms acquire companies with strong growth prospects, but they seek a balance between growth and profitability. They typically don’t back companies focused solely on growth at the expense of profit.

• Venture Capital Funds

  While buyout funds stick to established companies, venture capital funds target early-stage and growth-stage companies. In this case, the investment amount is considerably smaller.

  The time horizon for buyout funds and venture capital funds is more or less the same. What sets them (VC funds) apart is the specialisation in entry points of different General Partners (GPs) within the venture capital space. As a startup progresses and raises subsequent rounds of funding—such as seed, Series A, Series B, and so on—different GPs may take on the lead investor role at different stages of the company’s development.

  Take WaterBridge Ventures, for example. They invest in 20 seed-stage startups and help them get started, especially during the seed and pre-Series A round. But as these startups grow, other VC firms like Sequoia or US-based groups might take the lead in later rounds, like Series C or D. It’s like a relay race, with different VCs leading at different stages of the startup’s journey.

  For venture capital funds, exit strategies can include IPOs, strategic mergers, or even secondary sales during subsequent rounds of funding.

  Differences between buyout funds, venture capital funds, and growth funds:

  Aspect	Buyout Funds	Venture Capital Funds	Growth Funds
  Investment Stage	Mature Companies	Early-Stage Startups	Established Companies
  Focus	Acquiring existing companies, often with potential for restructuring and improving operations	High-risk startups with innovative ideas and growth potential	Rapidly growing firms with proven track records and revenue
  Risk Tolerance	Lower risk, lower potential for outsized returns	High risk, higher potential for outsized returns	Moderate risk, moderate potential for returns
  Investment Horizon	Typically 3-7 years	5-10 years or more(over a series of funds)	3-7 years
  Role in Company	Often takes control or significant influence, may replace management	Usually takes minority equity stakes and plays an advisory role	Usually takes minority equity stakes and plays an advisory role
  Source of Returns	Leverage, M&A, Operational improvements, cost-cutting, and cash flow generation	Capital appreciation and exit multiples, increase in valuation	Revenue & Profit Growth
  Typical Investment Size	Large, often in the hundreds of millions to billions of dollars	Smaller, early-stage investments, ranging from thousands to millions	Moderate to large, depending on the stage and needs of the company
  Exit Strategy	Typically exits through sale, merger, or IPO	Aims for IPO, acquisition by larger company, or secondary sale	Usually seeks an eventual exit through IPO or acquisition

Real estate funds invest in various types of real estate properties. They can be further sub-categorised based on their investment strategy and the types of properties they invest in.

• Opportunistic Funds

  These funds go for high-risk, high-reward strategies. Often, this can involve distressed properties, development projects, or even properties in emerging markets. Because of the high-risk nature, however, these funds require active management to create value and generate capital gains.

• Core Funds

  These funds prioritise stable, income-generating properties with a low-risk profile. They are ideal for investors who want to generate stable returns for the long term.
  Core funds invest in assets that are fully leased or have long-term leases in place. This ensures that they can provide a predictable stream of rental income. The focus is on wealth and income preservation in this case.

• Value-Added Funds

  Value-added funds target those properties where there is a potential for value enhancement by renovating and improving the property. Fixer-uppers, for instance, would fall into this category.

Infrastructure funds invest in infrastructure assets such as toll roads, airports, utilities, and renewable energy projects. As you can imagine, these investments involve quite a long time duration.

It’s important to note that these investments are focused on existing infrastructure rather than funding the development phase.

These investments typically span over extended timeframes and are recognized for their lower-risk nature. They offer investors consistent income streams over the long term.

Here’s why it’s important to invest in infrastructure – it has a multiplier effect that spills over to other sectors. This means, investing about 1% of the GDP in infrastructure can increase the GDP by at least twice that amount!

Like private equity funds provide equity financing to companies, private debt funds provide credit or loans. These are non-banking lenders who provide credit to companies in the small and medium-sized segments.

Private debt funds provide various forms of debt such as senior debt, mezzanine debt, and even convertible debt.

Venture debt funding is a form of debt financing tailored for startups and early-stage ventures that have previously secured equity investments from venture capital firms. Specialized venture capital funds offer venture debt, as they possess a deep understanding of startups and their potential for growth.

Fund of funds (FoFs) is a unique category that pools capital from investors and then allocates that capital to multiple underlying private market funds. This means FoFs don’t invest in their own portfolio of companies. Instead, it is a derived investment opportunity and provides convenient access to a range of asset classes. The main objective of a Fund of Funds is diversification. Investors get to access a whole range of different types of funds in one go.

Please keep in mind, however, that FoFs have a separate fee structure, with the investor paying on two levels. On the first level, the FoF will charge a management fee for handling the portfolio. Apart from that, the different funds in the portfolio will have their separate charges.

These funds, each with its unique purpose and strategy, form the backbone of private market investing, The plethora of options available to investors reflects the dynamism and adaptability of private markets. With this foundation in place, we delve deeper into the chapter ahead, understanding the pivotal role of private markets in fostering business growth and transformation.