How Private Equity Firms Operate?

5 Mins

Private equity isn’t your typical investing, and these firms aren’t your average investors who just buy stocks and hope for a bump in price. They take control of a company and try to fix what’s not working to make the business better before selling it.

So, what are private equity firms and how do they operate? And what role do they play in India’s economic story? Let’s break it down.

What is a Private Equity Firm?

Private equity refers to investments made directly into private companies or public companies that are taken private. PE firms typically look out for companies that are either underperforming, undervalued, or ones that simply have a lot of potential.

This drastically differs from public market investing. Public market investors buy a small chunk of a company with no real control. PE firms, on the other hand, aim for a majority stake in the company. They influence operations, hiring decisions, and restructuring plans.

But before any deals are made, it all starts with raising capital. Private equity firms don’t sit on piles of cash, but they go out and raise it. They meet with big investors like pension funds, insurance companies, and endowments. These are the institutions that have the capital and the patience to wait years for results.

1. Fundraising Phase

The people who provide this money are called Limited Partners, or LPs. They put in most of the capital but don’t get involved in running the fund. The General Partners, or GPs, handle that part. GPs are the ones who scout for deals, manage the portfolio, and handle everything from investment to exit.

The first few years go into investing, the next few into building and improving the companies, and the last few into exiting the investments.

2. Investment Phase

Once the capital is in place, a private equity firm starts looking for companies that fit their investment strategy. They may focus on a particular sector or size range, but the core idea stays the same – find companies where there’s room to grow or improve.

Before investing, they conduct deep due diligence, which involves looking at financials, legal documents, operations, and even customer relationships. If everything checks out, they go ahead with the deal.

Deals for a private equity firm can come in many forms. There are buyouts, where they take control of the company, usually with the help of debt. Then, there’s growth capital, where they invest in fast-growing businesses but don’t take over. Each deal is unique, but the aim is the same – create value and exit with a profit.

3. Value Creation Phase

This is where the real value is built and could mean reducing costs, solving operational issues, or launching new products. The goal isn’t just short-term profits, but to build a stronger, more efficient company that’s ready to grow or be sold.

4. Exit Phase

PE firms don’t plan to hold onto their investments forever. Most investments are made with a 5 to 10-year timeline in mind. After that, it’s time to exit and return money to the LPs.

There are a few ways they exit. One is through an IPO, where the company goes public and shares are sold on the market. Another is a strategic sale, where the company is sold to a bigger player in the industry or where another PE firm takes over the investment. In some cases, the company’s own management buys it back.

Who Regulates Private Equity in India?

In India, private equity is regulated by SEBI (Securities and Exchange Board of India). PE funds fall under the umbrella of Alternative Investment Funds, or AIFs.

SEBI introduced the AIF framework in 2012 to bring structure and transparency to private capital. PE firms usually register as Category II AIFs, which means they’re allowed to invest in unlisted companies but can’t use leverage beyond a point. The regulations also cover things like reporting standards, investor protections, and how funds are managed.

However, because a significant chunk of PE capital flows in from outside India, the Reserve Bank of India (RBI) also plays a key role. RBI oversees foreign investment under FEMA (Foreign Exchange Management Act) guidelines. This means any PE investment or exit involving cross-border capital must comply with the RBI’s rules. Then there’s the Ministry of Corporate Affairs (MCA), which steps in to ensure compliance at the company level. MCA looks at things like corporate governance, filings, and adherence to the Companies Act, 2013.

Conclusion

PE firms are about control and long-term value. Whether it is struggling companies looking for a second chance or a fast-growing one that needs capital and direction, PE firms play a key role in shaping businesses.

The process is slow and often complex. But when it works, it can help create stronger companies, better jobs, and solid returns for investors.

And, in a fast-growing economy like India’s, that kind of impact goes a long way.