How to Start a Private Equity Firm – A Practical Approach

(Last Updated On: August 22, 2018)

Private equity is a private investment made using an unlisted company whereby high risk is involved. However, there is a high possibility of substantial returns. Starting private equity can be an exciting endeavor especially if you like to interact with people,  manage finance portfolios for other people, and doing due diligence. However, the process involves professional exploration of target business sector to get a clear picture of what the private equity firm should comprise of. Without a proper examination of your target business sector, you will not have adequate information in regards to how to start a private equity firm which can lead to massive repercussions. Also you need be aware of the important types of business relationships to guarantee the firm’s success.

Why You Should Start a Private Equity Firm

If you have an investing flair, it is imperative that you build connections. You can do this by starting a private equity firm, but it is both lucrative and challenging endeavour. With such a firm, you will have privately raised funds which you can dedicate to buying a significant amount of stake in various companies. You can do this by inputting to the operations of these entities or by making private investments. The good thing is that these funds come in different tastes whereby there are those which focus on buying established businesses, offering leverage buy-out funds, and investing in start-up companies. As such, you will have the freedom to choose which path your firm takes. Notably, regardless of the path you choose, the steps of starting a successful private equity firm are similar, as outlined below.

Define Your Business Strategy

Before setting up the private equity firm, you should have a clear outline of your business strategy, and also able to differentiate your underlying financial plans from those of your competitors. To establish a business strategy, you will need to do significant research on your defined market or the individual sector. Notably, you may decide to focus on early-stage biotech companies or energy development, which is why research is essential since investors like to know more about the firm’s goals before making any financial commitments. As you deliberate on your preferred investment strategy, you should consider whether you will opt for a geographical focus or you choose to target a particular industry. Also, you should decide whether the firm will entirely deal with the clearing the existing balance sheets or it has an operational approach.

Setup a Business Plan

After defining the business strategy, you can start writing the business plan. A good plan comprises of calculations of cash flow expectations, the timeline of the private equity fund, and an exit strategy from the portfolio investment. Typically, the firm should have an average timeframe of 10 years, but this period can go up or down depending on the manager’s discretion. The plan should also have a marketing strategy and an executive summary for it to be as a sound one. Also, it is good to establish in-house operations which will cover tasks such as staff hiring, technology requirements, furniture, and purchase or renting of office space.

Establish the Investment Vehicle

Once the initial operations are perfectly in order, it is time to establish the legal structure of your firm. In the U.S. the firm can either be a limited liability or limited partnership. In case you are the founder of the fund, you occupy the position of a general partner, with the right of choosing the investments which comprise of the fund. Any other investor is a limited partner with no right of deciding the companies associated with your firm.

Determine the Fee Structure

As the firm manager, you should determine the provisions related to carried interests, management fees, and any other hurdle rates. Normally, the private equity firm manager will receive a yearly management fee of two percent of all the capital committed by investors. The carried interest is 20% more than the expected return amount. Finally, the hurdle rates should be approximately 5 percent, which means that you and other investors will split the returns in a 20 to 80 ratio. This is the most appropriate stage of establishing valuation, risk, and compliance guidelines for your firm.

Raise Capital

The biggest challenge of starting a private equity firm is convincing others to invest in it. To ensure a smooth kick-off, you should make the initial investments which can go to a tune of 2 to 3 percent of the firm’s total investment. This type of commitment will attract other investors since it creates a feeling that you have clear-cut goals to the extent that you are willing to risk your money. With adequate knowledge on how to start a private equity firm, such a commitment should not be an issue since you can easily apply for hard money business loans.

Pros of Starting a Private Equity Firm

  • You can get huge amounts of funding if you have a good business plan since investors are of sizeable returns.
  • There will be clear accountability as both clients and investors will be legally bound to keep their end of the deal.
  • With high financing, you can expect huge returns since more business investments can be made thus attracting more profit.
  • You will have unlimited access to professional advisors and consultants giving you an opportunity of learning new skills.
  • You can make quick decisions as you will not be subjected to the boardroom and internal politics.
  • You can partner with professional shareholders which will highly accelerate the firm’s growth.

Cons of Starting Private Equity Firm

  • Huge startup fee which can be a challenge if you are not financially endowed
  • There is no guarantee of immediate returns especially if you don’t have a clear-cut business plan.
  • You will be under high pressure to deliver to ensure that the firm remains afloat amidst the competition
  • You will be subjected to unpredictable working hours especially in a deal mode as you have to work according to client’s demands.

In conclusion

Starting a private equity firm is a step in the right direction, you get to decide how to run the company without being subjected to boardroom politics. Markedly, when you are in full control of all business decisions, you can easily transform your equity firm to very great heights within no time. All you need to know is how to start a private equity firm, and you are good to go. A good equity firm only requires a decent business strategy, workable business plan, reliable investment vehicle, and a constant source of funding. After satisfying these requirements, it is almost a sure guarantee that your private equity firm will be up and running within a few months and there will be a less financial risk.

how to start a private equity firm
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how to start a private equity firm
This article describes the steps you should take to start a private equity firm.
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