Private Equity Research: Definition, Benefits, and Limitations

What is private equity?

Private equity is an alternative investment option that is not publicly listed and consists of funds directly invested in private companies. Alternative investments refer to the financial assets that do not have one single investment category as opposed to conventional investments such as bonds, stocks, or cash.

Private equity firms also participate in the buyouts of public companies, turning them private. The companies that a private equity firm holds ownership or interest over are defined as portfolio companies.

Private equity funds usually have Limited Partners who own the vast majority (99%) of shares and General Partners who own the remaining 1%. Limited Partners (LPs) have limited liability, meaning they are not risking their private assets in case the fund fails. On the other hand, General Partners have full liability and risk losing all of their invested assets and may be personally liable for the accumulated debts of the firm.

Private equity investments essentially come from institutions (such as pension funds and insurance companies) and accredited investors that can devote large amounts of money for prolonged periods of time.

What is private equity research?

Private equity research mostly consists of due diligence, financial modeling, and valuation procedures.

How is it conducted?

A private equity analyst must research a handful of data from various sources to come up with accurate and relevant insights in regards to the researched entity.

• Due diligence is performed to investigate and confirm certain facts before engaging in a transaction with another party. For example, due diligence for stocks is conducted by analyzing the capitalization of the business, monitoring revenue, assessing competition, researching and comparing certain ratios (P/E, PEGs, and P/S), researching the management, checking the balance sheet, examining historical stock prices, among some others. It helps eliminate risks regarding investment decisions. It can be done using public information and allows making data-backed decisions.
• Financial modeling relies on historical data and allows to forecast a company's future success or failure. You can select relevant factors upon which you want to start modeling the company's trends and perform trend analysis to anticipate future outcomes of the business.
• Valuation is a process used to evaluate the worth of a specific asset or a business. Attributing value to a business can be done by taking into account the management, capital structure, potential future outcomes, the market value of the business's products, and more.

Who does it?

Private equity research is usually performed by a private equity analyst who implements financial analysis and determines the value of investing in specific private companies.

Private equity analysts perform research of the companies and businesses that are of interest to investors. However, since private companies do not have a predefined determinant of their stock value, one of the most challenging tasks for the analysts is to accurately determine the value of the company and provide the investors with precise and necessary information.

The outcome

After the research is concluded, private equity firms know their possible new investment or acquisition opportunities and can act on them with a level of certainty. Now they know exactly what they need to know to decide whether a company fits their expectations. All the required data is verified and validated; therefore, it's a good time to approach. Without the research process, a lot of guesswork would be required and the investment decisions would be lacking information, which could result in a failed investment and a massive loss of money.