Definition and basics of private equity Private equity refers to off-market equity capital that is typically invested in established, financially stable companies. The aim is to achieve value growth through targeted investments and to sell the investment at a profit after a few years. Unlike venture capital, which mainly invests in start-ups and young companies in the early stages of growth, private equity focuses on established companies, often by means of majority shareholdings as part of buy-outs. The funds come primarily from institutional investors such as insurance companies, pension funds and family offices as well as wealthy private individuals. These funds are pooled by specialized private equity companies in corresponding funds that invest strategically in target companies. The average holding period of such an investment is often between five and ten years.

Legal structure and regulation of private equity funds Private equity funds are often structured in the form of limited partnerships (KG), with the private equity company acting as the general partner and the investors as limited partners. In Germany, these funds are subject to the provisions of the German Investment Code (KAGB) if they exceed certain thresholds. According to the KAGB, most private equity funds are so-called alternative investment funds (AIF), which require authorization or registration with the German Federal Financial Supervisory Authority (BaFin). This imposes transparency and reporting obligations that are intended to protect the interests of investors. The legal requirements include detailed information obligations towards investors, strict governance requirements and binding regulations on the valuation and management of the fund’s assets.

Typical contractual arrangements for entry The entry of private equity investors regularly takes place via individually negotiated participation agreements and supplementary shareholder agreements. These agreements contain detailed provisions on important topics such as the structure of voting rights, dividend distributions, the composition of control and supervisory bodies as well as extensive agreements on exit strategies. The exit regulations include, for example, options for the subsequent sale of the investments, in particular through a resale to other financial investors, strategic investors or as part of an initial public offering (IPO). The contracts often also include protective mechanisms for investors, such as veto rights for fundamental company decisions or legal transactions requiring approval above defined thresholds. The contract design is strongly oriented towards the respective company situation and the strategic objectives of the investor and the shareholders.

Instruments in private equity – leveraged buy-out (LBO) A key instrument in private equity is the leveraged buy-out (LBO), in which the purchase of a company is mainly financed by debt capital. This form of financing allows investors to take over larger companies with a comparatively low equity investment. The debt capital required for the takeover is usually provided by banks or other financing partners and then serviced by the cash flows of the acquired company. This structure increases the return opportunities for equity investors, but is also associated with higher risks due to the debt burden. From a legal point of view, the LBO requires close scrutiny with regard to capital maintenance rules (Sections 30, 31 GmbHG and Sections 57 et seq. AktG) in order to avoid undue financial strain on the target company.

Benefits of private equity for companies In addition to additional capital, private equity often provides companies with strategic and operational support from experienced investors. This support can take the form of improved management practices, more efficient business processes and support for strategic growth initiatives. In addition, companies often benefit from the extensive experience and networks of private equity companies, particularly with regard to expansion plans and internationalization projects. This can have a positive effect on the competitiveness and long-term development of the target companies. In addition, private equity enables a reorganization of the shareholder structure, creating clearer decision-making structures and avoiding potential conflicts.

Risks and challenges of private equity In addition to the aforementioned advantages, private equity also harbors a number of challenges and risks. One major risk lies in the increased pressure to generate returns due to the high proportion of debt financing, which can lead to a short-term profit orientation. This could have a negative impact on long-term strategic developments or necessary investments. In addition, potential conflicts of interest could arise between private equity investors and the existing company management, for example with regard to strategic objectives or the direction of company management. Finally, the desired exit after a few years poses a significant challenge, particularly if market conditions are unfavorable and this makes the planned company sale or IPO more difficult.